Copyright 2002, Pearson Education Canada1 Monopoly Chapter 13.

Copyright 2002, Pearson Education Canada1

Monopoly

Chapter 13


Imperfectly Competitive Industry and Market Power

An imperfectly competitive industry is one in which single firms have some control over the price of their output.

Market power is an imperfectly competitive firm’s ability to raise price without losing all demand for their product.


Pure Monopoly

An industry with a single firm: that produces a product for which there are no

close substitutes, and in which significant barriers to entry prevent

other firms from entering the industry to compete for profits.


Barriers to Entry

A barrier to entry is something that prevents new firms from entering and competing in imperfectly competitive industries. Examples include: government franchises are monopolies by virtue of

government directive. patents are a barrier to entry that grant exclusive use

of the patented product or process to the inventor. economies of scale and other cost advantages ownership of a scarce factor of production (DeBeers)


Firms with market power must decide:

How much output to produce How to produce output How much to demand in each input

market What price to charge for output


Price and Output Decisions in Pure Monopoly Markets

Basic assumptions: Entry to the market is strictly blocked. Firms act to maximize profits. The monopolist cannot price discriminate (all

buyers pay the same price)


Demand in Monopoly Markets

With only one firm in the monopoly market, there is no distinction between the firm and the industry. In a monopoly, the firm is the industry and therefore faces the industry demand curve. The total quantity supplied is what the firm decides to produce.

For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output in order to sell it.


Marginal Revenue Facing a Monopolist (Table 13.1)

At every level except one unit, the monopolist’s marginal revenue is below price. This is because to sell more output and raise total revenue the firm lowers the price for all units sold.


Marginal Revenue and Total Revenue (Figure 13.4)

A monopoly’s marginal revenue curve bisects the quantity axis between the origin and the point where the demand curve hits the axis.

A monopoly’s MR curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.


Price and Output Choice for a Profit-Maximizing Monopolist (Figure 13.5)

The profit-maximizing level of output for a monopolist is the one where MR = MC.

Beyond that point, where marginal cost exceeds marginal revenue, the firm would reduce its profits.

Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns economic profits.


Price and Output Choice for a Monopolist Suffering Losses in the Short Run (Figure 13.6)

It is possible for a profit-maximizing monopolist to suffer losses in the short run.

At 10,000 units variable costs are covered but the business will fail in the long run.


Comparison of Monopoly and Perfectly Competitive Outcomes (Figure 13.8)

Quantity produced by the monopoly will be less than the competitive level of output, and the monopoly price will be higher.

Remember that the MC curve is also the supply curve for the entire industry.


Welfare Loss of Monopoly (Figure 13.9)

The triangle ABC roughly measures the net social gain from moving to 4000 units under perfect competition or the social loss that results when monopoly decreases output to 2000 units.


Collusion

Collusion is the act of working with other producers in an effort to limit competition and increase joint profits.

Successful collusion leads to the same market outcome as the monopoly.


Rent-Seeking Behaviour

Rent-seeking behaviour refers to actions taken by households or firms to preserve extranormal profits.

This includes actions such as government lobbying and has two important implications: it comsumes resources without producing

social value can lead to government failure


Government Failure and Public Choice Theory

Government failure occurs when the government becomes the tool of the rent seeker and the allocation of resources is made even less efficiently by the intervention of government.

Public choice theory is an economic theory that proceeds on the assumption that the public officials who set economic policies and regulate the players, act in their own self-interest, just as firms do.


Natural Monopoly

A natural monopoly occurs in an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is the most efficient.

Economies of scale must be realized at a scale that is close to total demand in the market.


Natural Monopoly (Figure 13.10)

Average cost declines until a single firm is producing nearly the entire amount demanded in the market.

With one firm producing 500,000 units the average cost is $1 and when five firms each produce 100,000 units the average cost is $5.


Regulating a Natural Monopoly

Acknowledging a single firm as a natural monopoly and allowing it to operate under the protection of a government franchise essentially requires that the government becomes involved in regulating the firm.


Regulating a Natural Monopoly (cont.)

Governments have three possibilities in regulating a natural monopoly: set the price equal to marginal cost in which

case the monopolist will always suffer a loss set a price ceiling which is a maximum price

per unit above which the producer of a good or service cannot legally charge

use average-cost pricing where the price is set to cover the average cost per unit including a fair return


The Problem of Regulating a Monopoly (Figure 13.11)

An unregulated monopolist produces where MC = MR, at 400,000 units.

If prices were set at MC the firm would always suffer a loss.

A compromise would be to set prices at $0.75 which covers costs and allows a normal profit rate.


Market Power in Input Markets: Monopsony

Monopsony is a market in which there is only one buyer for a good or service.

An example is the market for labour in a one company town.

Marginal factor cost is the additional cost of using one more unit of a given factor of production.


Monopsony vs. Perfect Competition in a Labour Market (Figure 13.12)

For a monopsonist the marginal cost of hiring one more worker is higher than the wage rate, since the firm increases all wages to attract the new worker.

The monopsonist only hires up to the point where MRPL = MFC.

Wages are held below MRPL and less labour is hired than under perfect competition.


Review Terms & Concepts

average-cost pricing barrier to entry collusion government failure government franchise imperfectly

competitive industry marginal factor cost

(MFC)

market power monopsony natural monopoly patent price ceiling public choice theory pure monopoly rent-seeking behavior

Copyright 2002, Pearson Education Canada1 Monopoly Chapter 13.

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