BUSN 502
ECON 201CHAPTER 15 MONOPOLY
A monopoly is a firm that is the sole seller of a product
without close substitutes. A monopoly firm has market power, the
ability to influence the market price of the product it sells. A
competitive firm has no market power. Sources of Monopoly Power
The main cause of monopolies is barriers to entry other firms
cannot enter the market.
Three sources of barriers to entry:1.A single firm owns a key
resource.
E.g., DeBeers owns most of the worlds diamond mines2.The
government gives a single firm the exclusive right to produce the
good.
E.g., patents, copyright laws3.Natural Monopoly: A single firm
can produce the entire market Q at lower cost than could several
firms (economies of scale over the relevant range of output).E.g.,
distribution of water or electricityMonopoly versus CompetitionIn a
competitive market, the market demand curve slopes downward. But
the demand curve for any individual firms product is horizontal at
the market price. The firm can increase Q without lowering P, so MR
= P for the competitive firm. A monopolist is the only seller, so
it faces the market demand curve. To sell a larger Q, the firm must
reduce P (thus, MR P). Note that the monopolist can choose a point
along the market demand curve (combination of price and quantity)
but cannot choose a point off (above) the market demand curve.
Monopolysts RevenueFor a monopolist MR MC increase
production
If MC > MR produce less
To maximize profit the monopolist produces quantity where MR=MC
(intersection of the marginal-revenue curve and the marginal-cost
curve)
Once the monopolist identifies the quantity where MR=MC, he sets
the highest price consumers are willing to pay for that quantity.
The monopolist finds this price from the D curve. A monopolys
Profit = TR TC = (P ATC) Q
Monopolized versus Competitive Markets The Case of Generic
DrugsNote the difference between perfect competition and
monopoly:
In perfect competition: P=MR=MC (Price equals Marginal Cost)A
competitive firm takes P as given and has a supply curve that shows
how its Q depends on P.In monopoly: P>MR=MC (Price exceeds
Marginal Cost)A monopoly firm is a price-maker, not a price-taker.
Q does not depend on P; rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.
Patents on new drugs give a temporary monopoly to the seller.
When the patent expires, the market becomes competitive, generic
drugs appear.New drug, patent laws monopoly
Produce Q where MR=MC
P>MC
Generic drugs competitive market
Produce Q where MR=MC
And P=MC
The price of the competitively produced generic drug is below
the price that the monopolist was able to charge due to the
patent.
The Welfare Cost of Monopolies
A monopolist produces a quantity such that MC = MR. This
quantity is less than the socially efficient quantity of output and
corresponds to a price P>MC.Monopoly pricing prevents some
mutual beneficial trades from taking place. There are in fact some
consumers that value the good at more than the monopolists marginal
cost but less than the monopolists price.
The deadweight loss is the triangle between the demand curve and
the MC curve.
Its not the profit earned by the monopolist the problem in terms
of social welfare, but rather the inefficiently low quantity of
output.
Price DiscriminationIn competitive markets many firms sell the
same good; therefore if one firm charges any consumer or group of
consumers a higher price, it would not be able to sell the good.
However, if a firm is a monopolist, it can try to sell the good to
different customers at different prices.
The characteristic used in price discrimination is willingness
to pay: a firm can increase profit by charging a higher price to
buyers with higher willingness to pay.When the monopolist charges
the same price to all buyers he obtains profits, however there is
also a consumer surplus and a deadweight loss. The consumer surplus
is due to the fact that some consumers would have been willing to
pay a higher price that the price set by the monopolist. The
deadweight loss is instead due to the fact that some consumers were
willing to pay a price smaller than the price set by the
monopolist, but still greater than the marginal cost for the
monopolist.
If the monopolist can perfectly price discriminate, he will
charge each customer exactly the price that the customer is willing
to pay. Therefore the entire surplus goes to the monopolist and
there is no consumer surplus and no deadweight loss.
In the real world, perfect price discrimination is not possible
because firms dont know every buyers willingness to pay. Therefore
firms divide customers into groups based on some observable trait
that is likely related to their willingness to pay, such as age.
Examples of Price Discrimination
Movie tickets: discounts for students, seniors and matinees.
Airline Prices: discounts for non-business travelers (Saturday
stays over)
Discount Coupons: people who have time to clip and organize
coupons are more likely to have lower income and lower willingness
to pay than others. Need-based financial aid: low income families
have lower willingness to pay for their childrens college
education. Schools price-discriminate by offering need-based aid to
low income families. Quantity discounts: a buyers willingness to
pay often declines with additional units, so firms charge less per
unit for large quantities than small ones. Public Policies toward
Monopolies
Monopolies, in contrast to perfectly competitive markets, fail
to allocate resources efficiently. Moreover, the monopoly related
losses may be greater than just the deadweight losses as potential
monopolies may spend resources on lobbying/lawyers and politicians
and this implies that resources are not being spent on productive
activities but being spent on increasing the probability of getting
a monopoly position. This kind of expenditure is sometimes referred
to as rent-seeking expenditure.
The basic objective of public policy in this context is to
increase and encourage competition.
a) Anti-trust Laws: The government can intervene directly and
break up monopolies, prevent collusive behavior and prevent
mergers. Mergers result in reduced competition and this can
potentially increase prices. However mergers may also result in
increased cost efficiencies which result in lower prices. If the
first negative effect is estimated to be stronger, then the
government will not approve the merger. b) Price Regulation: The
government can try and directly regulate the prices of natural
monopolies such as Electricity Companies, Water Companies, Postal
Systems etc. The ideal situation from the efficiency perspective is
to enforce marginal cost pricing. Because these are situations of
natural monopoly, the long run average total cost curve is downward
sloping and the MC is below the Average cost. So if the price is
restricted to be equal to MC then the price will be below the
average cost and the firm will face losses. The firm then will exit
the industry and there would be no provider for the service.
One way to solve the problem is to subsidize the natural
monopolist. An alternative policy may be to enforce average cost
pricing. In this case there will still be deadweight losses and the
quantity produced will be below the socially efficient level.
However in both policies the firm does not make profits and has no
incentive to reduce costs.
c) Public Ownership: The government can take over the ownership
of the monopoly and make it a public enterprise (U.S. Postal
Service). Public ownership is usually less efficient since there is
no incentive to minimize costs
d) Doing Nothing: The government can choose to do nothing and
let the market forces dictate the outcome.ConclusionIn the real
world, pure monopoly is rare. Yet, many firms have market power,
due to selling a unique variety of a product or having a large
market share and few significant competitors.
In many such cases, most of the results that we have studied
apply, including markup of price over marginal cost and deadweight
loss.
Competitive versus Monopoly Markets in Synthesis
Note however that although monopoly results in deadweight losses
for the economy, the potential for positive economic profits
creates an incentive for firms to invest and R&D and improve
the quality of existing products or come up with new products.
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