Monopoly
Monopoly
Intro video• https://www.youtube.com/watch?v=aboVjX-wbv4
Features of Monopoly
• Single seller•No close substitute•Price maker – since the monopolist
controls the total output in the market, they determine the price
Features of Monopoly
• Entry is blocked•Nonprice competition•Relatively rare–Government owned utilities–“Near monopolies” (high market
share)
Barriers to Entry
•Economies of scale–Monopolists are usually large firms•New entrants can’t compete
•Legal Barriers to Entry–Patents–Licenses
More Barriers
•Ownership or Control of Essential Resources•Pricing and Other Strategic Barriers–Cutting prices to deter new entrants
Building the Model of a Monopoly• Assumptions:–Patent’s, economies of scale, or resource
ownership secure a firm’s monopoly–No unit of government regulates the firm–The firm is a single price monopolist• Charges all consumers the same price
Monopoly Demand
• Perfect competition seller faces perfectly elastic demand at the price determined by market supply and demand–MR is constant and equal to price• Since the monopolist IS the market its
demand curve is the market demand curve–Downward sloping
Marginal Revenue is Less than Price• Since demand is downward sloping sales can only
increase with a drop in price– So MR <AR except for the first unit– The lower price of the extra unit of output also applies
to all prior units of outputs – Each additional unit of output sold increases TR by an
amount equal to its own price less the sum of the price cuts that apply to all prior units of output
Monopoly Demand Data
Monopoly Demand Graph
MR and TR
Pricing Decisions
• By determining output, the monopolist also determines price• Since demand is downward sloping, can
apply the TR test to determine profit maximizing price and output• Price set at or near point where Ed = 1
Output and Price Determination
MR=MC Rule
• If producing is preferable to shutting down, a monopolist will produce up to the output at which marginal revenue equals marginal cost• Output equals 5 units in textbook example–If cannot get MR=MC, choose last level
of output where MR>MC
Monopoly Graph
Helpful Graphing Hints
Monopoly Supply Curve• The pure monopolist has no supply curve• The monopolist does not equate MC to price– Different demand conditions can result in different prices for the
same output
Pricing Misconceptions• Monopolists don’t charge the highest price– Apply the TR test– Seek to maximize total profit, not price
• Total, Not unit, Profit– Maximizing distance between ATC and price does not maximize
profit
Monopoly Losses• Likelihood of economic
profit is higher for a monopolist than for a pure competitor–Profits are not
guaranteed• Change in tastes, costs
•Must maintain at least a normal profit in the long run or it will go out of business
Economic Effects of Monopoly• Under pure competition – long run efficiency is
P = MC = minimum ATC
Efficiency Loss and Monopoly• P exceeds MC• P exceeds lowest ATC• Producer surplus + Consumer surplus are not maximized• Income Transfer: monopoly transfers income from consumers
to stockholders of the monopoly since they can charge a higher price than would occur under perfect competition
Cost Complications• Costs may not be the same for purely competitive and
monopolist producers– Economies of scale– X-inefficiency– The need for monopoly-preserving expenditures– Very long run perspective
• Allows for technological advance
Economies of Scale• Market demand may not be sufficient to support a large
number of competing firms each producing at MES– Natural monopoly has lowest ATC
• Simultaneous consumption – a product’s ability to satisfy a large number of consumers at the same time (Dell vs. Microsoft example)
• Network effects – the value of a product to each user, including existing users, increases as the total number of users increases
Other Cost Issues• X Inefficiency occurs when a firm produces output, whatever
the level, at a higher cost than is necessary to produce– Usually “non economic” reason
• Rent seeking expenditures are any activities designed to transfer income or wealth to a particular firm or resource supplier at someone else’s or society’s expense
• Technological advance – monopolists tend not to be technologically progressive (unless it is a barrier to entry
Assessment and Policy Options• What should the government do about a monopoly?– If abusive, file charges– If a natural monopoly, allow it to continue– If it is unsustainable, ignore it or hasten its demise
Price Discrimination• Charging each customer in a single market the maximum price
he/she is willing to pay– Eliminate all consumer surplus
• Charge each customer one price for the first set of units purchased and a lower price for subsequent units purchased
• Charging some customers one price and other customers another price
Conditions• Monopoly power• Market segregation• No resale
• Examples– Movie theaters– Airlines– Discount coupons
Price Discrimination Graphs
Regulated Monopoly• Natural monopolies• Socially optimal price
® allocative efficiency at P=MC=D• Fair return price (f)
D=ATC• Dilemma of
regulation