Monopoly Structure: Monopoly

Monopoly

Chapter 7Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.McGraw-Hill/Irwin

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Monopoly Structure: Monopoly

• Market power is the ability to alter the price of a good or service.

• A monopoly is one firm that produces the entire market supply of a particular good or service.

• Since there is only one firm in a monopoly industry, the firm is the industry.

LO-1

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Monopoly = Industry

• The firm’s demand curve is identical to the market demand curve for the product.– Market demand is the total quantity of a

good or service people are willing and able to buy at alternative prices in a given time period.

LO-1

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Price versus Marginal Revenue

• Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in quantity sold.

• Price equals marginal revenue only for perfectly competitive firms.

• Marginal revenue is always less than price for a monopolist.

LO-1

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Price versus Marginal Revenue

• A monopolist can sell additional output only if it reduces prices.

• The MR curve lies below the demand curve at every point but the first.

LO-2

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Figure 7.1

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Profit Maximization

• The monopolist uses the profit-maximization rule to determine its rate of output.

• According to the rule, a monopolist maximizes profit at the rate of output where MR = MC.

LO-3

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• The profit maximization rule applies to all firms:– A perfectly competitive firm produces the

quantity where MC = MR (= p)– A monopolist produces the quantity

where MC = MR (< p)

Profit Maximization

LO-3

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Figure 7.2

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The Monopoly Price

• The intersection of the marginal revenue and marginal cost curves establishes the profit-maximizing rate of output.

• The demand curve tells us the highest price consumers are willing to pay for that specific quantity of output.

• Only one price is compatible with the profit-maximizing rate of output. LO-3

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Monopoly Profits

• Total profit equals profit per unit times the number of units produced.

• Profit per unit = price minus average total cost

Profit per unit = p – ATC

• Total profit = profit per unit times quantity

Total profit = (p – ATC) x q LO-3

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Monopoly versus Competitive Outcomes

• A monopolist produces less and charges a higher price than would a competitive industry.

LO-4

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Figure 7.3

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Barriers to Entry

• Obstacles that make it difficult or impossible for would-be producers to enter a particular market.

• Examples include patents, legal harassment, exclusive licensing, bundled products, and government franchises.

LO-4

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Competition versus Monopoly

• In competition, as well as in monopoly, high prices and profits signal consumers’ demand for more output.

• In competition, the high profits attract new suppliers.

• In monopoly, barriers to entry are erected to exclude potential competition.

LO-4

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• In competition, production and supplies expand, and prices slide down the market demand curve.

• In monopoly, production and supplies are constrained, and prices don’t move down the market demand curve.

Competition versus Monopoly

LO-4

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• In competition, a new equilibrium is established, and average costs of production approach their minimum.

• In monopoly, no new equilibrium is established, and average costs are not necessarily at or near a minimum.

Competition versus Monopoly

LO-4

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• In competition, economic profits approach zero, and price equals marginal cost throughout the process.

• In monopoly, economic profits are at a maximum, and price exceeds marginal cost at all times.

Competition versus Monopoly

LO-4

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• In competition, the profit squeeze pressures firms to reduce costs or improve product quality.

• In monopoly, there is no profit squeeze to pressure the firm to reduce costs or improve product quality.

Competition versus Monopoly

LO-4

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Competition versus Monopoly

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Near Monopolies

• In duopoly two firms together produce the industry output.

• In oligopoly several firms dominate the market.

• In monopolistic competition many firms each have a monopoly on its own brand image but must still contend with competing brands.

LO-4

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Redeeming Qualities of Monopolies?

Monopolies could also benefit society. We must consider:

• Research and Development

• Entrepreneurial Incentives

• Economies of Scale

• Natural Monopolies

• Contestable Markets

• Structure versus behavior LO-5

End of Chapter 7