Pure Monopoly 10 Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

Pure Monopoly

10

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Four Market Models

LO1

Characteristics of the Four Basic Market Models

CharacteristicPure

CompetitionMonopolistic Competition Oligopoly Monopoly

Number of firms A very large number

Many Few One

Type of product Standardized Differentiated Standardized or differentiated

Unique; no close subs.

Control over price

None Some, but within rather narrow limits

Limited by mutual inter-dependence; considerable with collusion

Considerable

Conditions of entry

Very easy, no obstacles

Relatively easy Significant obstacles

Blocked

Nonprice competition

None Considerable emphasis on advertising, brand names, trademarks

Typically a great deal, particularly with product differentiation

Mostly public relation advertising

Examples Agriculture Retail trade, dresses, shoes

Steel, auto, farm implements

Local utilities

10-2

An Introduction to Pure Monopoly

• Single seller – a sole producer

• No close substitutes – unique product

• Price maker – control over price

• Blocked entry – strong barriers to entry block potential competition

• Non-price competition – mostly PR or advertising the product

LO1

Public utility companies• Natural Gas• Electric• Water

Near monopolies• Intel• Wham-O

Professional sports teams

10-3

Barriers to Entry

• Barrier to entry: a factor that keeps firms from entering an industry

• Economies of scale

• Legal barriers: patents and licenses

• Ownership of essential resources

• Pricing

LO1 10-4

Monopoly Demand

• The pure monopolist is the industry

• Demand curve is the market demand curve

• Downsloping demand curve

• Marginal revenue is less than price

LO1 10-5

Monopoly Demand

• Marginal revenue < price

• Monopolist is a price maker

• Monopolist sets prices in elastic region of demand curve

LO2 10-6

Output and Price Determination

LO2

Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing Price, and Economic Profits (if Any) in Pure Monopoly

Step 1 Determine the profit-maximizing output by finding where MR=MC.

Step 2

Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist’s demand curve.

Step 3Determine the pure monopolist’s economic profit by using one of two methods:

Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any).

Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any).

10-7

$200

175

150

125

25

100

75

50Pri

ce,

Co

sts,

an

d R

even

ue

1 2 3 4 5 6 7 8 9 10Quantity

Output and Price Determination

LO2

0

D

MR

ATC

MC

MR=MCA=$94

EconomicProfit

Pm=$122

10-8

Misconceptions of Monopoly Pricing

• Not highest price

• Total profit

• Possibility of losses

LO2 10-9

Misconceptions of Monopoly Pricing

LO2

0

D

MR

ATC

MC

MR=MC

Loss

AVCPm

Qm

V

A

10-10

Economic Effects of Monopoly

LO3

(a)Purely Competitive Market

(b)Pure Monopoly

D D

S=MC MC

P=MC=Minimum

ATC

MR

Pc

Qc

Pc

Pm

QcQm

Pure competition is efficientMonopoly is inefficient

a

b

cd

10-11

Economic Effects of Monopoly

• Income transfer

• Cost complications

• Economies of scale

• X-Inefficiency

• Rent seeking expenditures

• Technological advance

LO3 10-12

X-Inefficiency

LO3

ATC2

ATC1

ATCx

Q1 Q2

AverageTotal Cost

X

X'ATCx'

10-13

Price Discrimination• Price discrimination

• Charging different buyers different prices

• Price differences are not based on cost differences

• Examples: business travel, electric utilities, movie theaters, golf courses, railroad companies, coupons, international trade

LO4

Price Discrimination

10-14

• Conditions for success:

• Monopoly power

• Market segregation

• No resale

Price Discrimination

LO4 10-15

Regulated Monopoly

• Natural monopolies

• Socially optimal price

• Set price = marginal cost

• Fair return price

• Set price = ATC

LO5 10-16

Regulated Monopoly

LO5

MonopolyPrice

Fair-ReturnPrice

SociallyOptimal

Price

Pr

D

r

f

b

aPf

Pm

Qm Qf Qr

MR

MC

ATC

10-17