1. Monopoly Outline: Outline: Characteristics of a monopoly Characteristics of a monopoly Why monopolies arise? Why monopolies arise? Production and pricing decision of monopolies Production and pricing decision of monopolies Monopoly and societal well- being Monopoly and societal well- being Government policy and monopolies Government policy and monopolies Price discrimination Price discrimination

2. What is a monopoly? Monopoly is a firm that is the sole seller of a product without close substitutes Monopoly is a firm that is the sole seller of a product without close substitutes Monopoly has market power and this alters relationship between a monopoly firm’s price and its costs. Monopoly has market power and this alters relationship between a monopoly firm’s price and its costs. A monopoly is a price maker A monopoly is a price maker Characteristics of a monopoly: Characteristics of a monopoly: Product has no close substitutes Product has no close substitutes There are barriers to entry There are barriers to entry

3. Barriers to entry Barriers to entry arise from three sources Barriers to entry arise from three sources Monopoly over key resources Monopoly over key resources Government gives a firm exclusive right to produce Government gives a firm exclusive right to produce Natural monopoly due to costs of production Natural monopoly due to costs of production Natural monopoly arises because a single firm can supply a good or service to an entire market at a smaller cost than could two firms (when a firm’s ATC continually declines) Natural monopoly arises because a single firm can supply a good or service to an entire market at a smaller cost than could two firms (when a firm’s ATC continually declines)

4. Production and Pricing Decisions Production and Pricing Decisions Monopoly versus Competition: Monopoly versus Competition: Monopoly has market power and perfect competition has no market power Monopoly has market power and perfect competition has no market power Monopoly is a price maker and competitive firm is a price taker Monopoly is a price maker and competitive firm is a price taker Demand curve faced by the competitive firm is perfectly elastic Demand curve faced by the competitive firm is perfectly elastic Demand curve faced by the monopoly is downward sloping Demand curve faced by the monopoly is downward sloping Market demand curve is a constraint on the monopolist’s profit Market demand curve is a constraint on the monopolist’s profit

5. Production and Pricing Decisions: Monopoly’s Revenue QPTRARMR 0110- 110101010 291898 382486 472874 563062 653050 74284-2 83243-4

6. Monopoly's Revenue Monopoly's Revenue TR=PQ TR=PQ AR=P AR=P MR<P (demand curve is down-ward sloping) MR<P (demand curve is down-ward sloping) There are two effects when a monopoly increases the amount it sells There are two effects when a monopoly increases the amount it sells Output effect: Q is higher Output effect: Q is higher Price effect: P is lower Price effect: P is lower MR=0, positive, negative (depending on the price effect on TR) MR=0, positive, negative (depending on the price effect on TR)

7. Monopoly's Profit Maximization Monopoly's Profit Maximization A monopoly maximizes profit by producing output at the point where MR=MC A monopoly maximizes profit by producing output at the point where MR=MC The price for the profit maximizing output is determined using the demand curve The price for the profit maximizing output is determined using the demand curve For a monopoly firm: For a monopoly firm: P>MR=MC P>MR=MC For a competitive firm: For a competitive firm: P=MR=MC P=MR=MC

8. Monopoly's Supply Curve Since a monopoly is a price maker, the monopolist’s decision to supply a particular quantity is linked to its demand curve Since a monopoly is a price maker, the monopolist’s decision to supply a particular quantity is linked to its demand curve The demand curve determines MR, which in turn determines the profit maximizing quantity to be sold The demand curve determines MR, which in turn determines the profit maximizing quantity to be sold

9. Welfare Cost of Monopoly P>MC and therefore this affects the well- being of the society by imposing a social cost on them P>MC and therefore this affects the well- being of the society by imposing a social cost on them Socially efficient quantity maximizing total surplus occurs at the intersection of the demand and MC curves Socially efficient quantity maximizing total surplus occurs at the intersection of the demand and MC curves Monopoly’s chosen level of output occurs at the intersection of the MC and MR curves Monopoly’s chosen level of output occurs at the intersection of the MC and MR curves

10. Welfare Cost of Monopoly Monopolist produces less than the socially efficient quantity of output thus minimizing total surplus Monopolist produces less than the socially efficient quantity of output thus minimizing total surplus P>MC implies that some potential consumers do not buy the good due to the deadweight loss imposed by the monopoly price (similar to a tax) P>MC implies that some potential consumers do not buy the good due to the deadweight loss imposed by the monopoly price (similar to a tax) The welfare cost= cost of rent seeking activities+ deadweight loss The welfare cost= cost of rent seeking activities+ deadweight loss

11. Public Policy Toward Monopolies Policy makers respond to the problem of monopoly in 4 ways: Policy makers respond to the problem of monopoly in 4 ways: Competition law : problem of synergies Competition law : problem of synergies Regulation: problems with MC and ATC pricing Regulation: problems with MC and ATC pricing Public ownership: problem with bureaucratic methods Public ownership: problem with bureaucratic methods Leaving it to market forces Leaving it to market forces

12. Price Discrimination The practice of selling the same good at different prices to different consumers is known as price discrimination The practice of selling the same good at different prices to different consumers is known as price discrimination Firms must have market power in order to price discriminate Firms must have market power in order to price discriminate Price discrimination is a rational strategy for a profit-maximizing monopolist Price discrimination is a rational strategy for a profit-maximizing monopolist Price discrimination requires ability to distinguish consumers according to their willingness to pay Price discrimination requires ability to distinguish consumers according to their willingness to pay

13. Price Discrimination Certain market forces (arbitrage) can prevent firms from price discriminating Certain market forces (arbitrage) can prevent firms from price discriminating Price discrimination can eliminate the inefficiency inherent in monopoly pricing Price discrimination can eliminate the inefficiency inherent in monopoly pricing Increase in welfare is reflected as an increase in producer surplus (profit) and there is no dead weight loss Increase in welfare is reflected as an increase in producer surplus (profit) and there is no dead weight loss Conclusion: monopoly power is a matter of degree and is usually limited Conclusion: monopoly power is a matter of degree and is usually limited