Monopoly CCE ECO 211 REMEDIAL

Section3.1 MONOPOLY A monopoly is a type of an imperfect market. It is a market structure in which a single seller is the only seller of a product for which there are no close substitutes. Likewise, Botswana Power corporation is the sole producer provider of electricity in Botswana, and the UB bar is the only seller of alcohol on campus.

Characteristics of a Monopoly 1. There is a single seller. Since there is only one seller, the single seller makes up the entire market. Therefore, the demand curve for the single firm is also the market demand curve. 2. Products have no close substitutes. 3. There are barriers to entry. 4. The monopolist sets the price. Therefore, contrast to perfect competition, the monopolist is the price maker/setter. Since a monopoly is able to influence the price, it is said to have some market power and this is reflected by a downward sloping demand curve.

Causes of a monopoly: What factors give rise to a monopoly? 1.Exclusive control over important Inputs A firm may have control over an input that is essential to the production of a certain product. 2. Government created monopolies By issuing things like patent rights, copyright protection, franchises, licenses, governments give 3. Economies of scale, relative to demand – production function may entail substantial economies of scale such that efficiency in production may only be possible if carried out one firm only 4. Strategic or pricing behavior of firms – firms may threaten to destroy potential entrants if they ever enter the industry, e.g., through predatory pricing, raising their production costs

MR A Monopoly’s Marginal Revenue – When a monopoly increases the amount it sells, it has two effects on total revenue (P  Q). The output effect—more output is sold, so Q is higher. The price effect—price falls, so P is lower.

Price Elasticity and MR As noted earlier, since the demand curve facing a monopoly firms is downward sloping, MR < P MR > 0 when demand is elastic MR = 0 when demand is unit elastic MR < 0 when demand is inelastic

Total Revenue (Perfect Competition vs Monopolist’s) Total Revenue (TR) = P*Q A perfectly competitive firm cannot change the price, only the quantity, therefore, TR for a PC firm varies proportionally (linearly) with changes in output. Graphically

Average Revenue As in all other market structures, AR=P (note that AR = TR/Q = (PxQ) / Q = P) The price given by the demand curve is the average revenue that the firm receives at each level of output.

Marginal Revenue for a Monopolist Firm Recall that for a PC firm, profit maximization is where P=MC, and since P=MR, P=MC=MR. However, for a monopolist, P>MR. This is because: At P=6, Q=2; TR=12 At P=5, Q=3; TR=15 MR= P3 P3 is less than both P=6 and P=5 Therefore unlike a PC firm, P>MR

The MR curve for a Monopolist The vertical intercept of the marginal revenue curve is the same as that of the demand curve. The MR curve is twice as steep as the demand curve The MR revenue curve intercepts the horizontal axis at exactly half way the intercept of the demand curve

Profit maximisation Comparing Monopoly and Competition We use the same MR=MC rule – For a competitive firm, price equals marginal cost. P = MR = MC – For a monopoly firm, price exceeds marginal cost. P > MR = MC

Monopoly Profit Profit equals total revenue minus total costs. – Profit = TR - TC – Profit = (TR/Q - TC/Q)  Q – Profit = (P - ATC)  Q

Profit maximisation A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity. The monopolist will receive economic profits as long as price is greater than average total cost

Formally: profit maximization for a PC firm is derived as follows:.

Steps to find the Profit maximizing point for a Monopolist 1. Plot the demand, MR, ATC, and MC curves. Find where MR = MC, and determine the profit maximizing output quantity. 2. At this output level, find the corresponding level on the Demand curve to determine the price charged by a monopolist. Thus the price the monopolist sets is where MR=MC at the corresponding point on the demand curve.

Profit Profit Maximization for a Monopoly Copyright © 2004 South-Western Quantity QQ0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost Monopoly price Q MAX B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... A and then the demand curve shows the price consistent with this quantity.

Monopolist receiving Positive Profit

Zero-Profit monopolist

The Welfare Cost of Monopoly In contrast to a competitive firm, the monopoly charges a price above the marginal cost. From the standpoint of consumers, this high price makes monopoly undesirable. However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.

Deadweight loss Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. – This wedge causes the quantity sold to fall short of the social optimum

Deadweight loss due to a monopoly

Deadweight loss The Inefficiency of Monopoly Copyright © 2004 South-Western Quantity 0 Price Deadweight loss Demand Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity

Total surplus Consumer surplus Producer surplus Total surplus supply demand a b c d e f g output Price (P’000) MR Deadweight loss

The Inefficiency of Monopoly – The monopolist produces less than the socially efficient quantity of output. The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.

Price Discrimination Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

Price Discrimination Necessary conditions for price discrimination: – the firm must not be a price-taker – firms must be able to sort customers by their elasticity of demand – resale must not be feasible

Example of Price Discrimination Example: air travel

Summary A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product. A monopoly’s marginal revenue is always below the price of its good

Summary Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.

Summary A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.