Chapter 10 Pure Monopoly Characteristics of pure monopoly How a pure monopoly sets its profit-maximizing output and price Economic effects of monopoly Dilemma of regulation Price discrimination

Characteristics of Pure Monopoly Single seller—one firm industry; firm and industry are synonymous No close substitutes—buyers have no alternatives; unique product Price Maker—the monopolistic firm controls total supply. Monopolies can manipulate output to its advantage Blocked entry—economic, technological, legal Nonprice competition—sometimes done to increase demand What are some examples of monopolies??

Barriers to Entry Economies of Scale protect the monopolist from competition Financial obstacles and risks of “starting big” are prohibitive in such industries In a natural monopoly economies of scale are so great the product can be produced by one firm at a lower ATC than if the product were produced by more than one firm Most natural monopolies would set price above minimum ATC to max profit. As a result, govt. regulates price/output.

Barriers to Entry—con’t Legal barriers to entry Patents—20 years on most products Licenses Ownership or control of essential resources— a firm owning or controlling a resource essential to the production process can prohibit the creation of rival firms. Strategic barriers—price cutting to drive out competition, distribution, technology. Bottom line: barriers are seldom complete, so pure monopolies are rare. (And sometimes, monopolies are desirable.)

Monopoly Demand Simplifying assumptions: The firm is not regulated. The firm is a single price monopolist—it charges the same price for all units of output. Marginal Revenue must be less than price! The monopolist faces a downward sloping demand curve. (Its demand curve is the market demand curve.) Figure it out and graph it:

Because the monopolist must set a lower price to obtain greater sales, MR is less than Price for every level of output except the first. Each additional unit of output sold increases TR by an amount equal to its own price minus the sum of the price cuts which apply to all prior units of output. By controlling supply (Q), the monopolist can indirectly control price. The monopolist always sets price in the elastic region of the D curve. The total revenue test explains why…

Output and Price Determination Profit Max: MR = MC Like the purely competitive firm, the monopoly will produce one more unit of output as long as that unit adds more to total revenue than to total cost. No supply curve for the monopoly. As a price maker, it sets price when it decides how much to produce. There’s no single, unique P associated with each level of Q. Losses are possible. Pure monopoly does not guarantee profit. Same shutdown point as pure competition.

Economic Effects of Monopoly Efficiency: Monopolies are neither productively efficient nor allocatively efficient. Monopolies produce less than society wants. P > MC Monopolies are not incented to produce at min. ATC; P > min. ATC

More Economic Effects… Income Distribution: Monopoly contributes to inequality in income distribution. Think of the monopolist’s economic profit as a “private tax” on consumers which is then distributed to the firm’s owners/shareholders. Consumers “overpay” and owners receive the windfall. But what if the consumers are wealthier than the owners? (that’s an exception)

Cost complications—costs are not the same for monopolies and purely competitive firms. Benefits of economies of scale of the natural monopoly rarely offset the monopolist’s higher price and reduced output. Monopolist’s actual cost is greater then the lowest possible cost of production. This is called X-inefficiency. Rent seeking expenditures—costs of obtaining govt. approval or license. little incentive to adopt cost-saving technology

Regulated Monopoly Natural monopolies are subject to government regulation (New York Public Service Commission—electric, gas, water, telecommunications, cable) The unregulated monopoly will produce at MR=MC, which results in an underallocation of resources to the product and a higher price. Dilemma of regulation: Which price should regulators impose?...

Dilemma of regulation Socially Optimal Price: P=MC Allocative Efficiency Achieved with a Price Ceiling But what if this price ceiling is set below ATC? Fair Return Price: P=ATC Most regulatory commissions use this because the Supreme Court has ruled that regulators must permit a fair return to utility owners. At this price, the firm will realize a normal profit.

Price Discrimination Definition: the practice of selling a specific product at more than one price when the price differences are not justified by cost differences. Conditions necessary for price discrimination: A. Monopoly power—seller has some ability to control output and prices. B. Market segregation—seller must be able to divide buyers into different categories (often based on elasticities.) C. No resale (which would result in competition)

Price Discrimination (con’t) Graph: Consequences of price discrimination: A. More profit! B. More production! C. For the perfectly discriminating monopolist, D = MR, so it is allocatively efficient (just like pure competition)