Monopoly A firm is considered a monopoly if . . . . . . it is the sole seller of its product. . . . its product does not have close substitutes. . . . it has some ability to influence the market price of its product. 2 2

Why Monopolies Arise The fundamental cause of monopoly is barriers to entry. 5 3

Why Monopolies Arise Barriers to entry have four sources: ä Ownership of key resource ä Legal barriers by government ä Pricing and Strategic attempts ä Large economies of scale 5 4

Monopoly Resources Exclusive ownership of an important resource that cannot be readily duplicated is a potential source of monopoly. 9 5

Government-Created Monopolies Patent and copyright laws are a major source of government-created monopolies. 10 6

Government-Created Monopolies Governments also restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. 10 7

Natural Monopolies An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. 11 8

Natural Monopolies Because of economies of scale, the minimum efficient scale of one firm’s plant is so large that only one firm can supply the market efficiently. 11 9

Quick Quiz! What are the three reasons that a market might have a monopoly? 12 10

Quick Quiz! Give two examples of monopolies and explain the reason for each. 12 11

Monopoly versus Competition ä Is the sole producer ä Is a price maker ä Has a downward-sloping demand curve reduces price to increase sales 13 12

Competition versus Monopoly Competitive Firm ä Is one of many producers ä Is a price taker ä Has a horizontal demand curve Sells as much or as little at same price 14 13

Monopoly’s Revenue P x Q = TR TR/Q = AR = P Total Revenue Average Revenue TR/Q = AR = P Marginal Revenue DTR/DQ = MR 15 14

Monopoly’s, Total, Average, and Marginal Revenue 18 15

Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less than the price of its good. ä The demand curve is downward sloping. ä When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases. 15 16

Monopoly’s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). ä The output effect—more output is sold, so Q is higher. ä The price effect—price falls, so P is lower. 18 17

Monopoly’s Marginal Revenue The marginal revenue curve lies below its demand curve. 18 18

Monopoly’s Demand and Marginal Revenue Curves 16 19

Monopoly’s Demand and Marginal Revenue Curves Price $11 10 9 8 7 6 5 4 3 2 1 -1 1 2 3 4 5 6 7 8 Quantity of Water -2 -3 -4 16 20

Monopoly’s Demand and Marginal Revenue Curves Price $11 10 9 8 7 6 5 4 3 Demand (average revenue) 2 1 -1 1 2 3 4 5 6 7 8 Quantity of Water -2 -3 -4 16 21

Monopoly’s Demand and Marginal Revenue Curves Price $11 10 9 8 7 6 5 4 3 Demand (average revenue) 2 Marginal revenue 1 -1 1 2 3 4 5 6 7 8 Quantity of Water -2 -3 -4 16 22

Profit Maximization of a Monopoly 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. 19 23

Profit Maximization of a Monopoly Costs and Revenue Quantity 20 24

Profit Maximization of a Monopoly Costs and Revenue Demand Marginal revenue Quantity 20 25

Profit Maximization of a Monopoly Costs and Revenue Marginal cost Average total cost Demand Marginal revenue Quantity 20 26

Profit Maximization of a Monopoly Costs and Revenue Marginal cost Average total cost A Demand Marginal revenue Quantity 20 27

Profit Maximization of a Monopoly Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Average total cost A Demand Marginal cost Marginal revenue Quantity 20 28

Profit Maximization of a Monopoly Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity 20 29

Profit Maximization of a Monopoly Costs and Revenue 2. ...and then the demand curve shows the price consistent with this quantity. 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... B Monopoly price Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity 20 30

Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC 23 31

Calculating Monopoly Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q 40 32

The Monopolist’s Profit 27 33

The Monopolist’s Profit Costs and Revenue Quantity 27 34

The Monopolist’s Profit Costs and Revenue Demand Marginal revenue Quantity 27 35

The Monopolist’s Profit Costs and Revenue Marginal cost Average total cost Demand Marginal revenue Quantity 27 36

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price Average total cost Demand Marginal revenue QMAX Quantity 27 37

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price Average total cost Average total cost Demand Marginal revenue QMAX Quantity 27 38

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price E B Monopoly prophat Average total cost Average total cost D C Demand Marginal revenue QMAX Quantity 27 39

The Monopolist’s Profit The monopolist will receive economic profits as long as price is greater than average total cost. 23 40

Quick Quiz! Explain how a monopolist chooses the quantity of output to produce and the price to charge. 30 41

The Welfare Cost of Monopoly The monopolist produces less than the socially efficient quantity of output. 31 43

The Welfare Cost of Monopoly Because a monopoly charges a price above marginal cost, consumers who value the good at more than its marginal cost but less than the monopolist’s price won’t buy it. 32 44

The Welfare Cost of Monopoly Monopoly pricing prevents some mutually beneficial trades from taking place. 31 45

The Welfare Cost of Monopoly A monopoly leads to an inefficient allocation of resources and a failure to maximize total economic well-being. 31 42

The 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. ä This wedge causes the quantity sold to fall short of the social optimum. 33 47

The Deadweight Loss Price Quantity 34 48

The Deadweight Loss Price Marginal revenue Demand Quantity 34 49

The Deadweight Loss Price Marginal cost Marginal revenue Demand Quantity 34 50

The Deadweight Loss Price Marginal cost Monopoly price Marginal revenue Demand Monopoly quantity Quantity 34 51

The Deadweight Loss Price Marginal cost Monopoly price Marginal revenue Demand Monopoly quantity Efficient quantity Quantity 34 52

The Deadweight Loss Price Deadweight loss Marginal cost Monopoly price revenue Demand Monopoly quantity Efficient quantity Quantity 34 53

Price Discrimination Price discrimination is the practice of selling the same good at different prices to different customers. Some degree of monopoly power Market segregation No resale 41 68

Price Discrimination Three important effects of price discrimination: It can reduce deadweight loss. It can reduce consumer surplus. It can increase the monopolist’s profits. 41 69

Welfare Without Price Discrimination 41 70

Welfare Without Price Discrimination Quantity 41 71

Welfare Without Price Discrimination Consumer surplus Deadweight loss Monopoly price Profit Marginal cost Marginal revenue Demand Quantity sold Quantity 41 72

Welfare With Price Discrimination Profit Monopoly price Marginal cost Demand = MR Quantity sold Quantity 41 73

Examples of Price Discrimination Movie tickets Airline tickets Insurance Discounts (coupons) College Tuition Parking 42 74

Quick Quiz! Give two examples of price discrimination. 43 75

Quick Quiz! How does perfect price discrimination affect consumer surplus, producer surplus, and total surplus? 43 76

Public Policy & Monopolies Government responds in one of four ways. ä Making monopolized industries more competitive. ä Regulating the behavior of monopolies. ä Turning some private monopolies into public enterprises. ä Doing nothing at all. 39 54

Creating a Competitive Market Government may implement and enforce antitrust laws to make the industry more competitive. 39 55

Government may regulate the prices that the monopoly charges. Regulation Government may regulate the prices that the monopoly charges. ä The allocation of resources will be efficient if price is set to equal marginal cost. 39 56

There are two practical problems with marginal-cost pricing. Regulation There are two practical problems with marginal-cost pricing. ä Price may be less than average total cost, and the firm will lose money. ä It gives the monopolist no incentive to reduce cost. 39 57

Marginal-Cost Pricing 58

Marginal-Cost Pricing Price Quantity 59

Marginal-Cost Pricing Price Average total cost Marginal cost Demand Quantity 60

Marginal-Cost Pricing Price Average total cost Regulated price Marginal cost Demand Regulated quantity Quantity 61

Marginal-Cost Pricing Price Average total cost Average total cost Loss Regulated price Marginal cost Demand Regulated quantity Quantity 63

Marginal-Cost Pricing Price Average total cost Average total cost Regulated price Marginal cost Demand Regulated quantity Quantity 62

Government can turn the monopolist into a government-run enterprise. Public Ownership Government can turn the monopolist into a government-run enterprise. 39 64

Doing Nothing Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies. 39 65

Quick Quiz! Describe the ways policymakers can respond to the inefficiencies caused by monopolies. 40 66

Quick Quiz! List a potential problem with each of these policy responses. 40 67

Monopoly Misc X-Inefficiency Rent Seeking Behavior Network Effect Monopolies often operate at a higher cost than necessary Rent Seeking Behavior Transfer wealth at someone else’s expense. Network Effect Allocative Efficiency (MC=D or P) Productive Efficiency (MC=ATC) Fair-Return/Cost of Service/Average Cost Pricing Marginal Cost Pricing 44 77

Marginal-Cost Pricing Price Average total cost Average total cost Regulated price Marginal cost Demand Regulated quantity Quantity 62

The Prevalence of Monopoly How prevalent are the problems of monopolies? ä Monopolies are around you……. ä Most firms have some control over their prices because of differentiated products. ä Firms with substantial monopoly power are rare. ä Few goods are truly unique. 44 77

Conclusion A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product.

Conclusion 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.

Conclusion 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.

Conclusion Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. Price discrimination can raise economic welfare and lessen deadweight losses.

Conclusion Policymakers can try to remedy the inefficiencies of monopolies with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. If the market failure is small, policymakers may decide to do nothing at all.