Economic Analysis for Managers (ECO 501) Fall: 2012 Semester Khurrum S. Mughal

MONOPOLY Copyright © 2001 by Harcourt, Inc. All rights reserved.   Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Monopoly While a competitive firm is a price taker, a monopoly firm is a price maker.

A firm is considered a monopoly if it is the sole seller of its product. its product does not have close substitutes. 2 2

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

Why Monopolies Arise? Barriers to entry have three sources: Ownership of a key resource The government Costs of production 5 4

Monopoly Resources Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. 9 5

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

Government-Created Monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws 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. A natural monopoly arises when there are economies of scale over the relevant range of output. 11 8

Economies of Scale as a Cause of Monopoly… Average total cost Quantity of Output Cost

Monopoly versus Competition Is the sole producer Has a downward-sloping demand curve Is a price maker Reduces price to increase sales Competitive Firm Is one of many producers Has a horizontal demand curve Is a price taker Sells as much or as little at same price 13 12

Demand Curves for Competitive and Monopoly Firms… Quantity of Output Demand (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Price 2

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

A Monopoly’s Total, Average, and Marginal Revenue Quantity (Q) Price (P) Total Revenue (TR=PxQ) Average Revenue (AR=TR/Q) Marginal Revenue (MR= ) $11.00 $0.00 1 $10.00 2 $9.00 $18.00 $8.00 3 $24.00 $6.00 4 $7.00 $28.00 $4.00 5 $30.00 $2.00 6 $5.00 7 -$2.00 8 $3.00 -$4.00 Q TR D /

price falls, so P is lower. A Monopoly’s Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). more output is sold, so Q is higher. price falls, so P is lower. 15 14

Demand and Marginal Revenue Curves for a Monopoly... Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 -1 -2 -3 -4 Marginal revenue Demand 16 22

Profit Maximizing Output and Price 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 Maximizing Output and Price Monopoly price Quantity QMAX Costs and Revenue Demand Average total cost Marginal revenue Marginal cost 20 30

Profit Maximizing Output and Price Monopoly price Quantity QMAX Costs and Revenue Demand Average total cost Marginal revenue Marginal cost Economic Profit 20 30

Profit Maximizing Output and Price 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

The Welfare Cost of Monopoly Monopoly charges a price above the marginal cost. Consumers: this high price makes monopoly undesirable. Owners: the high price makes monopoly very desirable. 19 23

Evaluating Monopoly Costs and Revenue Price during patent life Price after patent expires Marginal cost Marginal revenue Demand Monopoly quantity Competitive quantity Quantity

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

Income Redistribution Evaluating Monopoly Allocative Inefficiency Income Redistribution 39 54

Evaluating Monopoly Deadweight loss Consumer surplus Price Quantity Quantity Profit Demand Marginal cost Marginal revenue Qm Pm Pc Qc 41 72

Technical Inefficiency Evaluating Monopoly Technical Inefficiency Rent Seeking 39 54

Technical Inefficiency Evaluating Monopoly Price Quantity Profit Demand Marginal cost Marginal revenue Qm Pm Pc Qc Economic Profit Rent Seeking + Technical Inefficiency 41 72