Monopoly Chapter 7 Section 2

What is a monopoly? A monopoly forms when barriers prevent firms from entering a market that has a single supplier with close to no substitute goods. Monopoly markets only have one seller, whereas, perfectly competitive markets have multiple sellers. Barriers to entry are the main reason that monopolies exist. Because some firms can’t push past barriers, other rise to the top. Monopolies can be problematic because they take advantage of their market power and charge high prices.

Forming a monopoly All monopolies share one trait – a single seller market. There are different factors that contribute to the creation of monopolies: Economies of scale – businesses that have high start- up costs but whose costs begin to drop as they product more goods. The lower the costs, the more products a company can make….closer to monopoly. Natural monopoly – market that run most efficiently when one large firm provides all of the output. Ex. – public water or electricity Technology and Change – sometimes new technology can destroy natural monopolies Exclusive ownership of a resource

Shark Tank – Daisy Cakes

Government Monopolies In the case of a natural monopoly, the government allows the monopoly to form and then regulates it (public water). However, government actions themselves can cause monopolies to form from the barriers to entry the government creates by its actions. Technological Monopolies – formed when government issues as patent (rights to sell a certain good or service) – this often creates a sole producers who sets the prices. Franchise - is a contract issue by a local authority that gives a single firm the right to sell its goods. Coca-Cola products at Six Flags License – is a government issued grant to the right to own a business. Radio stations/TV Industrial Organization – in some rare cases, the government might restrict an industry. Professional sports teams

The Monopolist’s Dilemma The law of demand says that buyers will demand more of a good at lower prices…less at a higher price. This means that in order to keep prices lower, monopolists will have to produce more goods. In order to maximize profits, the seller should set it’s marginal revenue equal to marginal cost. MR = MC In a perfectly competitive market, this will always be true. But in a monopoly, not so much…monopolies can adjust their prices and their production to adjust their profits.

Daisy Cakes Update

Price Discrimination Sometimes monopolies will use price discrimination to adjust their prices depending on their consumer groups. This is based on the idea that each customer has his/her own max price that they are willing to pay – so monopolist categorize their customers. If the price is set too high, only people who value the good at the price will buy it. If the price is too low, the monopolist will gain lots of customers, but might sacrifice profits from people who would have been willing to pay more. The ability for a business to control prices and output is called market power.

Targeted Discounts Monopolist categorize their customers and design their pricing for maximum profit. Some customers will pay regular price. Some customers want a discount. Examples – discounted airline tickets (offer lower fares for purchasing in advance or who can stay through Saturday; business travelers don’t want to stay through Saturday and likely don’t book in advance and pay higher fares); senior citizen discounts/student discounts (lower incomes mean that fixed income persons will likely not spend full price on “luxuries”), etc.

Limits of Price Discrimination For price discrimination to work, a market must meet three conditions: Some market power Distinct customer groups Difficult resale Although normal PD is totally legal, PD can sometimes put other firms out of business – this is called predatory pricing and is illegal.

Crash Course - Monopolies