Pure Monopoly

Characteristics of pure monopoly Single seller No close substitutes “Price maker” Blocked entry Non-price competition

Economies of scale in a pure monopoly Economies of Scale = declining average total cost (ATC) as production increases Pure Monopoly has a constant downward sloping long-run ATC curve Long Run ATC in Pure Competition Long Run ATC in Pure Monopoly

Economies of scale in a pure monopoly Economies of Scale in a Pure Monopoly are a barrier to entry for other firms: Smaller scale = less economies of scale Massive amounts of start up costs and obtaining financing to launch new large scale production

Other Barriers to entry Patents Licenses Control of Resources Private Property Rights Locational control of resources Pricing Distribution agreements

Monopoly demand Assumptions: Barriers to entry ensure firm’s monopoly Government doesn’t regulate the monopolist The firm is a single-price monopolist Charges same price for all units of output Monopolist demand curve = market demand curve Demand curve is not perfectly elastic = A downward sloping demand curve

Marginal Revenue < price Monopolist can only increase sales by lowering price But as single-price monopolist – by lowering price for the additional output, it must also lower prices for all of the previous units of production!

Marginal Revenue < price Example: 3 Halo VI video games at $55.00 each = $165 4 Halo VI video games at $45.00 each = $180 Forgone amount (revenue loss) = 3 x $10 ($55 - $45) = $30 MR = $45(1 additional unit) - $30(revenue loss) = $15 P = $45.00 Therefore MR < P

Marginal and total revenue curves Points where Total Revenue is maximized TR D MR

Profit maximization Monopolistic firm competes for resources (just like in pure competition!) Monopolistic firm will produce where MR = MC (just like in pure competition!) Monopolistic firm will produce at the level of production which has the greatest positive difference between TR and TC (just like in pure competition!)

Supply Curve in Pure Monopoly Is there a supply curve in pure monopoly? No!!!! Why??? There is no unique relationship between price and quantity supplied. The price and quantity supplied will always depend on the location of the demand curve!

Marginal Cost and revenue curves Economic Profits MC ATC Profit Maximization: MC = MR P D QD MR

Misconceptions about monopolies Monopolists cannot charge the highest price it can get Maximize profits where TR – TC is greatest Depends on quantity sold and price Total profits is the goal of monopolists Unit profit does not indicate profit maximization Pure monopoly doesn’t guarantee profit

Losses in monopoly Causes of Loss: Effects of Loss: Change in people’s tastes Upward shifting cost curves (ex: rise in resources) Effects of Loss: Monopoly firm will continue to operate for a while even if incurring losses IF Total loss < fixed costs Price > AVC Firm will reallocate resources to more profitable industries

Economic effects of monopoly Monopolies will sell less products at a higher price Monopoly price will exceed marginal cost and marginal revenue b/c consumers will still pay at the higher level Allocative efficiency is not achieved Productive efficiency is not achieved Efficiency loss (or deadweight loss) occurs

Income effects of monopoly Income distribution more unequal Business owners receive unbalance share of income from consumers

Cost complications of monopoly Extensive Economies of Scale = monopoly has a lower ATC than purely competitive firms X-inefficiency – output is produced at a higher cost than is necessary to produce it (no incentive to be more efficient) Rent-seeking behavior – trying to obtain/maintain a monopoly even at a cost to the consumer or society Rate of technological advances slowed – less incentives to improve technology which would improve efficiency

Price discrimination Occurs when a given product is sold at more than one price and the price differences are not based on cost differences Charging each customer a single market maximum price Charging each customer one price for the first set of units purchased and a lower price for subsequent sets of units (bulk purchases) Charging one group of customers one price and another group a different price

Price discrimination Success = Examples: Monopoly power to control output and price Ability to segregate the market (based on differing elasticities of demand) Buyers unable to resell the original product or service Examples: Airline tickets (business vs. coach) Electric utilities (higher rates during the day) Discount coupons Movie theaters and golf courses

Price discrimination Different groups result in different demand curves and MR curves Results in different profit maximization and quantity levels Each segment still follows MR = MC output and price level Don’t write this down!!!

Price discrimination and consumer surplus

Price discrimination and profit Therefore, a price discriminating monopolist will earn profits like this: Notice that for the price discriminating monopolist the MR and the Demand curve are the same!

Socially optimal price vs. Fair return price Gov’t might set a price at the “socially optimal price” (P = MC) – where production is allocatively efficient OR…Gov’ts may set artificial price level higher/lower than the socially optimum price (Fair Return Price) To give the firm a “fair return” on it’s investment and avoid losses Where P = ATC EX: Washington Metro Right now P < ATC so govt’s have to subsidize Metro

Marginal Cost and revenue curves Economic Profits Socially Optimal Price: MC = D MC Fair Return Price: ATC = D (Earn only NORMAL Profits) ATC P Profit Maximization: MC = MR D QD MR

Draw a graph On a piece of paper draw the graph for a single-price monopolist experiencing economic losses! On your graph, label the following The axis (or axes) Demand Curve Marginal Revenue Curve Marginal Cost Curve Average Total Cost Curve Profit Maximizing Price (Pm) and Quantity (Qm) The area of economic losses (shaded completely) The Fair Return Price (Pfr) and Quantity (Qfr) The Socially Optimal (or allocatively efficient) Price (Pso) and Quantity (Qso) The point of productive efficiency (PE)

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