Chapter 24: Pure Monopoly

Pure Monopoly I. INTRODUCTION A. Main Characteristics Single Seller: only one firm is the sole producer of the product in the market (the firm and the industry are the same). No Close Substitutes: the monopolist sells a unique product that has no close substitutes. Price Making: the monopolist controls total quantity supplied to the market and thus has control over the price.

Blocked Entry: the monopolist has no immediate competitors because certain barriers prevent potential competitors from entering the market. Non-price Competition: monopolists that sell standardized products engage mainly in public relations advertising, whereas those with differentiated products sometimes advertise their products’ attributes.

B. Monopoly Examples Pure Monopoly: the existence of one producer. Near Monopolies: the existence of more than one producer, but one of them has a very large market share.

II. BARRIERS TO ENTRY Economies of Scale (Natural Monopoly): some industries require producing large output to achieve lower average total cost. Thus, economies of scale serve as entry barrier.

ATC THE NATURAL MONOPOLY CASE $20 15 ATC Average Total Cost 10 If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly 50 100 200 Quantity

Legal Barriers to Entry: Patents: a patent is the exclusive right of an inventor to use, or allowing others, to use its invention. Patents provide the inventor with a monopoly position for the life of the patent (i.e. 20 years). Licenses: the government blocks entry to an industry through the control of issuance of licenses. Ownership or Control of Essential Resources Pricing and Other Strategic Barriers to Entry

III. MONOPOLY DEMAND Basic Assumptions: Monopoly Status is Secured 2) No Governmental Regulation 3) Firm Charges the Same Price for all Units Sold

NOTES: Market Demand Curve is the Firm’s Demand Curve The monopolist sets the price in the elastic region of demand. In the elastic region of demand, lower price leads to higher total revenue. The monopolist avoids the inelastic region in the demand curve. Profit maximization and loss minimization rule of monopolist: MR = MC Note that price > MR

MONOPOLY REVENUES & COSTS Elastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

The monopolist has no supply curve. The monopolist equates MR and MC to determine output. The monopolist does not set the highest possible price. Monopolist’s goal is maximum profit not maximum price. Higher price may lead to less profit.

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost x $172 = $ 0 - $100 = - $100

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 1 $172 $172 162 $ 0 $ 0 162 $100 190 $100 - $100 - $100 - 28 ] $162 ] 90 x = - $190.00 = MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 ] $162 142 122 102 82 62 42 22 2 - 18 ] 90 80 70 60 110 130 150 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

Can you see profit maximization? MR > = MC MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost Can you see profit maximization? 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 MR > = MC ] $162 142 122 102 82 62 42 22 2 - 18 ] 90 80 70 60 110 130 150 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

IV. OUTPUT AND PRICE DETERMINATION Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions: Not Highest Price Total, Not Unit, Profit Possibility of Losses Graphically…

Remember the MR=MC Rule? OUTPUT AND PRICE DETERMINATION Case 1: Profit Maximization Under Monopoly Remember the MR=MC Rule? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

Case 2 :Loss Minimization Under Monopoly OUTPUT AND PRICE DETERMINATION Case 2 :Loss Minimization Under Monopoly Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Since Pm exceeds AVC, the firm will produce Loss Per Unit MC ATC A Loss AVC Pm V D MR = MC MR Qm

V. Economic Effects of Monopoly What are the Economic Effects of Monopoly? Monopoly pricing effectively creates an income transfer from buyers to the seller! X-Inefficiency: When the cost of producing is more than the lowest possible cost Monopolists are likely to experience X inefficiency than pure competition producers (who are under pressures) Rent-Seeking Behavior: using the monopolistic position to make more profits. Technological Advance: monopolists are less likely to care about Research & Development.

INEFFICIENCY OF PURE MONOPOLY An industry in pure competition sells where supply and demand are equal P S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Q Qm Qc

Inefficient internal operation leads to higher-than- necessary costs Average total costs Quantity Average Total Costs X X’ Q1 Q2 ATCx ATC1 ATC2 ATCx’

VI. PRICE DISCRIMINATION Definition: the sale of a specific product at more than one price, and price differences are not justified by cost differences. Conditions: Monopoly Power: the seller must be a monopolist or at least have some monopoly power (ability to control P&Q). Market Segregation: the seller is able to segregate buyers into distinct classes based on different demand elasticities. No Resale: the buyer cannot resell the good or service. Consequences: More Profit: monopolist can gain more profits. More Production: monopolist is willing to produce more

MC P Economic profits with a single MR=MC price ATC Price and Costs D MR Q Q1

A perfectly discriminating producing more product monopolist has MR=D, producing more product and more profit! MC P ATC Price and Costs MR=D D Q Q1 Q2

VII. REGULATED MONOPOLY Natural Monopolies: they are subject to rate (price) regulation. Socially Optimum Price: if the objective is achieving allocative efficiency, the regulator should set a legal (ceiling) price equals the MC: P = MC Fair-Return Price: because optimum price may lead to losses, price must be set where no losses occur, that’s at ATC: P = ATC

MR = MC Fair-Return Price Socially-Optimum Price Dilemma of Regulation: Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr