12 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Monopoly

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 2 of 43 Imperfect Competition and Market Power: Core Concepts An imperfectly competitive industry is an industry in which single firms have some control over the price of their output. Market power is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 3 of 43 Pure Monopoly A pure monopoly is an industry 1.with a single firm that produces a product for which there are no close substitutes and 2. in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 4 of 43 Defining Industry Boundaries If the product that the monopolist produces has many substitutes, the monopolist will have a limited market power. The more broader a market is, the more difficult it becomes to find substitutes.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 5 of 43 Barriers to Entry A barrier to entry is something that prevents new firms from entering and competing in imperfectly competitive industries. 1.Government franchises, or firms that become monopolies by virtue of a government directive. 2.Patents or barriers that grant the exclusive use of the patented product or process to the inventor.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 6 of 43 Barriers to Entry 3.Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry. 4.Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 7 of 43 Price: The Fourth Decision Variable Firms with market power must decide: 1. how much to produce, 2. how to produce it, 3. how much to demand in each input market, and 4. what price to charge for their output.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 8 of 43 Price and Output Decisions in Pure Monopoly Markets To analyze monopoly behavior we assume that: Entry to the market is blocked Firms act to maximize profit The pure monopolist buys inputs in competitive input markets The monopolistic firm cannot price discriminate The monopoly faces a known demand curve

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 9 of 43 Price and Output Decisions in Pure Monopoly Markets In a monopoly market, there is no distinction between the firm and the industry because the firm is the industry. The market demand curve is the demand curve facing the firm, and total quantity supplied in the market is what the firm decides to produce.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 10 of 43 Price and Output Decisions in Pure Monopoly Markets The demand curve facing a perfectly competitive firm is perfectly elastic.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 11 of 43 Marginal Revenue Facing a Monopolist (1) QUANTITY (2) PRICE (3) TOTAL REVENUE (4) MARGINAL REVENUE 0$110  110$ 2 4 66 101 88

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 12 of 43 Marginal Revenue and Market Demand At every level of output except one unit, a monopolist’s marginal revenue is below price.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 13 of 43 Marginal Revenue and Total Revenue The marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it. Total revenue is maximum when marginal revenue equals zero.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 14 of 43 The Monopolist’s Profit-Maximizing Price and Output The profit-maximizing level of output (Q m ) occurs where MR = MC. Notice that the outcome is different from that of perfect competition. Here, the price ($4.00) is less than the marginal cost ($1.50), and the monopolist earns positive economic profit.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 15 of 43 The Absence of a Supply Curve in Monopoly A monopoly firm has no supply curve that is independent of the demand curve for its product. A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 16 of 43 Monopoly in the Long and Short-Run It is possible for a profit-maximizing monopolist to suffer short-run losses and go out of business in the long-run.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 17 of 43 Perfect Competition and Monopoly Compared In a perfectly competitive industry in the long-run, price will be equal to long-run average cost.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 18 of 43 Perfect Competition and Monopoly Compared Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 19 of 43 The Social Costs of Monopoly Monopoly leads to an inefficient mix of output. Price is above marginal cost, which means that the firm is underproducing from society’s point of view.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 20 of 43 The Social Costs of Monopoly The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 21 of 43 Price Discrimination Charging different prices to different buyers is called price discrimination. A firm that charges the maximum amount that buyers are willing to pay for each unit is practicing perfect price discrimination.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 22 of 43 Price Discrimination A monopolist who cannot price discriminate would maximize profit by charging $4. There is profit and consumer surplus.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 23 of 43 Price Discrimination For a perfectly price discriminating monopolist, the demand curve is the same as marginal revenue. There is profit but no consumer surplus.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 24 of 43 Natural Monopoly A natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

C H A P T E R 12: Monopoly and Antitrust Policy © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair 25 of 43 Natural Monopoly With one firm producing 500,000 units, average cost is $1 per unit. With five firms each producing 100,000 units, average cost is $5 per unit.