Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopoly u A monopoly is the sole seller of its product.  its product does not have close substitutes. u While a competitive firm is a price taker, a monopoly is a price maker.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The fundamental cause of monopoly is barriers to entry Why barriers to entry? u Ownership of key resource. u Government franchise: exclusive right to produce the good. u Costs of production: a single producer is more efficient than many producers  natural monopoly..

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Natural Monopolies An industry is a natural monopoly when one firm can supply the entire market at a lower cost than could two or more firms.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economies of Scale as a Cause of Monopoly: HIGH fixed costs  ATC turn up only beyond the extent of the market. Average total cost Quantity of Output Cost 0

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Quantity of Output Demand (a) A Competitive Firm’s Demand Curve The competitive firm takes the market price (b) A Monopolist’s Demand Curve is the downward sloping industry demand curve 0 Price 0Quantity of Output Price Demand Demand Curves for Competitive and Monopoly Firms...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Monopoly Revenue u Total Revenue P x Q = TR … just like competitive firm. u Average Revenue TR/Q = AR = P … just like competitive firm. u Marginal Revenue  TR /  Q = MR < P

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Monopoly’s Total, Average, and Marginal Revenue Quantity (Q) Price (P) Total Revenue (TR=PxQ) Average Revenue (AR=TR/Q) Marginal Revenue (MR= ) 0 $11.00 $0.00 1$ $9.00 $18.00 $9.00$ $24.00 $8.00$6.00 4$7.00 $28.00 $7.00$4.00 5$6.00 $30.00 $6.00$2.00 6$5.00 $30.00 $5.00$0.00 7$4.00 $28.00 $4.00-$2.00 8$3.00 $24.00 $3.00-$4.00 QTR  /

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Monopoly’s Marginal Revenue  TR/  Q = MR < P When a monopoly increases the amount it sells, it has two effects on total revenue (TR = P x Q). u The output effect—more output is sold, so Q is higher. u The price effect—price falls, so P is lower.

Demand and Marginal Revenue Curves for a Monopoly... Quantity of Water Price $ Marginal revenue Demand (average revenue) Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Profit Maximization of a Monopoly u Produce quantity where MR = MC u Sell at the price where consumers buy that profit maximizing quantity. P = AR > MR = MC

Profit-Maximization for a Monopoly... Monopoly price QuantityQ MAX 0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost A 1. The intersection of the marginal-revenue curve and the marginal- cost curve determines the profit-maximizing quantity... B 2....and then the demand curve shows the price consistent with this quantity. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Comparing Monopoly and Competition u For a competitive firm, price equals marginal cost. P = MR = MC u For a monopoly firm, price exceeds marginal cost. P > MR = MC

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Monopoly’s Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q

Monopoly profit The Monopolist’s Profit... Quantity0 Costs and Revenue Demand Marginal cost Marginal revenue Q MAX B Monopoly price E Average total cost D Average total cost C Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Market for Patented Drugs... Costs and Revenue Price during patent life Price after patent expires Monopoly quantity Competitive quantity 0 Quantity Demand Marginal cost Marginal revenue

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price 0 Quantity Marginal cost Demand (value to buyers) Efficient quantity Cost to monopolist Value to buyers Cost to monopolist Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller. The Efficient Level of Output...

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Deadweight Loss u A monopoly sets price above marginal cost P > MR = MC u It places a wedge between the consumer’s willingness to pay and the producer’s cost. u The quantity sold falls short of the social optimum.

The Inefficiency of Monopoly... Quantity0 Demand Marginal revenue Marginal cost Monopoly price Deadweight loss Efficient quantity Monopoly quantity Price Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Inefficiency of Monopoly u The monopolist produces less than socially efficient output. u The monopolist earns more by doing less.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Public Policy Toward Monopolies u Antitrust Laws: Make monopolized industries more competitive. u Regulate monopoly prices. u Run monopolies as public enterprises. u Do nothing.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Increasing Competition with Antitrust Laws u Prevent mergers. u Break up companies. u Forbid anticompetitive practices.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Regulation Government may regulate the prices that the monopoly charges. u The allocation of resources will be efficient if price is set to equal marginal cost.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Marginal-Cost Pricing for a Natural Monopoly... Regulated price Quantity 0 Loss Price Demand Marginal cost Average total cost Average total cost

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price Discrimination u Price discrimination -- selling the same good at different prices to different customers. u In order to price discriminate, the firm must have some market power.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Deadweight loss Consumer surplus Welfare Without Price Discrimination... Price 0Quantity Profit Demand Marginal cost Marginal revenue Quantity sold Monopoly price (a) Monopolist with Single Price

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Welfare With Price Discrimination... Price 0Quantity Demand Marginal cost Quantity sold (b) Monopolist with Perfect Price Discrimination Profit

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Examples of Price Discrimination u Movie tickets u Airline prices u Discount coupons u Financial aid u Quantity discounts

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Prevalence of Monopoly u Most firms have some control over their prices because of differentiated products. u Firms with substantial monopoly power are rare: few goods are truly unique. u Monopolists face competition from other industries.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u A monopoly is a firm that is the sole seller in its market. u It faces a downward-sloping demand curve for its product. u A monopoly’s marginal revenue is always below the price of its good.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. u Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. u A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Policymakers can respond to the inefficiencies of monopoly behavior with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. u If the market failure is deemed small, policymakers may decide to do nothing at all.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. u Price discrimination can raise economic welfare and lessen deadweight losses.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Economies of Scale as a Cause of Monopoly... Average total cost Quantity of Output Cost 0

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Quantity of Output Demand (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve 0 Price 0Quantity of Output Price Demand Demand Curves for Competitive and Monopoly Firms...

Demand and Marginal Revenue Curves for a Monopoly... Quantity of Water Price $ Marginal revenue Demand (average revenue) Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Profit-Maximization for a Monopoly... Monopoly price QuantityQ MAX 0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost A 1. The intersection of the marginal-revenue curve and the marginal- cost curve determines the profit-maximizing quantity... B 2....and then the demand curve shows the price consistent with this quantity. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Monopolist’s Profit... Monopoly profit Quantity0 Costs and Revenue Demand Marginal cost Marginal revenue Q MAX B Monopoly price E Average total cost D Average total cost C Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Market for Drugs... Costs and Revenue Price during patent life Price after patent expires Monopoly quantity Competitive quantity 0 Quantity Demand Marginal cost Marginal revenue

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Efficient Level of Output... Price 0 Quantity Marginal cost Demand (value to buyers) Efficient quantity Cost to monopolist Value to buyers Cost to monopolist Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller.

The Inefficiency of Monopoly... Quantity0 Demand Marginal revenue Marginal cost Monopoly price Deadweight loss Efficient quantity Monopoly quantity Price Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Marginal-Cost Pricing for a Natural Monopoly... Regulated price Quantity 0 Loss Price Demand Marginal cost Average total cost Average total cost

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Welfare Without Price Discrimination... Deadweight loss Consumer surplus Price 0Quantity Profit Demand Marginal cost Marginal revenue Quantity sold Monopoly price (a) Monopolist with Single Price

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Welfare With Price Discrimination... Price 0Quantity Demand Marginal cost Quantity sold (b) Monopolist with Perfect Price Discrimination Profit