Pure Monopoly 10 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

An Introduction to Pure Monopoly Single seller – a sole producer No close substitutes – unique product Price maker – control over price Blocked entry – strong barriers to entry block potential competition Non-price competition – mostly PR or advertising the product LO1 10-2

Examples of Monopoly Public utility companies Natural Gas Electric Water Near monopolies Intel Wham-O Professional Sports Teams LO1 10-3

Barriers to Entry Barrier to Entry: a factor that keeps firms from entering an industry. Economies of Scale Legal Barriers: Patents and Licenses Ownership of Essential Resources Pricing LO1 10-4

Economies of Scale LO1 0 Average total cost Quantity $ ATC 10-5

Monopoly Demand The pure monopolist is the industry Demand curve is the market demand curve Downsloping demand curve Marginal revenue is less than price LO1 10-6

Table 10.1 Revenue and Cost Data of a Pure Monopolist Revenue DataCost Data (1) Quantity of Output (2) Price (Average Revenue) (3) Total Revenue (1) X (2) ( 4) Marginal Revenue (5) Average Total Cost (6) Total Cost (1) X (5) (7) Marginal Cost (8) Profit (+) or Loss (-) 0 $ 172$0 $ 100$ $ 162 $ $ Monopoly Demand LO1 10-7

Monopoly Demand LO $ D Gain = $132 Loss = $30 All customers must pay the same price 10-8

$ D Gain = $132 Loss = $30 Monopoly Demand LO1 All customers must pay the same price MR 10-9

Monopoly Demand Marginal Revenue < Price Monopolist is a price maker Monopolist sets prices in elastic region of demand curve LO

Output and Price Determination LO2 $ $ Price Total Revenue ElasticInelastic Demand and Marginal-Revenue Curves Total-Revenue Curve D MR TR 10-11

Output and Price Determination LO2 Steps for Graphically Determining the Profit-Maximizing Output, Profit- Maximizing Price, and Economic Profits (if Any) in Pure Monopoly Step 1 Determine the profit-maximizing output by finding where MR=MC. Step 2 Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist’s demand curve. Step 3 Determine the pure monopolist’s economic profit by using one of two methods: Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any). Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any)

$ Price, Costs, and Revenue Quantity Output and Price Determination LO2 0 D MR ATC MC MR=MC A=$94 Economic Profit P m =$

Misconceptions of Monopoly Pricing Not highest price Total profit Possibility of losses LO

Misconceptions of Monopoly Pricing LO2 0 Price, Costs, and Revenue Quantity D MR ATC MC MR=MC Loss AVC PmPm QmQm V A 10-15

Economic Effects of Monopoly LO3 (a) Purely Competitive Market (b) Pure Monopoly D D S=MC MC P=MC= Minimum ATC MR PcPc QcQc PcPc PmPm QcQc QmQm Pure competition is efficient Monopoly is inefficient a b c d 10-16

Economic Effects of Monopoly Income transfer Cost complications Economies of scale X-Inefficiency Rent seeking expenditures Technological advance LO

X-Inefficiency LO3 0 Average total costs Quantity ATC 2 ATC 1 ATC x Q1Q1 Q2Q2 Average total cost X X' ATC x' 10-18

Assessment and Policy Options Antitrust laws Break up the firm Regulate it Government determines price and quantity Ignore it Let time and markets get rid of monopoly LO

Global Perspective LO3 Competition from Foreign Multinational Corporations 10-20

Price Discrimination Price discrimination Charging different buyers different prices Price differences are not based on cost differences Conditions for success: Monopoly power Market segregation No resale LO

Examples of Price Discrimination Business travel Electric utilities Movie theaters Golf courses Railroad companies Coupons International trade LO

Graphical Analysis LO4 MC = ATC QbQb Qs Qs PsPs PbPb P P MR b MR s DbDb DsDs (a) Small businesses (b) Students Economic profit 10-23

Regulated Monopoly Natural monopolies Socially optimal price Set price = marginal cost Fair return price Set price = ATC LO

Regulated Monopoly LO5 0 Price and Costs (Dollars) Quantity Monopoly Price Fair-Return Price Socially Optimal Price PrPr D r f b a PfPf PmPm QmQm QfQf QrQr MR MC ATC 10-25

De Beers’s Diamonds De Beers once controlled about 80% of the world’s diamond market Monopoly position eroded over time New diamond discoveries Nearly perfect artificial diamonds Unfavorable media attention Now focus on increasing demand for diamonds rather than controlling supply 10-26