ECO 2023 Principles of Microeconomics Dr. McCaleb MONOPOLY ECO 2023 Principles of Microeconomics Dr. McCaleb Monopoly

TOPIC OUTLINE Sources of Monopoly Monopoly Equilibrium Monopoly and Competition Price Discrimination Monopoly

Sources of Monopoly Monopoly

SOURCES OF MONOPOLY Characteristics of a Monopoly Market Definition A market with a single supplier of a good or service that has no close substitutes and in which there are economic or legal barriers to the entry of new competition. Two key features No close substitutes Barriers to entry Monopoly

SOURCES OF MONOPOLY Characteristics of a Monopoly Market Absence of close substitutes Even a single seller in a market faces competition from substitute goods outside its market. The closer the available substitutes, the greater the competition and the less market power the monopolist can exercise. If a good has a close substitute, even though there is only one seller, the market is effectively competitive. The single seller is unable to exercise any significant degree of market power. Monopoly

SOURCES OF MONOPOLY Characteristics of a Monopoly Market Barriers to entry Anything that protects a seller from new competition, for example Exclusive ownership of an essential resource Economies of scale Government grant of an exclusive franchise. Monopoly

SOURCES OF MONOPOLY Barriers to Entry Exclusive ownership of an essential resource A seller can create its own barrier to entry if it owns a significant portion of a key resource required for the production of the good or service. In practice, monopolies rarely arise for this reason. The market for most resources is national or even international, and ownership of most resources is dispersed among a large number of people and nations. Monopoly

SOURCES OF MONOPOLY Barriers to Entry Economies of scale Economies of scale arise when a single seller can supply the entire market at lower average total cost than two or more sellers. A monopoly that arises because of economies of scale is called a natural monopoly. Natural monopoly provides an economic argument for regulated public utilities. Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market. Monopoly

SOURCES OF MONOPOLY Economies of Scale The cost to distribute 4 million kilowatt hours of electric power is 5 cents a kilowatt-hour with one seller in the market, or . . . 10 cents a kilowatt-hour with two sellers, or . . . 15 cents a kilowatt-hour with four sellers. Because of economies of scale, one seller can meet the market demand at a lower average cost than two or more sellers. Monopoly

SOURCES OF MONOPOLY Barriers to Entry Government grant of an exclusive franchise Legal barriers to entry are the source of most present-day monopolies. Entry into the market or competition within the market are restricted by the granting of a public franchise, government license, patent, or copyright. Monopoly

Monopoly Equilibrium Monopoly

MONOPOLY EQUILIBRIUM Demand and Marginal Revenue Demand and marginal revenue are negatively-sloped Demand Market demand is negatively-sloped. The monopolist faces a tradeoff between price and quantity sold. To obtain a higher price, the monopolist must lower quantity. Or, if it wants to sell a larger quantity, it must lower price. Monopoly

MONOPOLY EQUILIBRIUM Demand and Marginal Revenue Marginal revenue is less than price An increase in quantity has two opposing effects on total revenue: Output effect: An increase in TR equal to the price of the additional quantity sold, which is partly offset by the Price effect: A decrease in total revenue equal to the decrease in price required to sell the additional quantity, multiplied by the quantity sold before the price decrease. The marginal revenue curve is negatively-sloped but lies below the demand curve at each quantity: MR<P at all Q. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue Calculate the marginal revenue generated along the demand curve. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue If the price is $16, quantity demanded is 2 haircuts per hour. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue If the price is $14, quantity demanded is 3 haircuts per hour. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue Total revenue from two haircuts per hour decreases by $4. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue Total revenue from the additional haircut is $14. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue Marginal revenue from the additional haircut is $10. Monopoly

MONOPOLY EQUILIBRIUM Example: Demand and Marginal Revenue The marginal revenue curve is negatively-sloped and lies below the demand curve. Marginal revenue is less than price at each quantity. Monopoly

MONOPOLY EQUILIBRIUM Profit Maximization by a Monopolist The diagram shows the monopolist’s average total cost (ATC), marginal cost (MC), demand (D), and marginal revenue (MR). The monopolist maximizes profits or minimizes losses by producing the quantity at which marginal revenue equals marginal cost. Monopoly

MONOPOLY EQUILIBRIUM Profit Maximization by a Monopolist The equilibrium quantity is 3 haircuts per hour where MR=MC, and the equilibrium price is $14, shown by the demand at the quantity 3. The ATC of 3 haircuts is $10. Because P>ATC at the equilibrium quantity, the monopolist earns a profit of $4 per haircut or $12 per hour. Monopoly

MONOPOLY EQUILIBRIUM Profit Maximization by a Monopolist: Numerical Example The data in the table below verify that 3 haircuts per hour maximizes the monopolist’s profit. Monopoly

MONOPOLY EQUILIBRIUM Short-Run and Long-Run Equilibria When a monopolist earns short-run profits Because new competitors are barred from entering the market, a monopolist’s short-run profits are not competed away. They persist into the long-run. Without new competition to increase quantity and lower price, the monopolist’s long-run equilibrium quantity and price are the same as the short-run equilibrium quantity and price. Monopoly

MONOPOLY EQUILIBRIUM Short-Run and Long-Run Equilibria When a monopolist incurs short-run losses However, if a monopolist incurs economic losses in the short-run, it exits the market in the long-run. The long-run equilibrium quantity is zero. Monopoly

Monopoly and Competition

MONOPOLY AND COMPETITION Competitive Equilibrium The market demand curve is D. The market supply curve is S. The competitive market equilibrium is where quantity demanded equals quantity supplied. The competitive equilibrium quantity is QC and the equilibrium price is PC. Monopoly

MONOPOLY AND COMPETITION Monopoly Equilibrium The competitive market supply curve, S, is the monopolist’s marginal cost curve, MC. The monopolist’s marginal revenue curve is MR. The monopolist’s equilibrium quantity is QM where marginal revenue equals marginal cost. The equilibrium price is PM , shown by the demand at QM. Monopoly

MONOPOLY AND COMPETITION Competitive and Monopolistic Equilibria Monopoly quantity is lower and price is higher A monopolist supplies a smaller quantity than a competitive market would supply at a higher price. The higher price allows a monopolist to earn positive long-run economic profits. Monopoly

MONOPOLY AND COMPETITION Economic Consequences of Monopoly The absence of competition results in Inefficiency and deadweight loss Redistribution of wealth Monopoly

MONOPOLY AND COMPETITION Efficiency of Competitive Equilibrium The competitive equilibrium price, PC, brings consumers’ marginal benefit into equality with producers’ marginal cost. Therefore, the competitive equilibrium quantity, QC, is efficient. The sum of consumer surplus and producer surplus is maximized. Monopoly

MONOPOLY AND COMPETITION Inefficiency of Monopoly Marginal benefit in the monopoly equilibrium (equals to the monopoly equilibrium price, PM) exceeds marginal cost. Therefore, the monopoly equilibrium quantity, QM, is inefficient because of underproduction. Monopoly results in a deadweight loss. Monopoly

MONOPOLY AND COMPETITION Economic Consequences of Monopoly Redistribution of wealth Because of barriers to entry, a monopolist may earn positive long-run economic profits--more than a normal accounting profit. Unlike short-run profits (or losses) in a competitive market, a monopolist’s positive long-run economic profits perform no useful economic function. They provide no incentive for increasing the supply of the good because new sellers cannot enter the market. Positive long-run profits in a monopoly market only redistribute wealth from consumers to the monopoly’s workers, managers, or investors. Monopoly

MONOPOLY AND COMPETITION Monopoly Redistributes Wealth The deadweight loss of monopoly arises from a net loss in both consumer and producer surplus compared with the competitive equilibrium. In addition to the net loss in the total surplus, monopoly also redistributes some of the remaining surplus from consumers to the monopolist. Monopoly

Price Discrimination Monopoly

PRICE DISCRIMINATION Characteristics of Price Discrimination Definition Selling a good or service at a number of different prices where the price differences do not reflect differences in cost but instead reflect differences in consumers’ price elasticities of demand. Successful price discrimination requires Market segmentation—the seller is able to identify different types of buyers based on differences in their demand elasticities. Costly arbitrage—it is costly for one consumer to buy the good at a lower price and resell to another consumer at a higher price Monopoly

PRICE DISCRIMINATION Characteristics of Price Discrimination Two types of price discrimination Discriminating among groups of consumers Different prices for consumers with different elasticities. The market is segmented based on some easily distinguished characteristic of consumers—age, for example. Monopoly

PRICE DISCRIMINATION Characteristics of Price Discrimination Discriminating among units of a good The seller charges the same prices to all consumers but offers each consumer a lower price for a larger number of units bought—volume discounts, for example. Monopoly

PRICE DISCRIMINATION Characteristics of Price Discrimination Comments There is nothing evil or illegal about economic price discrimination. It simply means charging different prices for the same good or service unrelated to differences in cost. Price discrimination is common in all markets other than perfectly competitive markets. Monopoly

PRICE DISCRIMINATION Effects of Price Discrimination Price discrimination may Increase seller’s profit, at least in the short run Enhance economic efficiency Conserve on scarce resources. Monopoly

PRICE DISCRIMINATION Effects of Price Discrimination Increases seller’s profits Reducing price to buyers with elastic demands increases revenues. Raising price to buyers with inelastic demands also increases revenues. If total quantity is unchanged, then costs are unchanged but revenues and profits are higher. Monopoly

PRICE DISCRIMINATION Effects of Price Discrimination Enhances economic efficiency Monopoly is inefficient because of underproduction. Too little of the good—less than the efficient quantity—is supplied by the monopolist. A price-discriminating monopolist is able to sell a larger quantity than a single-price monopolist by reducing price only on the additional units sold, not on all units sold. Because the problem with monopoly is underproduction, increasing quantity enhances efficiency. The sum of producer and consumer surplus is higher in a monopoly market with price discrimination than in a market with a single-price monopolist. Monopoly

PRICE DISCRIMINATION Enhances Economic Efficiency 20 Consumer 18 Surplus A non-discriminating monopolist sets a price of $12 and sells 3,000 units. Producer 16 Surplus 14 Deadweight Loss 12 MC Consumer surplus is shown by the green area. Producer surplus is shown by the blue area. 10 8 6 The deadweight loss of monopoly is shown by the purple area. The deadweight loss is a measure of the inefficiency because of underproduction by the monopolist. 4 D 2 MR 1 2 3 4 5 6 7 8 Monopoly

PRICE DISCRIMINATION Enhances Economic Efficiency If the monopolist discriminates by charging $12 for the first 3,000 units and $9 for any additional units, consumers buy 4,500 units. The deadweight loss disappears. A portion of the deadweight loss is added to producer surplus, and . . . the rest of the deadweight loss is added to consumer surplus. Price discrimination in this example benefits both sellers and buyers. Monopoly

PRICE DISCRIMINATION Effects of Price Discrimination Conserves on scarce resources In many markets, demand fluctuates systematically, often by time of day or day of the week or seasonally. Demand fluctuations result in crowding of facilities during peak periods and excess capacity during off-peak periods. Price discrimination reallocates demand from peak times to off-peak times. With lower demand during peak times, the capacity of a facility needed to serve the market is smaller and fewer resources are required to satisfy consumer demand. Monopoly