Chapter 25 Monopoly

Slide 25-2 You are familiar with the type of patent protection that applies to mechanical inventions, giving the owner exclusive rights to use an innovative technology. A similar type of protection can also apply to innovations in business methods. Introduction In either case, a patent bestows the rights of a monopoly and prohibits competition.

Slide 25-3 Identify situations that can give rise to monopoly Describe the demand and marginal revenue conditions a monopolist faces Discuss how a monopolist determines how much output to produce and what price to charge Learning Objectives

Slide 25-4 Learning Objectives Evaluate the profits earned by a monopolist Understand price discrimination Explain the social cost of monopolies

Slide 25-5 Chapter Outline Definition of a Monopolist Barriers to Entry The Demand Curve a Monopolist Faces Elasticity and Monopoly

Slide 25-6 Cost and Monopoly Profit Maximization Calculating Monopoly Profit On Making Higher Profits: Price Discrimination On Making Higher Profits: Price Discrimination The Social Cost of Monopolies Chapter Outline

Slide 25-7 A monopoly can arise whenever a seller is given exclusive rights to distribute a good? In the case of hearing aids, a legally- protected distribution system through state-certified audiologists has increased hearing-aid prices to the monopoly level? Did You Know That...

Slide 25-8 Definition of a Monopolist Monopolist –A single supplier of a good or service for which there is no close substitute

Slide 25-9 The source of monopoly –A barrier to entry that allows the firm to make long-run economic profits Barriers to Entry

Slide Ownership of resources without close substitutes –If you owned all the oil reserves, who could enter the refining business? –The Aluminum Company of America (ALCOA) at one time owned 90 percent of the world’s bauxite. Barriers to Entry

Slide Problems in raising adequate capital –Choose a product that requires a substantial capital investment –Why not enter the microprocessor market and compete with Intel? Barriers to Entry

Slide Economies of scale –Low unit costs and prices drive out rivals –The largest firm can produce at the lowest average total cost Barriers to Entry

Slide Natural Monopoly –A monopoly that arises from the peculiar production characteristics in an industry –It usually arises when there are large economies of scale Barriers to Entry

Slide Figure 25-1 LAC LMC Kilowatts of Electricity per Time Period Price per Kilowatt The Cost Curves that Might Lead to a Natural Monopoly: The Case of Electricity

Slide Legal or governmental restrictions –Licenses, franchises, and certificates of convenience –Is the postal service still a monopoly? Consider –UPS –FedEx –Fax machines –The Internet Barriers to Entry

Slide In order to sell any arranged flowers in Louisiana, one must first become a licensed florist. This involves paying a $150 fee to take an exam in which other florists judge the skills of those seeking the license. Nearly half of the applicants receive failing grades. This serves as a barrier to entry, although the floral industry is not a monopoly. Example: Barriers to Entry in Selling Flowers

Slide Legal or governmental restrictions –Patents Intellectual property –Tariffs Taxes on imported goods –Regulation Barriers to Entry

Slide Cartels –An association of producers in an industry that agree to set common prices and output quotas to prevent competition Barriers to Entry

Slide Monopolist’s demand = market demand –Monopolist is the industry The Demand Curve a Monopolist Faces

Slide Recall –In perfectly competitive markets: All firms combined create the industry supply Industry supply relative to market demand (D) determines equilibrium price and quantity The industry faces the market demand The Demand Curve a Monopolist Faces

Slide Demand Curves for the Perfect Competitor and the Monopolist Figure 25-3, Panels (a) and (b) d =D Q Panel (b) Demand If Individual Supplier Is the Only Supplier in a Pure Monopoly d q Panel (a) Demand If Individual Supplier Is in Perfect Competition Price per Unit

Slide MonopolyPerfect Competition Single Seller Faces market demand Must lower price to sell more MR < P One of many sellers Perfectly elastic demand (price takers) Must only produce more to sell more All units sold for same price (P = MR) The Demand Curve a Monopolist Faces

Slide Figure 25-4 P 1 MR = area A– area B Quantity of Electricity per Time Period Q + 1Q P 2 Area A (+) Gain Area B (–) Loss Demand curve = AR curve D Price of Electricity Marginal Revenue: Always Less Than Price

Slide A monopoly is a single seller of a well- defined good or service with no close substitutes. The more imperfect substitutes there are, and the better these substitutes are, the greater the price elasticity of demand of the monopolist’s demand curve Elasticity and Monopoly

Slide Elasticity and Monopoly Question –If a monopoly raises price, what will happen to quantity demanded? Hint –Remember how consumers respond to a change in price.

Slide Price Searcher –A firm that must determine the price- output combination that maximizes profit because it faces a downward-sloping demand curve Cost and Monopoly Profit Maximization

Slide E-Commerce Example: Online Journal Subscriptions JSTOR is a organization providing back issues of journals to researchers in academic fields. To determine the fees it will charge for a subscription, JSTOR analyzes the frequency with which each journal is accessed.

Slide E-Commerce Example: Online Journal Subscriptions The goal is to charge relatively higher fees for those articles characterized by a somewhat inelastic demand. As a result, a higher price is assigned to those journals which are accessed less frequently.

Slide Figure 25-5, Panel (a) Monopoly Costs, Revenues, and Profits

Slide Figure 25-5, Panels (b) and (c) Monopoly Costs, Revenues, and Profits Profit- maximizing rate of output MC = MR MR D MC Panel (c) Output per Time Period Losses Maximum profit TR Losses Panel (b) Output per Time Period Price, Marginal Costs, and Marginal Revenue per Unit ($) Total Costs and Total Revenue ($) TC

Slide Example: Stifling Competition for Replacement Ink and Toner Cartridges There are many manufacturers of computer printers, fax machines, and copiers. But each manufacturer designs the equipment so that the ink and toner cartridges are a unique fit.

Slide Example: Stifling Competition for Replacement Ink and Toner Cartridges In this way, each manufacturer can operate as a monopolist in the market for replacement cartridges. Some firms have entered the market of collecting and refilling empty cartridges which then can sell at a much lower price than the manufacturer’s replacements.

Slide Why produce where marginal revenue equals marginal cost? –Producing past where MR = MC Incremental cost > Incremental revenue –Producing less than where MR = MC Incremental revenue > Incremental cost Cost and Monopoly Profit Maximization

Slide Figure 25-6 Maximizing Profits MC Quantity per Time Period D Price, Marginal Cost, and Marginal Revenue per Unit MR Q 1 B A Q m P m Q 2 F C

Slide Figure 25-7 Calculating Monopoly Profit Output per Time Period MC D MR ATC Q m P m Price, Marginal Revenue, and Cost per unit ($) Monopoly profit

Slide Figure 25-8 Monopolies: Not Always Profitable Losses MR P m C 1 Q m D ATC MC Output per Time Period Price, Marginal Revenue, and Cost per unit A

Slide Price Discrimination –Selling a given product at more than one price, with the difference being unrelated to differences in cost On Making Higher Profits: Price Discrimination

Slide Price Differentiation –Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers On Making Higher Profits: Price Discrimination

Slide Necessary conditions for price discrimination –The firm must face a downward-sloping demand curve –The firm must be able to separate markets at a reasonable cost On Making Higher Profits: Price Discrimination

Slide Necessary conditions for price discrimination –The buyers in the various markets must have different price elasticities of demand –The firm must be able to prevent resale of the product or service On Making Higher Profits: Price Discrimination

Slide The amount of out-of-pocket tuition you pay for your college courses may differ greatly from the amount paid by your classmates. Colleges tailor tuition charges to suit the financial resources of each student. This is a form of price discrimination. Example: Price Differentiation in College Tuition

Slide Figure 25-9 Example: Price Differentiation in College Tuition College Students Enrolled D P 7 Q 1 P 6 Q 2 P 5 Q 3 P 4 Q 4 P 3 Q 5 P 2 Q 6 P 1 Q 7 Tuition Price

Slide Scenario –Start with a perfectly competitive market in long-run equilibrium P e : Q d = Q s MR = MC P e = MC Zero economic profits The Social Cost of Monopolies

Slide Scenario –Now, assume the industry is acquired by one firm with no impact on cost. The Social Cost of Monopolies

Slide The Effects of Monopolizing an Industry Figure 25-10, Panels (a) and (b) MC m P m Q m D S = MC Panel (b) MR Quantity per Time Period D S = ΣMC Panel (a) Quantity per Time Period Price, Marginal Revenue, and Marginal Cost per Unit Price per Unit P e Q e E

Slide Issues and Applications: Business Method Patents Business method patents are granted for innovations combining computer software with business policies and procedures. It is not always clear which types of innovations really need patent protection. Each time a patent is granted, there is some part of a market that loses the efficiency that would arise from competition.

Slide Summary Discussion of Learning Objectives Why a monopoly can occur –Barriers to entry Demand and marginal revenue conditions faced by a monopolist –The monopolist’s demand curve is the industry demand curve –Marginal revenue is less than price

Slide Summary Discussion of Learning Objectives How a monopolist determines how much output to produce and what price to charge –Produce where marginal cost equals marginal revenue –Set price for that output on the demand curve

Slide Summary Discussion of Learning Objectives A monopolist’s profits –Price minus average total cost times output equals profits (losses)

Slide Summary Discussion of Learning Objectives Price discrimination –Selling at more than one price with the price differences being unrelated to differences in production costs –Buyers with the more elastic demand pay a lower price

Slide Summary Discussion of Learning Objectives Social cost of monopolies –Price exceeds marginal cost –The price is higher and output is lower for a monopolist as compared to a perfectly competitive industry

End of Chapter 25 Monopoly