10 Monopoly The price of monopoly is upon every occasion the highest which can be got. ADAM SMITH Monopoly The price of monopoly is upon every occasion the highest which can be got. ADAM SMITH

●Monopoly Defined ●The Monopolist’s Supply Decision ●Can Anything Good Be Said About Monopoly? ●Price Discrimination Under Monopoly ●Monopoly Defined ●The Monopolist’s Supply Decision ●Can Anything Good Be Said About Monopoly? ●Price Discrimination Under Monopoly Contents Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Monopoly Defined ●Only one firm in the industry ●No close substitute for the product ●Little chance of successful entry by a competitor ●Only one firm in the industry ●No close substitute for the product ●Little chance of successful entry by a competitor

●Barriers to entry ♦Legal restrictions ♦Patents ♦Control of a scarce resource or input ♦Deliberately erected entry barriers ♦Large sunk costs ●Barriers to entry ♦Legal restrictions ♦Patents ♦Control of a scarce resource or input ♦Deliberately erected entry barriers ♦Large sunk costs Sources of Monopoly Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

●Cost advantages ♦Technical superiority ♦Economies of scale ●Cost advantages ♦Technical superiority ♦Economies of scale Sources of Monopoly Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

●Declining long-run average costs ●When a large firm can produce and sell more cheaply than a small firm ●Declining long-run average costs ●When a large firm can produce and sell more cheaply than a small firm Natural Monopoly Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

FIGURE 10-1 Natural Monopoly AC Average Cost Quantity Supplied $3.00 C B A Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ●Price maker (or price searcher) ●Faces a negatively sloped demand curve ●Standard supply-demand analysis does not apply. ●Price maker (or price searcher) ●Faces a negatively sloped demand curve ●Standard supply-demand analysis does not apply.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ●Joint decision about price and output ●Marginal revenue < selling price ●Joint decision about price and output ●Marginal revenue < selling price

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ●Monopolist sets output where MC = MR ●Market demand  price for this output ●P > MR ●Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost. ●Monopolist sets output where MC = MR ●Market demand  price for this output ●P > MR ●Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.

FIGURE 10-2 Profit-Maximizing Equilibrium for a Monopolist MC 0 4 $9 AC Quantity Price per Unit C D(AR) D P MR M Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

TABLE 10-1 A Monopolist’s Price-Output Decision Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ●Compared to perfect competition, a monopoly: ♦May enjoy a long-run profit ♦Restricts its output to raise its selling price (both in the long and short runs) ♦Leads to inefficient resource allocation (MC < MU) ●Compared to perfect competition, a monopoly: ♦May enjoy a long-run profit ♦Restricts its output to raise its selling price (both in the long and short runs) ♦Leads to inefficient resource allocation (MC < MU)

FIGURE 10-3 Compare Monopoly to Competitive Industry 300 $9 AC Quantity Price per Unit D(AR) D MC MR B P M C Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Can Anything Good Be Said About Monopoly? ●Under some circumstances a monopoly may: ♦Raise demand for its product (thus negating the inefficient reduction in output noted above) ♦Reduce marginal and average cost (produce more efficiently) ♦Stimulate innovation ●Under some circumstances a monopoly may: ♦Raise demand for its product (thus negating the inefficient reduction in output noted above) ♦Reduce marginal and average cost (produce more efficiently) ♦Stimulate innovation

●Natural monopoly = average costs fall as output rises ●Costs of production would be higher if a natural monopoly were broken up into many smaller firms. ●Natural monopoly = average costs fall as output rises ●Costs of production would be higher if a natural monopoly were broken up into many smaller firms. Natural Monopoly: Where Single- Firm Production Is Cheapest Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

●Natural monopolies may allow lower average cost than a market with numerous competing firms. (Natural monopoly must be regulated in order for consumers to receive lower prices, however.) ●Monopolist may have incentive to produce more innovation than firms in more competitive markets. ●Natural monopolies may allow lower average cost than a market with numerous competing firms. (Natural monopoly must be regulated in order for consumers to receive lower prices, however.) ●Monopolist may have incentive to produce more innovation than firms in more competitive markets. Natural Monopoly: Where Single- Firm Production Is Cheapest Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Price Discrimination Under Monopoly ●Price discrimination = charge different prices to different groups of customers (or charge the same price in markets where costs vary) ●Allows a monopolist to maximize profits ●Price discrimination = charge different prices to different groups of customers (or charge the same price in markets where costs vary) ●Allows a monopolist to maximize profits

Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Price Discrimination Under Monopoly ●Monopolist sets marginal revenue (not price) equal in each market ●Assumes equal cost conditions in each markets ●Monopolist sets marginal revenue (not price) equal in each market ●Assumes equal cost conditions in each markets

FIGURE 10-4 Prices/Quantities under Price Discrimination D b D b MR a Q a b Q b P b W (b) Customer Group BCustomer Group A Quantity 0 HH Price (a) Quantity D a D a 0 J P a Copyright© 2003 South-Western/Thomson Learning. All rights reserved.

●No, although sometimes justice appears to demand different prices in different markets. ●In some cases, price discrimination may be necessary for a firm to survive. ●In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices. ●No, although sometimes justice appears to demand different prices in different markets. ●In some cases, price discrimination may be necessary for a firm to survive. ●In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices. Is Price Discrimination Always Undesirable? Copyright© 2003 South-Western/Thomson Learning. All rights reserved.