Monopoly Topic 6

MONOPOLY- Contents 1. Monopoly Characteristics 2. Monopoly profit maximization 3. Assessment of Monopoly 4. Regulation of Monopoly 5. Price Discrimination

Characteristics of a pure monopoly Single seller High barriers to entry Unique Product

Barriers to Entry High barriers to entry explain the existence of monopolies Block all potential competitors

Barriers to Entry Economies of scale In some industries, efficient, low-cost production can only be achieved if producers are large – Natural monopoly Legal Barriers Regulations, Patents and Licences Control of the supply of raw materials

Monopoly Demand curve Monopolist’s demand curve is the industry demand curve and therefore is down-sloping Monopolist is a ‘price maker’ since it can influence total supply

$ Q O D Demand Curve of a Monopoly Firm Copyright 2001 Pearson Education Australia

Q Dollars MR Elastic Q D TR Inelastic Unit Elasticity Unit Elasticity Demand, Marginal Revenue, Total Revenue

Demand and MR Demand curve: P= a - bQ MR= a – 2bQ D & MR start from the same point Everywhere else MR bisects the distance between D curve & vertical axis

Profit maximisation under Monopoly Rules for Profit maximization same as under Perfect Competition MR = MC (where MC cuts MR from below) Short Run: P ≥ AVC Long Run : P ≥ ATC

Profit maximising under monopoly $ Q O MC QmQm MR AR Copyright 2001 Pearson Education Australia

$ Q O ATC MC AR AC QmQm MR AR a b Profit maximising under monopoly Copyright 2001 Pearson Education Australia

$ Q O ATC MC AR AC QmQm MR AR Profit maximising under monopoly Copyright 2001 Pearson Education Australia

Profit maximisation under Monopoly Profit Maximisation Loss Minimisation

Points to remember No supplier will produce an output corresponding to the inelastic section of the demand curve. Why?

Points to remember A monopolist will not charge the highest price possible (A monopolist seeks to maximise profit, not necessarily price) A monopolist will not maximize profit per units but total profits Monopolies are not always making profit Losses are possible Pure monopoly does not guarantee economic profits In the short-run, monopolist may experience losses because of weak demand or high costs

Assessment of Monopoly Comparison with PC (with no monopolist economies of scale) No economies of scale: means that the cost curve ( MC & AC) are the same under both PC and Monopoly Monopoly: higher price, lower output smaller consumer surplus no allocative efficiency no productive efficiency deadweight loss to society (area ABE)

Assessment of Monopoly Comparison with PC (with monopolist economies of scale) Economies of scale: means that the costs will be lower under Monopoly Monopoly: lower price, higher output larger consumer surplus more efficient as overall costs will be lower than under PC

Assessment of other factors Income distribution: Monopoly profits tend to concentrate in higher income groups. X-inefficiency the difference between theoretically defined efficient behavior of firms and how they actually behave Monopoly tends to perform less well compared to PC since they face less pressure to improve efficiency & cut costs Technological progress: Monopoly have financial resources hence more R& D than competitive firms

Regulating Monopolies Historically, monopolies have been operated or heavily regulated by the government Competition policy & Legal action: Actions against firms overcharging price Incentives to new entrants Price ceilings at the point where MC cuts the D curve (allocative efficiency achieved)

More about price ceilings - When MC is increasing- Price ceiling is set at P C Increase in consumer surplus: PmAEPc Allocative efficiency is achieved (Price = MC) Deadweight lost ABE is eliminated Monopolist still earn a profit: PcETPt

More about price ceilings - When MC is decreasing- Two part pricing regulation: Price ceiling is set at PC Monopoly firm will incur a loss PaPcEB Allow monopolist to charge a fixed fee so that the loss will be recovered

Price Discrimination Prerequisites There is Monopoly control Clearly identifiable market segments between which resale cannot take place Different price elasticities of demand in the different segments This is 3 rd degree price discrimination

Degrees of price discrimination 1 st Degree Each unit sold at the highest price a buyer is willing to pay (leaving zero consumer surplus) 2 nd Degree Different prices charged for blocks of output, rather than each unit as in 1 st degree discrimination 3 rd Degree Different prices to different groups of consumers. Within a group the price remains constant irrespective of the number of units consumed