Monopoly!

Review: Perfect Competition In perfect competition: –Firms are price takers –Marginal revenues are constant (MR=P) –Firms cannot control price, but can control quantity they produce –Firms can enter and leave market easily –Many firms' production comprises the supply curve –Firms face a flat demand curve (they can sell as much or as little at the market price) Few markets are truly perfect competition, but model is still instructive

Defining Monopoly True monopoly: –Firm has no rivals –No close substitutes for its product –Entry of rivals is prohibitively difficult Many competitive firms strive to achieve these characteristics (How does Apple try?) Monopolies are price setters –Firms set both price and quantity produced –Monopoly’s output alone defines the supply curve –Setting price is known as “monopoly power” –Monopolies face a downward sloping demand curve (they can sell more, but only at a lower price)

What Causes Monopoly? “Barriers to entry” prevent rival firms from entering market. Caused by: –Economies of scale: one firm can satisfy all demand with increasing efficiency (e.g. Xcel energy) –Location (market may not be sufficient to support more than one firm) –“Sunk costs:” high up-front fixed costs that firms can’t recoup if they leave the industry –Restricted ownership of inputs: one firm owns all of a required factor of production (De Beers) –Government restrictions: government gives monopolistic license to one firm( e.g., license to operate, patents)

Marginal Revenue for Monopolies For perfectly competitive firms, MR = P For monopolies, MR will fall as output rises Remember: monopolies must produce at a price/quantity combination dictated by the demand curve If they want to increase output, they must lower price or else some units will go unsold. They lower price for all buyers. Assuming they sell all units at same price, increasing output will lower the average revenue (AR = P for monopolies) MR will always bisect x-axis value of demand curve MR will cross axis where demand is “unit elastic” (increasing Q after that point will decrease revenues)

How Monopolies Set Prices Monopolies can set prices and quantity, but combination is dictated by demand curve Can’t set any price/quantity combination Aren’t guaranteed large profits Even for monopolies, MR=MC Find MR=MC then find quantity and price Profit = Q x (P-ATC) just as for perfectly competitive firms Monopolies will always produce in the elastic portion of the demand curve to maximize profits (unless forced by government to do otherwise)

Thoughts about Monopolies Monopolies are price setter – but can they set any price? Monopolies can choose their production quantity – but can they set any quantity? Are monopolies’ profits always huge? Why do monopolies always produce at the elastic portion of the demand curve? If production were in a competitive market, would more or less be produced? (Can you use the graph to say at which quantity and price?) Which area is the deadweight loss incurred by society when firms produce at monopoly pricing? What does this loss mean?

Thoughts about Monopolies Do monopolies maximize their revenue? Where would this occur? Where would the most allocatively efficient point be from society’s perspective? Why are monopolies considered a form of “market failure?” For the monopoly pictured, what would be required of the government if it were to force the firm to produce at the most allocatively efficient quantity?