Pure Monopoly 13 McGraw-Hill/IrwinCopyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Four Market Models LO1 Characteristics of the Four Basic Market Models Characteristic Pure Competition Monopolistic CompetitionOligopolyMonopoly Number of firmsA very large number ManyFewOne Type of productStandardizedDifferentiatedStandardized or differentiated Unique; no close subs. Control over price NoneSome, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Considerable Conditions of entry Very easy, no obstacles Relatively easySignificant obstacles Blocked Nonprice competition NoneConsiderable emphasis on advertising, brand names, trademarks Typically a great deal, particularly with product differentiation Mostly public relation advertising ExamplesAgricultureRetail trade, dresses, shoes Steel, auto, farm implements Local utilities

An Introduction to Pure Monopoly Single seller – a sole producer No close substitutes – unique product Price maker – control over price Blocked entry – strong barriers to entry block potential competition Non-price competition – mostly PR or advertising the product LO1 Public utility companies Natural Gas Electric Water Near monopolies Intel Wham-O Professional sports teams

Barriers to Entry Barrier to entry: a factor that keeps firms from entering an industry Economies of scale Legal barriers: patents and licenses Ownership of essential resources Pricing LO1

Monopoly Demand The pure monopolist is the industry Demand curve is the market demand curve Downsloping demand curve Marginal revenue is less than price LO1

Monopoly Demand Marginal revenue < price Monopolist is a price maker Monopolist sets prices in elastic region of demand curve LO2

Output and Price Determination LO2 Steps for Graphically Determining the Profit-Maximizing Output, Profit- Maximizing Price, and Economic Profits (if Any) in Pure Monopoly Step 1 Determine the profit-maximizing output by finding where MR=MC. Step 2 Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist’s demand curve. Step 3 Determine the pure monopolist’s economic profit by using one of two methods: Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any). Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any).

$ Price, Costs, and Revenue Quantity Output and Price Determination LO2 0 D MR ATC MC MR=MC A=$94 Economic Profit P m =$122

Misconceptions of Monopoly Pricing Not highest price Total profit Possibility of losses LO2

Misconceptions of Monopoly Pricing LO2 0 Price, Costs, and Revenue Quantity D MR ATC MC MR=MC Loss AVC PmPm QmQm V A

Economic Effects of Monopoly LO3 (a) Purely Competitive Market (b) Pure Monopoly D D S=MC MC P=MC= Minimum ATC MR PcPc QcQc PcPc PmPm QcQc QmQm Pure competition is efficient Monopoly is inefficient a b c d

Economic Effects of Monopoly Income transfer Cost complications Economies of scale X-Inefficiency Rent seeking expenditures Technological advance LO3

X-Inefficiency LO3 0 Average total costs Quantity ATC 2 ATC 1 ATC x Q1Q1 Q2Q2 Average Total Cost X X' ATC x'

Price Discrimination Price discrimination Charging different buyers different prices Price differences are not based on cost differences Examples: business travel, electric utilities, movie theaters, golf courses, railroad companies, coupons, international trade LO4 Price Discrimination

Conditions for success: Monopoly power Market segregation No resale Price Discrimination LO4

Regulated Monopoly Natural monopolies Socially optimal price Set price = marginal cost Fair return price Set price = ATC LO5

Regulated Monopoly LO5 0 Price and Costs (Dollars) Quantity Monopoly Price Fair-Return Price Socially Optimal Price PrPr D r f b a PfPf PmPm QmQm QfQf QrQr MR MC ATC