11-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 11 Pure monopoly

11-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives Review the nature of barriers to entry into an industry, their form and their likely occurrence Examine demand from a monopolist’s viewpoint Understand how monopoly adjusts price and output in short-run and long-run situations

11-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives (cont.) Compare the outcome of a monopoly industry with that of one that is purely competitive. Is the allocative and productive efficiency observed in pure competition achieved by the monopolist? Discuss whether government can play a role in modifying monopoly behaviour

11-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Barriers to entry High barriers to entry explain the existence of monopolies Entry barriers block all potential competitors Economies of scale: –Defined as the forces that reduce the average cost of producing a product as the firm expands the size of the output in the long run –In some industries, efficient, low-cost production can only be achieved if producers are large

11-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Barriers to entry (cont.) Ownership of essential raw materials –BHP controlled all known iron deposits in Australia in the 1940s and 1950s Legal barriers: patents and licences Note: –Pure monopolies are rare –Monopolies may be desirable or undesirable depending on what premise is used –Natural monopoly occurs in industries whose technological and economic realities are out of the possibility of competitive markets

11-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Monopoly demand Three assumptions: 1.Monopolist’s position is guaranteed: –Ownership of patent or control of raw materials 2.No prospect of government intervention or regulation of the firm 3.Monopolist does not discriminate between buyers by charging different prices

11-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Monopoly demand (cont.) Monopolist’s demand curve is the industry demand curve and therefore is down-sloping Price (P) exceeds marginal revenue (MR) Monopolist is a ‘price maker’ since it can influence total supply

11-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Marginal Revenue Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or Loss – Average Total Cost Total Cost $ ] ] $ ] ] ] ] ] ] ] ] ] $ – 18 $ $ ] ] ] ] ] ] ] ] ] – $100 – – 14 – 142 – 310 Monopoly revenue and cost ] ]

11-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Monopoly demand Price elasticity and total revenue Marginal revenue is negative beyond the point of unit elasticity of demand

11-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Q Dollars MR Elastic Q D TR Inelastic Unit elasticity Unit elasticity Demand, MR, TR: imperfectly competitive firm

11-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Price and output determination Profit-seeking monopolist employs same rationale as in a competitive industry: –MR = MC rule No supply curve. Why? –At any given demand and cost conditions, there is only one profit-maximising price–output combination

11-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Misconceptions concerning monopoly pricing Not highest price –Monopolists seek to maximise profit, not necessarily price Total profits not unit profits –Monopolists seek to maximise total profit, not necessarily per-unit 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

11-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Profit Q P D MR MC ATC $94 $122 MR = MC Profit per unit Competitive price Profit maximisation under a pure monopoly

11-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Loss Q P D MR MC ATC Loss per unit AVC Loss minimisation under monopoly MR = MC

11-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic effects of monopoly Productive inefficiency: – Minimum ATC is not necessarily chosen Allocative inefficiency: – P price does not necessary equal MC –Monopoly will produce a smaller output and charge a higher price than would a competitive industry Income distribution –Substantial economic profits of a monopolist are not widely distributed and are often concentrated in the hands of upper income groups, contributing to inequality in the distribution of income

11-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Q P D MR MC PmPm QmQm Monopolist will sell less units at a higher price than in competition PcPc QcQc Profit maximisation under monopoly

11-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Economic effects of monopoly (cont.) Cost complications Economies of scale –Demand may not be sufficient to support a large number of competing firms. Only a single firm can produce the output efficiently — natural monopoly X-inefficiency –The failure to produce any given output at the lowest average cost possible Very long run may allow for technological progress

11-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Technological progress Dynamic efficiency: –Ability to develop the most efficient production techniques over time Are purely competitive firms or monopolists more innovative over time? –The competitive model — has the incentive to be efficient to reap economic profits over time –The monopolist model — barriers to entry ensure economic profit even in the long run, and the incentive to develop new product and techniques will be weak

11-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Price discrimination A situation where a given product is sold at more than one price and the price differences are not justified by cost differences Three required conditions are: Monopoly power Market segmentation No resale

11-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Price discrimination (cont.) Consequences More profits –Price discrimination can yield additional profits for a monopolist More production –The discriminating monopolist will produce a larger output than a non-discriminating monopolist

11-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Regulating monopolies Historically, in Australia monopolies have been operated or heavily regulated by the government Socially optimal price: P = MC –May result in severe losses ‘Fair-return’ price: P = AC –Normal profit is generated –Only partially resolves problem of under-allocation

11-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Regulated monopoly Q D MR P Price and costs MC ATC Monopoly price: MR = MC Fair return price: Price = ATC Socially optimum price: Price = MC

11-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: Monopolistic competition