Monopoly

Intro video

Features of Monopoly Single seller No close substitute Price maker – since the monopolist controls the total output in the market, they determine the price

Features of Monopoly Entry is blocked Nonprice competition Relatively rare – Government owned utilities – “Near monopolies” (high market share)

Barriers to Entry Economies of scale – Monopolists are usually large firms New entrants can’t compete Legal Barriers to Entry – Patents – Licenses

More Barriers Ownership or Control of Essential Resources Pricing and Other Strategic Barriers – Cutting prices to deter new entrants

Building the Model of a Monopoly Assumptions: – Patent’s, economies of scale, or resource ownership secure a firm’s monopoly – No unit of government regulates the firm – The firm is a single price monopolist Charges all consumers the same price

Monopoly Demand Perfect competition seller faces perfectly elastic demand at the price determined by market supply and demand – MR is constant and equal to price Since the monopolist IS the market its demand curve is the market demand curve – Downward sloping

Marginal Revenue is Less than Price Since demand is downward sloping sales can only increase with a drop in price – So MR <AR except for the first unit – The lower price of the extra unit of output also applies to all prior units of outputs – Each additional unit of output sold increases TR by an amount equal to its own price less the sum of the price cuts that apply to all prior units of output

Monopoly Demand Data

Monopoly Demand Graph

MR and TR

Pricing Decisions By determining output, the monopolist also determines price Since demand is downward sloping, can apply the TR test to determine profit maximizing price and output Price set at or near point where E d = 1

Output and Price Determination

MR=MC Rule If producing is preferable to shutting down, a monopolist will produce up to the output at which marginal revenue equals marginal cost Output equals 5 units in textbook example – If cannot get MR=MC, choose last level of output where MR>MC

Monopoly Graph

Helpful Graphing Hints

Monopoly Supply Curve The pure monopolist has no supply curve The monopolist does not equate MC to price – Different demand conditions can result in different prices for the same output

Pricing Misconceptions Monopolists don’t charge the highest price – Apply the TR test – Seek to maximize total profit, not price Total, Not unit, Profit – Maximizing distance between ATC and price does not maximize profit

Monopoly Losses Likelihood of economic profit is higher for a monopolist than for a pure competitor – Profits are not guaranteed Change in tastes, costs Must maintain at least a normal profit in the long run or it will go out of business

Economic Effects of Monopoly Under pure competition – long run efficiency is P = MC = minimum ATC

Efficiency Loss and Monopoly P exceeds MC P exceeds lowest ATC Producer surplus + Consumer surplus are not maximized Income Transfer: monopoly transfers income from consumers to stockholders of the monopoly since they can charge a higher price than would occur under perfect competition

Cost Complications Costs may not be the same for purely competitive and monopolist producers – Economies of scale – X-inefficiency – The need for monopoly-preserving expenditures – Very long run perspective Allows for technological advance

Economies of Scale Market demand may not be sufficient to support a large number of competing firms each producing at MES – Natural monopoly has lowest ATC Simultaneous consumption – a product’s ability to satisfy a large number of consumers at the same time (Dell vs. Microsoft example) Network effects – the value of a product to each user, including existing users, increases as the total number of users increases

Other Cost Issues X Inefficiency occurs when a firm produces output, whatever the level, at a higher cost than is necessary to produce – Usually“non economic” reason Rent seeking expenditures are any activities designed to transfer income or wealth to a particular firm or resource supplier at someone else’s or society’s expense Technological advance – monopolists tend not to be technologically progressive (unless it is a barrier to entry

Assessment and Policy Options What should the government do about a monopoly? – If abusive, file charges – If a natural monopoly, allow it to continue – If it is unsustainable, ignore it or hasten its demise

Price Discrimination Charging each customer in a single market the maximum price he/she is willing to pay – Eliminate all consumer surplus Charge each customer one price for the first set of units purchased and a lower price for subsequent units purchased Charging some customers one price and other customers another price

Conditions Monopoly power Market segregation No resale Examples – Movie theaters – Airlines – Discount coupons

Price Discrimination Graphs

Regulated Monopoly Natural monopolies Socially optimal price ® allocative efficiency at P=MC=D Fair return price (f) D=ATC Dilemma of regulation