1. Chapter 25 Monopoly Economics, 7th Edition Boyes/Melvin http://www.youtube.com/watch?v=cuQUen Y_dNg&feature=related

2. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 2 What is a Monopoly? A monopoly is a market structure in which there is a single supplier of a product. The monopoly firm (monopolist): –May be small or large. –Must be the ONLY supplier of the product. –Sells a product for which there are NO close substitutes. Monopolies are fairly common: U.S. Postal Service, local utility companies, local cable providers, etc.

3. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 3 The Creation of Monopolies Monopolies often arise as a result of barriers to entry. Barrier to entry: anything that impedes the ability of firms to begin a new business in an industry in which existing firms are earning positive economic profits. There are three general classes of barriers to entry: –Natural barriers, the most common being economies of scale –Actions by firms to keep other firms out –Government (legal) barriers

4. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 4 Economies of Scale In some industries, the larger the scale of production, the lower the costs of production. Entrants are not usually able to enter the market assured of or capable of a very large volume of production and sales. This gives incumbent firms a significant advantage. Examples are electric power companies and other similar utility providers.

5. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 5 Economies of Scale

6. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 6 Actions by Firms Entry is barred when one firm owns an essential resource. Examples are inventions, discoveries, recipes, and specific materials. –Microsoft owns Windows, and has been challenged by the U.S. Dept. of Justice as a monopolist.

7. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 7 Government Governments often provide barriers, creating monopolies. As incentives to innovation, governments often grant patents, providing firms with legal monopolies on their products or the use of their inventions or discoveries for a period of 17 years.

8. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 8 Types of Monopolies Natural monopoly: A monopoly that arises from economies of scale. The economies of scale arise from natural supply and demand conditions, and not from government actions. Local (or geographic) monopoly: a monopoly that exists in a limited geographic area. Regulated monopoly: a monopoly firm whose behavior is overseen by a government entity. (government or technological) Monopoly power: market power, the power to set prices. Monopolization: an attempt by a firm to dominate a market or become a monopoly.

9. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 9 The Demand Curve Facing a Monopoly Firm In any market, the industry demand curve is downward-sloping. This is the result of the law of demand. Critical to understanding the profit maximization of the monopolist is remembering that the monopolist IS the industry because it is the sole producer. Therefore the monopolist confronts a downward-sloping demand curve. The industry demand curve is the firm’s demand curve.

10. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 10 Marginal Revenue Recall that the marginal revenue (MR) is: MR is less than price for a monopoly firm. The MR is less than price and declines as output increases because the monopolist must lower the price in order to sell more units (because the demand curve slopes downward).

11. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 11 Demand Curve for Monopoly Firm

12. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 12 Average Revenue Whenever MR is greater than AR, AR rises. Whenever MR is less than AR, AR falls. Average revenue is: Note that the AR is the same as price. In fact, the AR curve is the demand curve. With a downward-sloping demand curve, prices fall as output increases. This means that AR falls. MR must always be less than AR.

13. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 13 Demand and Revenue for the Monopolist

14. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 14 Profit Maximization The monopoly firm will not set the price arbitrarily high, the profit-maximizing price still corresponds to the point where MR=MC. The monopoly firm’s market power will allow the firm to achieve above-normal profits.

15. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 15 Profit Maximization

16. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 16 Monopoly Profit and Loss A monopolist will suspend operations in the short run if its price does not exceed the average variable cost at the quantity the firm produces. A monopolist will shut down permanently if revenue is not likely to equal or exceed all costs in the long run. In contrast, however, if a monopolist makes a profit, barriers to entry will keep other firms out of the industry.

17. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 17 Monopoly Myths 1.A monopolist can charge any price it wants and will reap unseemly profits by continually increasing the price. 2.A monopolist is not sensitive to customers. 3.A monopolist cannot make a loss.

18. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 18 Price Discrimination Under certain conditions, a firm with market power is able to charge different customers different prices. This is called price discrimination.

19. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 19 Necessary Conditions for Price Discrimination For price discrimination to work, the firm must be able to set the price. The firm must be able to “segment the market” That is, the firm must be able to: –Separate the customers –Prevent resale of the product

20. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 20 Price Discrimination in Action

21. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 21 The Early Bird Gets a Lower Price Early Bird Specials— Restaurants charge special, lower prices for early diners. Matinees—Theaters charge less for earlier shows. Air Fares—Airlines charge less for flyers willing to fly “off peak,” i.e. early morning and late night.

22. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 22 Perfect Price Discrimination By discriminating, a monopoly firm makes greater profits than it would make by charging both groups the same price. A firm with market power could collect the entire consumer surplus if it could charge each customer exactly the price that that customer was willing and able to pay. This is called perfect price discrimination.

23. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 23 Monopoly and Perfect Competition: Comparison

24. Copyright © Houghton Mifflin Company. All rights reserved. 25 | 24 Utility Companies and Competition The federal government opened the business of generating electricity to competition a decade ago hoping to lower prices for consumers. Results have been varied. Three states in the New York area opened their electricity markets to competition, with different results: –In Connecticut, residential electric rates rose 27 percent. –In New Jersey, rates rose 13 percent. –In New York, however, residential customers paid an inflation- adjusted average of 16 percent less than before deregulation.