1. Monopoly 15

2. Monopoly A firm is considered a monopoly if... it is the sole seller of its product. it is the sole seller of its product. its product does not have close substitutes. its product does not have close substitutes. While a competitive firm is a price taker, a monopoly firm is a price maker.

3. HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS Monopoly versus Competition Monopoly Is the sole producer Faces a downward-sloping demand curve Is a price maker Reduces sales to raise price Competitive Firm Is one of many producers Faces a horizontal demand curve Is a price taker Sells as much or as little at same price

4. WHY MONOPOLIES ARISE The fundamental cause of monopoly is barriers to entry.

5. WHY MONOPOLIES ARISE Some barriers to entry: Ownership of a key resource. Ownership of a key resource. The government gives a single firm the exclusive right to produce some good. The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers. Costs of production make a single producer more efficient than a large number of producers.

6. Monopoly Resources Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.

7. Government-Created Monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.

8. Natural Monopoly An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. A natural monopoly arises when there are economies of scale over the relevant range of output.

9. Economies of Scale as a Cause of Monopoly Quantity of Output Average total cost 0 Cost 20 40 5 7 A monopoly Firm produces 40 units at a cost of $5/unit If this output was produced in a market with two firms, each produces 20 units and average cost rises to $7/unit

10. Demand Curves for Competitive and Monopoly Firms Quantity of Output Demand (a) A Competitive Firm’s Demand Curve(b) A Monopolist’s Demand Curve 0 Price Quantity of Output 0 Price Demand Since a monopoly is the sole producer in its market, it faces the market demand curve.

11. A Monopoly’s Total, Average, and Marginal Revenue

12. A Monopoly’s Revenue Marginal Revenue ∆TR/∆Q = MR ∆TR/∆Q = MR How does MR compare to P in a monopoly market? To sell an extra unit the monopolist has to lower price. To sell an extra unit the monopolist has to lower price. He sells the extra unit at the new price (thus total revenue rises), but lowers price on all previous units sold (which reduces total revenue) He sells the extra unit at the new price (thus total revenue rises), but lowers price on all previous units sold (which reduces total revenue) MR<P MR<P

13. A Monopoly’s Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P  Q) The output effect—more output is sold, so Q is higher. The price effect—price falls, so P is lower. $5 $4 PQTRMR $5315 $1 $4416 Note that MR<P

14. Total Revenue Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 –1 –2 –3 –4 12345678 Total Revenue increases and then decreases. The slope of the total revenue curve is MR 9 Total Revenue

15. Q Total Revenue increases and then decreases. The slope of the total revenue curve is MR Total Revenue Q Marginal Revenue Marginal Revenue is the slope of the total revenue curve Marginal revenue is positive (negative) when total revenue is increasing (decreasing) Marginal revenue is zero when total revenue reaches a maximum

16. Demand and Marginal-Revenue Curves for a Monopoly Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 –1 –2 –3 –4 Demand (average revenue) Marginal revenue 12345678 If a monopoly wants to sell more, it must lower price. Price falls for ALL units sold. This is why MR is < P.

17. Profit Maximization A monopoly maximizes profit by producing the quantity where: MR= MC To induce consumers to buy that quantity, the monopolist uses the demand curve to find the right price

18. Profit Maximization Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 –1 –2 –3 –4 12345678 Total Cost 9 Total Revenue MC MR

19. Profit Maximization for a Monopoly Quantity QQ0 Costs and Revenue Demand ATC Marginal revenue Marginal cost Monopoly price Q MAX B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... A 2.... and then the demand curve shows the price consistent with this quantity. The monopolist earns an economic profit as long as price is greater than average total cost

20. Profit Maximization Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. For a monopoly firm, price exceeds marginal cost. P > MR = MC Remember, all profit-maximizing firms set MR = MC.

21. Monopoly vs. PC market pricing: Market for Drugs Quantity 0 Costs and Revenue Demand Marginal revenue Price during patent life Monopoly quantity Marginal cost Competitive quantity When the patent expires, the market becomes a perfect competitive market. The competitive quantity is where Demand intersects Supply (MC)

22. THE WELFARE COST OF MONOPOLY From the standpoint of consumers, the high price makes monopolies undesirable However, from the standpoint of the firm, the monopoly power is desirable since it results in higher profit

23. Two concepts of efficiency 1. Allocative efficiency is achieved when the quantity produced results in The maximum possible sum for consumer and producer surplus The maximum possible sum for consumer and producer surplus Marginal benefit to society from the last unit produced equals the marginal cost. Marginal benefit to society from the last unit produced equals the marginal cost. In the absence of externalities, Demand (price) =MC. In the absence of externalities, Demand (price) =MC.

24. Allocative Efficiency Quantity 0 Price Demand (value to buyers) Marginal cost Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller. Cost to Firm Cost to Firm Value to buyers Value to buyers Efficient Quantity

25. Two concepts of efficiency 2. Production efficiency: achieved when the firm produces an output level at which average total cost reaches a minimum. Average total cost Q

26. The Inefficiency of Monopoly Quantity 0 Price Deadweight loss Demand Marginal Benefit Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity ATC Production Efficiency Allocative Efficiency

27. The Deadweight Loss The Inefficiency of Monopoly The monopolist sets its P > MC and produces less than the socially efficient output level. Allocative efficiency is not achieved The monopolist sets its P > MC and produces less than the socially efficient output level. Allocative efficiency is not achieved The per unit cost of a monopoly may not be at its minimum. Production efficiency is not necessarily achieved The per unit cost of a monopoly may not be at its minimum. Production efficiency is not necessarily achieved

28. PUBLIC POLICY TOWARD MONOPOLIES Government responds to the problem of monopoly in one of four ways. Making monopolized industries more competitive. Making monopolized industries more competitive. Regulating the behavior of monopolies. Regulating the behavior of monopolies. Turning some private monopolies into public enterprises. Turning some private monopolies into public enterprises. Doing nothing at all. Doing nothing at all.

29. Competition versus Monopoly: A Summary Comparison