1. Chapter 15 Monopoly

2. What is a monopoly?
Firm that is sole seller of product without close substitutes
Price Maker not a Price Taker
There are barriers to entry thru:
Monopoly Resources, Gov’t Regulation or Production Process
Will produce when P > MC

3. Monopoly resources
One firm has sole ownership of a key resource used in production of a good
DeBeers is good example with diamonds

4. Government-created monopolies
Usually created because of use of patents and copyrights
Trade-off is less competition, but encourages research & development

5. Natural monopolies
A single firm can supply a good/service to a market at a smaller cost than 2 or more firms could
There are economies of scale, ATC falls as scale becomes larger

6. How monopolies make production & pricing decisions
Demand curve for monopolist is downward sloping, not perfectly elastic as in a competitive market

7. A Monopoly’s revenue MR is always less than P for monopolist
True because of downward shaped D curve
When monopolist increases Q, there is an output effect (higher Q, increases TR) and a price effect (lower P, decreases TR)
MR can even be negative if price effect is greater than output effect

8. Demand & mr curves

9. Profit maximization
Also produce where MR = MC just like competitive markets
However for a monopoly:
P > MR = MC
So monopolist sets Q where MR = MC then goes up to Demand curve to set P

10. Profit maximization

11. Monopoly’s profit
Profit = (P – ATC) x Q

12. Welfare cost of monopolies
Does a monopoly maximize total surplus?
To do this, we would need to produce where Demand & MC intersect

13. Deadweight loss
Monopolist produces less than the socially efficient quantity of output
Similar to situation with a tax, but instead of tax revenue it is profit to the monopolist

14. Monopoly’s profit: Social cost?
Monopoly’s profit gives producers more surplus than consumers’ surplus, but keeps same total surplus as it would have had
Deadweight loss is created by inefficiently low level of output, not really the higher price

15. Price discrimination
Selling the same good at different prices to different customers
Ex: Hardback vs. Paperback Novels
Strategy for monopolists to increase profit
Requires ability to separate customers based on their willingness to pay
Can raise economic welfare by lowering DWL, shows up as higher producer surplus

16. Arbitrage
Buying a good at a lower price in one market and reselling it in another market at a higher price
This prevents price discrimination by monopolists

17. Perfect price discrimination
Monopolist knows exactly each customer’s willingness to pay and can charge each person a different price
In this case, consumer surplus is zero and total surplus equals the firm’s profit – no DWL

18. Examples of price discrimination
Movie tickets
Airline prices
Discount coupons
Financial aid
Quantity discounts

19. Public policy 1. Antitrust Laws Sherman Antitrust Act (1890)
Clayton Antitrust Act (1914)
Allows gov’t to prevent mergers that limit competition, and can break up companies that reduce social welfare
Can the gov’t effectively judge social benefit vs. social cost?

20. Public policy 2. Regulation
Often regulate prices of natural monopolies (PUCO)
Where does the gov’t set the price? MC pricing?
Problem with that is MC < ATC for monopolist, so this would mean the company loses $

21. Regulation Alternatives:
Subsidize the monopoly: but this creates need for taxes to pay for it & more DWL
Average-cost pricing: like a tax on the good because P no longer = MC
MC-pricing also gives no incentive to monopolist to lower costs (unless you let them keep part of cost savings as profit)

22. Public policy 3. Public Ownership
Common in Europe; in U.S., we do this with Post Office
Problem again is creating incentive to cut costs

23. Public policy
4. Doing Nothing - All “solutions” to monopolies have their drawbacks, so many economists prefer doing nothing