1. Lecture 9 Monopoly
Sources:  
Case, Fair, Oster, Introduction to Microeconomics
Case, Fair, Principles of Microeconomics

2. Market Structures: Briefly
Perfectly Competitive:
many firms
identical products
free entry and exit
full and symmetric information
Monopoly:
single firm
no close substitutes, only imperfect substitutes in related markets
barriers to entry and possibly exit
full and symmetric information, or possibly not
Monopolistic competition:
several firms
similar products but with some degree of differentiation
Oligopoly:
A few firms full and symmetric information, or possibly not
similar products, degree of product differentiation varies depending upon the market
there often are barriers to entry of some kind

3. Classic Monopoly Structure
Single firm  firm is the market
No extremely close substitutes, only imperfect substitutes in related markets
Barriers to entry and possibly exit
Full and symmetric information, or possibly not

4. Sources of Monopoly Entry Barriers
Technical:
Natural monopoly
Vital input ownership
Technical secrets
Legal:
Patents
Franchises
Licenses
Strategic:
Buy ‘em up
Blow ‘em up
Let’s make a deal (cartel)

5. Monopoly
Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political.
For instance, a government can create a monopoly over an industry that it wants to control, such as electricity.
Another reason for the barriers against entry into a monopolistic industry is that oftentimes, one entity has the exclusive rights to a natural resource.
For example, in Saudi Arabia the government has sole control over the oil industry.
A monopoly may also form when a company has a copyright or patent that prevents others from entering the market.

6. A natural monopolist or the largest supplier is often the first supplier to have entered the said industry. What Causes Natural Monopoly? There are a couple of cost factors that are responsible for the rise of a natural monopoly.
The initial cost of setting up a business, although generally large for all enterprises, varies in magnitude from industry to industry. In case of a prospect venturing into a business involving a public utility, the initial investment cost is gigantic. This acts as an entry barrier for most enterprises despite the prospects of tremendous earnings once the revenues start rolling in and that is the reason why we see very few entrants in the utilities sector.

7. The Classic Monopoly Polar extreme from perfect competition.
Monopolist is a “price maker” rather than a price taker.
Market demand = firm demand
Cost curves are pretty much the same (except in the case of natural monopoly – which we ignore).

8. The Simple Monopolist - Conduct
The simple monopolist abides by the “law of one price.” Everyone pays the same market price for all units purchased, there is no price discrimination.
The monopolist faces a declining market demand curve for its product and chooses price which implies the quantity (or chooses quantity which implies the price).
Now P > mr (before, under perfect competition, P=mr)

9. Relationship Between Price & Marginal Revenue for the Simple Monopolist
For all quantities greater than zero, the simple monopolist’s price will be larger than the corresponding marginal revenue.
Why?
To sell an additional unit, the simple monopolist must lower the price on ALL units sold.
Example:

10. Rules for SR Profit Maximization
Suppose we are in the short run.
Rules for profit maximization are the same as before.
If QSM maximizes profit, then
mr(at QSM) = srmc(at QSM)
QSM is a at a max (not a min).
at QSM it’s worth operating, rather than shutting down. i.e. (П(QSM )≥ П(0)

11. Simple Monopoly Marginal Revenue with Linear Demand$
Suppose demand curve is: PD = 20 – 2Q
Total revenue = PD∙Q
Total revenue = (20 – 2Q)∙Q = [20∙Q - 2∙Q2 ]
Marginal revenue = mr = ∆Total revenue/∆Quantity
mr = Q
Now compare this with PD
With a linear demand, marginal revenue will have the same vertical intercept and be twice as steep!
$20
Demand
Marginal Revenue 5 10 Q

12. Graphical Display of Simple Monopolist’s Short Run Profit Maximizing Solution
(1) The monopolist sets marginal revenue equal to marginal cost.
Then goes up to the demand curve to get the price.
(2) Then makes sure he is at a max (and not a min).
(3) Then makes sure it is worth operating in the short run. $
srmc
Psm
Demand
Marginal Revenue
Qsm Q

13. Graphical Display of Simple Monopolist’s Short Run Profit Maximizing Solution$
srmc
In the short run, the simple monopolist can have +, 0, or – economic profit.
Psm
Demand
Marginal Revenue
Qsm Q

14. Simple Monopoly with a Table: New Demand & Cost Information

16. Long Run Profit Maximization with Simple Monopoly
Pretty much the same story as in the short run, but, use correctly calculated long run cost information.
Positive economic profit invites entry, but since there are barriers to entry positive economic profit can persist.
Negative economic profit encourages exit, and if the monopolist can get out he will.
Monopolist might make long run adjustments to changes in the economic environment.

17. Graphical Display of Simple Monopolist’s Long Run Profit Maximizing Solution
(1) The monopolist sets marginal revenue equal to marginal cost.
Then goes up to the demand curve to get the price.
(2) Then makes sure he is at a max (and not a min).
(3) Then makes sure it is worth operating in the long run. $
lrmc
Psm
Marginal Revenue
Demand
Qsm Q

18. Long Run Performance Measures
Efficiency:
Pareto/Allocative Efficiency
An allocation, QPE is Pareto Efficient if no participant in the market can be made better off (feasibly) without making at least one other participant worse off.
That is, at QPE net social surplus (NSS) in the market is maximized.
When NSS is maximized, $MBsociety = $MCsociety

19. A monopolist sets a single price for all consumers, the monopolist will sell a lesser quantity of goods at a higher price than would companies by perfect competition.
Because the monopolist ultimately forgoes transactions with consumers who value the product or service more than its cost, monopoly pricing creates a deadweight loss referring to potential gains that went neither to the monopolist nor to consumers.
Given the presence of this deadweight loss, the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers by perfect competition.
Where efficiency is defined by the total gains from trade, the monopoly setting is less efficient than perfect competition.
In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, people who have more marginal cost than marginal benefit are buying the product.

20. SO: Are Monopolies Good? Bad?
Depends....
What kind of monopoly is it?
From whose point of view are we asking?
How did the monopoly position come about?
How is the monopoly position maintained?
How does the monopoly behave?

21. Should the Government Regulate Monopolies?
Essentially all monopolies are regulated, in some way or another.
Natural monopolies are regulated by price commissions that determine the rates the monopolies may charge.
Patent, copyright and license protections are a form of ex ante regulation: firms that follow the rules for establishing the validity of their innovations receive the protection of the patent, copyright or license.
Should the government do more? Good question.
Ex ante is latin for "beforehand"
ex-post (actual)
"Afterward", "after the event". Based on knowledge of the past.