1. Monopoly Eco 2023 Chapter 10 Fall 2007

2. Monopoly A market with a single seller with a product that is differentiated from other products.

3. Characteristics Single seller –Firm and industry are synonymous No close substitutes Price maker Blocked entry –Barriers to entry keep competitors out of the market Standardized or differentiated

4. Barriers to Entry Any impediment that prevents new firms from entering an industry and competing on an equal basis with existing firms Types –Economies of scale –Legal restrictions –Control over essential resource

5. Economies of Scale Declining average total cost with added firm size are extensive Long run average total cost will decline over a wide range of output Only a single large firm can achieve low average total costs Protects the firm from competitors Natural monopoly –the market demand curve cuts the long-run ATC curve where average total costs are still declining

6. Legal Restrictions Patent –A legal barriers to entry that grants its holder the exclusive right to sell a product for 20 years from the date the patent application is filed –Innovation »The process of turning an invention into a marketable product Licenses –Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service

7. Control over Essential Resource Firms owns all sources of a resource –ALCOA – aluminum –DeBeers – diamonds

8. Monopoly Demand Three assumptions –Patents, economies of scale or resource ownership secure our monopolist’s status –No unit of government regulates the firm –Single price monopolist, Demand curve –Downward sloping demand curve –Quantity demanded increases as price decreases

9. Implications Marginal revenue is less than price –The downward sloping demand curve means that it can increase sales by charging a lower price –Marginal revenue is less than price for every level of output –Marginal revenue curve is below the demand curve –Marginal revenue is positive while total revenue is increasing. –When total revenue is decreasing, marginal revenue is negative

10. Monopoly Demand = Average Revenue Price Elastic Unit Elastic Inelastic Marginal Revee

11. Monopoly Where demand is price elastic, marginal revenue is positive Therefore: TR increasesas Price decreases Where demand is price inelastic, marginal revenue is negative TR decreasesas Price increases Where demand is unit elastic, marginal revenue is zero, –TR is at a maximum, neither increasing nor decreasing

12. Implications Price Maker –When monopolist decides on output level, he determines price. Elastic Region –Monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease Marginal revenue is NEGATIVE

13. Example OutputPriceTotal Revenue Marginal Reven ue Average Total CostTotal CostMarginal CostProfit or Loss Q Average RevenueP X QMRATCTCMCTR - TC 0 $ 172.00 $ - $ 100.00 $ (100.00) $ 162.00 $ 90.00 1 $ 162.00 $ 190.00 $ (28.00) $ 142.00 $ 80.00 2 $ 152.00 $ 304.00 $ 135.00 $ 270.00 $ (34.00) $ 122.00 $ 70.00 3 $ 142.00 $ 426.00 $ 113.33 $ 340.00 $ 86.00 $ 102.00 $ 60.00 4 $ 132.00 $ 528.00 $ 100.00 $ 400.00 $ 128.00 $ 82.00 $ 70.00 5 $ 122.00 $ 610.00 $ 94.00 $ 470.00 $ 140.00 $ 62.00 $ 80.00 6 $ 112.00 $ 672.00 $ 91.67 $ 550.00 $ 122.00 $ 42.00 $ 90.00 7 $ 102.00 $ 714.00 $ 91.43 $ 640.00 $ 74.00 $ 22.00 $ 110.00 8 $ 92.00 $ 736.00 $ 93.75 $ 750.00 $ (14.00) $ 2.00 $ 130.00 9 $ 82.00 $ 738.00 $ 97.78 $ 880.00 $ (142.00) $ (18.00) $ 150.00 10 $ 72.00 $ 720.00 $ 103.00 $1,030.00 $ (310.00)

14. Monopoly Profit Maximization –A firm that must find the profit maximizing price when the demand curve for its output slopes downward –Monopolist produces the quantity at which total revenue > total cost by greatest amount –Marginal revenue = Marginal cost

15. Monopoly – short run Demand = Average Revenue Price Average Total Cost Marginal Cost P Profit Marginal Revenue Q

16. Monopoly Short run –Economic profits can exist –Losses Can exist If the price covers average variable cost, the firm will produce If not, the firm will shut down at least in the short run

17. Long run Profit Maximization Long run efficiency in pure competition is –P = MC = Minimum ATC Monopoly –MR < P, monopolist will sell smaller output at a higher price than pure competition –An efficiency loss occurs because P > MC P > minimum ATC

18. Long-Run Profit Maximization If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run.

19. Monopoly Allocation of Resources –If monopolists are no greedier than perfect competitors because both maximize profit –What is the problem with monopoly? Lower output Higher price –Than perfect competition

20. Monopoly Price Discrimination –Increasing profits by charging different groups of consumers different prices when the price differences are not justified by differences in production costs

21. Monopoly Conditions –Demand must be downward sloping –At least to separate groups of consumers Each with different price elasticity of demand –Firm must be able to charge each group a different price for essentially the same product –The firmmust be able to prevent those who pay the lower price from reselling the product to those who pay the higher price –Each market, the firms equates marginal revenue with marginal cost