Economics 2010Economics 2010

Lecture 13

Monopoly

MonopolyMonopoly

How monopoly arisesSingle price monopoly

How Monopoly ArisesHow Monopoly Arises

A monopoly is an industry in which there is a single supplier of a good, service, or resource, that has no close substitutes and in which there is a barrier preventing the entry of new firms

How Monopoly ArisesHow Monopoly Arises

Barriers to entry can be: legal barriers natural barriers

Legal barriers to entry create legal monopolies, examples are:

Public franchise (Canada Post, Royal Mail, in some countries the train companies of the telecomm or the electricity even the tobacco production or the selling of gas)

Government license (in most countries doctors, dentists, architects, bus drivers need a license to operate, sometimes hairdressers too!!!)

Patent (20 years in Canada); copyright is the same idea

Barriers to EntryBarriers to Entry

Natural barriers to entry create natural monopolies

Natural barriers arise if economies of scale are still available when a single firm can meet the entire market demand

The following figure shows this situation

Barriers to EntryBarriers to Entry

Barriers to EntryBarriers to Entry

The firm’s average total cost curve is ATC

The market demand curve is D

Barriers to EntryBarriers to Entry

Suppose the price is 5 cents per kilowatt-hour and the quantity demanded is 4 million killowatt-hours (per day)

Barriers to EntryBarriers to Entry

1 firm can produce this quantity for 5 cents a kilowatt-hour

But with 2 firms sharing the production, it costs 10 cents

Barriers to EntryBarriers to Entry

And with 4 firms sharing the production, it costs 15 cents per kilowatt-hour

This industry is a natural monopoly

Barriers to EntryBarriers to Entry•Knowing about the Minimum Efficient Scale of a type of business and the level of demand will help us predict the number of firms in a market in the long run

•We can then check whether an industry should be expected to be competitive

•Now we can check if it is expected to be a monopoly but it is for the same reasons

•Train services, electricity services, water, gas distributions, telecommunications services: they all have very high fixed costs and they have economies of scale for long ranges

Barriers to EntryBarriers to Entry•Therefore it is very easy than when we compare the MES with the demand level we see that one firm should be expected

•Sometimes even only one firm is too much => losses need to be subsidized if the service is deemed essential: most countries treat the railways this way...

Most real-world monopolies are regulated

You can read a brief intro about regulation at the end of Ch. 13 and a lot more in advanced courses

but we are going to focus on unregulated monopoly so that we can: understand why monopoly is regulated, understand monopolistic elements in many

markets

Monopoly and regulationMonopoly and regulation

Single-Price MonopolySingle-Price Monopoly

A single-price monopoly is a firm that sells all its output for one single price

All the firm’s customers pay the same price for each unit

Many monopolies operate in this way, but many do not: they price-discriminate instead

A price-discriminating monopoly is a firm that sells each unit of output for the highest price it can get by:

Discriminating among customers--different customers pay different prices

Discriminating across quantities--one customer pays different prices for different quantities

Single-Price MonopolySingle-Price Monopoly

We’re going to study a single-price monopoly first

What is the price charged by a monopoly and what is the quantity produced?

Monopoly costs are just like those we have seen for competitive industries

But monopoly revenue is special

Single-Price MonopolySingle-Price Monopoly

A monopolist faces the market demand curve He sees the big picture (like the astronauts, who

can see the Earth round, while the competitive firm could only see the small picture, as we see a flat horizon)

A monopolist’s demand curve is downward-sloping

A monopolist is a price maker, in contrast to a perfectly competitive firm, which is a price taker

Demand and RevenueDemand and Revenue

A monopolist’s marginal revenue is the addition to total revenue from selling one more unit

Recall that in perfect competition, marginal revenue equaled price

In single-pricing monopoly, marginal revenue is always less than price

Demand and RevenueDemand and Revenue

The following table illustrates a monopoly’s demand and revenue schedules

Demand and RevenueDemand and Revenue

Price Quantity

demanded

a 20 0

b 18 1

c 16 2

d 14 3

e 12 4

f 10 5

g 8 6

Single-Price Monopoly RevenueSingle-Price Monopoly Revenue

Total

revenue

0

18

32

42

48

50

48

Marginal

revenue

…………18

…………14

…………10

………… 6

………… 2

…………–2

This illustrates the demand curve and marginal revenue curve of a single-price monopolist

Demand and RevenueDemand and Revenue

The demand curve is D

The price is cut from $16 to $14

Marginal revenue is $10

The marginal revenue curve is MR

Demand and RevenueDemand and Revenue

A single-price monopoly always charges a price at which demand is elastic

The easiest way to see why is to look again at the demand curve and marginal revenue curve and recall what you learned weeks ago about the elasticity along a linear demand curve

Revenue and ElasticityRevenue and Elasticity

Look at this monopoly’s demand curve and marginal revenue curve

Check the three elasticity ranges

Revenue and ElasticityRevenue and Elasticity

At prices above $10, demand is elastic

At prices below $10, demand is inelastic

At $10, demand is unit elastic

Revenue and ElasticityRevenue and Elasticity

When demand is unit elastic, total revenue is maximized

Marginal revenue becomes negative at prices below $10

Revenue and ElasticityRevenue and Elasticity

Revenue and Revenue and ElasticityElasticity

When demand is unit elastic, total revenue is maximized

Marginal revenue becomes negative at prices below $10

Revenue and Revenue and ElasticityElasticity

When demand is unit elastic, total revenue is maximized

Marginal revenue becomes negative at prices below $10

Revenue and Revenue and ElasticityElasticity

When demand is unit elastic, total revenue is maximized

Marginal revenue becomes negative at prices below $10

Revenue and Revenue and ElasticityElasticity

Producing more than 5 haircuts a day brings in less revenue that producing 5 a day

Price and Output DecisionPrice and Output Decision

But revenue is not all that matters!!!A single-price monopoly produces the

quantity that maximizes profitThis quantity occurs where total

revenue minus total cost is largest

Price and Output DecisionPrice and Output Decision

Here, economic profit is maximized by producing 3 haircuts an hour

Price and Output DecisionPrice and Output Decision

The profit-maximizing output also can be found as the quantity at which marginal cost equals marginal revenue (as we know from competition)

The following figure shows this way of looking at the profit-maximizing decision

Price and Output DecisionPrice and Output DecisionMarginal

cost equals marginal revenue at 3 haircuts an hour

Economic profit is $12 an hour

Price and Output DecisionPrice and Output DecisionThis figure

also shows how a monopoly sets its price

Price and Output DecisionPrice and Output DecisionThe price is

the highest at which the profit-maximizing quantity can be sold

Price and Output DecisionPrice and Output DecisionHere, that

price is $14 per haircut

Price and Output DecisionPrice and Output Decision

There is no monopoly supply curveJust a decision about how much to

produce and at what price to sell it

NextNextPrice discriminating

monopolyREAD THE CHAPTER!!!