Chapter 12

Monopoly

Basic Definitions

• Imperfect Competition: Occurs when firms in a market or industry have some control over the price of their output.– Monopoly, Oligopoly, and Monopolistic Competition

• Pure Monopoly:An industry with a single firm that produces a product for which there are no close substitutes, and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

Barriers to Entry

• Government franchises

• Patents

• Economies of scale and other cost advantages

• Ownership of a scarce factor of production

There are now four firm decisions that must be characterized:

• There are now four firm decisions that must be characterized:– How much output to produce – How to produce output – How much to demand in each input market – What price to charge for output

Similarities and differences - Monopoly and Competition

• Similarities:– Both know exactly what the demand curve and

price will be

• Differences:– Competitor has no control over price – Monopolist has total control over price

Price and Output Decisions in Pure Monopoly Markets

• Basic assumptions:– Entry to the market is strictly blocked. – Firms act to maximize profits. – The monopolistic firm cannot price

discriminate. – The monopoly faces a known demand curve.

Consider this hypothetical data for a monopolist’s demand curve

Q P TR MR0 11 01 10 10 102 9 18 83 8 24 64 7 28 45 6 30 26 5 30 07 4 28 -28 3 24 -49 2 18 -6

Example-Demand/MR

-8

-6

-4

-2

0

2

4

6

8

10

12

0 1 2 3 4 5 6 7 8 9 10

P

MR

$$$

Quantity

Example -Demand/MR/TR TR/MR

-10

-5

0

5

10

15

20

25

30

35

0 2 4 6 8 10

Q

P (

$) P

TR

MR

The monopolist’s profit-maximizing output and price:

D

MRQ

$

ATC

MC

Pm=$4

ATC=$3

4000

Profit = $1*4000 = $4000

MC=$1.5

• Maximizing profit at MR=MC

Details...

• The monopolist has no supply curve; there is no unique relationship between price and quantity supplied.

• Since entry is blocked, the monopolist can earn economic profits in the long run.

• Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high.

Comparison of monopoly and perfectly competitive market solutions:

D

MR

Q

$

Pm=$4

4000

Ppc=MCc=MCm=$2 MC=MR=P=ATC

2000

Monopoly: MC=MR

Comparison of monopoly and perfectly competitive market solutions:

D

MR

Q

$

Pm=$4

4000

Ppc=MCc=MCm=$2 MC=MR=P=ATC

2000

Monopoly

Perfectly competitive market

Losses from Monopoly

• LESS output is produced than would be produced in a competitive industry.

• If we look at the diagram, we see that output stops short of where Mgl. Benefits = Mgl. Costs.

• Buyers must pay MORE than they would pay in a competitive market

• Figure 13.6

The Social Costs of Monopoly

• Prices are higher when a market is monopolized than when it is perfectly competitive.

• Output is lower when a market is monopolized than when it is perfectly competitive.

• Some consumer surplus is reallocated to producers when a market is monopolized.

• Some consumer surplus is lost when a market is monopolized.

Consumer Surplus

• The difference between the market price and what people are willing to pay for a unit of output

Consumer Surplus

Millions of hamburgers per month

Price ($)

1 7

$2.50

$5.00

Demand

A

E

2 3

B C

Price ($)

1 7

$2.50

$5.00

Demand

E

2 3

Total consumer surplus

Consumer surplus in a perfectly competitive market:

D

MR

Q

$

Pm=$4

4000

Ppc=MCc=MCm=$2 MC=MR=P=ATC

2000

Monopoly

Perfectly competitive market

Consumer surplus of PC

Consumer surplus in a monopoly market

D

MR

Q

$

Pm=$4

4000

Ppc=MCc=MCm=$2 MC=MR=P=ATC

2000

Monopoly

Perfectly competitive market

Consumer surplus of Monopoly

Consumer surplus in a monopoly market:

D

MR

Q

$

Pm=$4

4000

Ppc=MCc=MCm=$2 MC=MR=P=ATC

2000

Net loss of social welfare

Consumer surplus of MonopolyCS reallocated to producer

Rent-Seeking Behavior (1)

• Rent-seeking behavior: Actions taken by households or firms to preserve positive profits.

• Suppose someone is in a competitive market, but would like, somehow, to be a monopolist and earn monopoly rents.

Rent-Seeking Behavior (2)

• Actions taken by households or firms to acquire or preserve extra normal profits

• Lobbying gov’t officials; asking for licensure.

• Some argue that many medical professionals lobby for licensure in order to earn monopolistic rents.

Natural Monopoly

• An industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

Natural Monopoly

• Economies of scale must be realized at a scale that is close to total demand in the market.

• Figure 13

There are several ways to regulate natural monopoly

• The government sets a monopoly’s price equal to marginal cost.

• The government sets a monopoly’s price to cover average cost per unit.

Summary

• Monopolies exist when there is a single seller of a unique product and significant entry barriers.

• The monopolist will produce where MR=MC and determine its price from demand.

Review questions

• Application– Decide the output level for monopoly– Calculate consumer surplus

• Definitions:– Imperfect competition– Pure monopoly– Natural monopoly