Monopoly

Eco 2023Chapter 10Fall 2007

Monopoly

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

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

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

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

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

Control over Essential Resource

• Firms owns all sources of a resource– ALCOA – aluminum– DeBeers – diamonds

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

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

Monopoly

Demand = Average Revenue

PriceElastic

Unit Elastic

Inelastic

Marginal Revee

Monopoly

• Where demand is price elastic, marginal revenue is positive

• Therefore: • TR increases as Price decreases • Where demand is price inelastic, marginal

revenue is negative• TR decreases as Price increases • Where demand is unit elastic, marginal revenue

is zero, – TR is at a maximum, neither increasing nor

decreasing

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

Example

Output Price Total Revenue

Marginal Reven

ueAverage Total

Cost Total Cost Marginal Cost Profit or Loss

QAverage

Revenue P X Q MR ATC TC MC TR - TC

0 $ 172.00 $ -     $ 100.00   $ (100.00)

      $ 162.00     $ 90.00  

1 $ 162.00 $ 162.00   $ 190.00 $ 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)

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 costMarginal revenue = Marginal cost

Monopoly – short run

Demand = Average Revenue

Price

Average Total Cost

Marginal Cost

P

Profit

Marginal Revenue

Q

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

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

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.

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

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

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