Chapter 9
Monopoly
The Monopoly Market Structure What is a monopoly exactly?
A monopoly is a market structure characterized by: A single seller A unique product Impossible entry into the market
Under a monopoly, the consumer has only one choice. Thus, they can either buy from the producer or not consume
There are no close substitutes.
A Single Seller One single firm IS the industry.
Local monopolies are more commonly observed in the real-world than national monopolies. Examples
Unique Products Why do Monopolists have unique
products? Absence of close substitutes
Impossible Entry Barriers to Entry are high
It is different or impossible for a new firm to enter an industry due to: Ownership of Vital Resources Legal Barriers Economies of Scale
Ownership of Vital Resources
A seller can create its own barrier to entry if it owns a significant portion of a key resource required for the production of the good or service.
In practice, monopolies rarely arise for this reason. The market for most resources is national or even international, and ownership of most resources is dispersed among a large number of people and nations.
Example
Legal Barriers Legal barriers to entry are the source of most
present-day monopolies.
Entry into the market or competition within the market are restricted by the granting of a public franchise, government license, patent, or copyright.
Examples:
Economies of Scale Monopolies can emerge in time naturally
because of the relationship between average cost and the scale of the operation.
This is called “natural monopolies” Def: A natural monopoly is an industry in which
the LRAC of production declines throughout the entire market.
Natural monopoly provides an economic argument for regulated public utilities.
Economies of Scale When this happens a single firm can supply
the entire market demand at a lower cost than two or more smaller firms.
Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market.
SOURCES OF MONOPOLY
10 cents a kilowatt-hour with two sellers, or . . .
Because of economies of scale, one seller can meet the market demand at a lower average cost than two or more sellers.
15 cents a kilowatt-hour with four sellers.
The cost to distribute 4 million kilowatt hours of electric power is
Economies of Scale
5 cents a kilowatt-hour with one seller in the market, or . . .
Price and Output Decisions for a Monopolist The demand curve for a monopolist differs
from the competitive firm because the monopolist is a price maker not taker. Def: A price maker is a firm that faces a downward
sloping demand curve.
More Demand and some Marginal Revenue
Demand and Marginal Revenue They are both negatively-sloped
Demand Market demand is negatively-sloped. The
monopolist faces a tradeoff between price and quantity sold.
To obtain a higher price, the monopolist must lower quantity. Or, if it wants to sell a larger quantity, it must lower price.
MONOPOLY EQUILIBRIUM
Demand and Marginal Revenue
Marginal revenue is less than price
The marginal revenue curve is negatively-sloped but lies below the demand curve at each quantity: MR<P at all Q.
Calculate the marginal revenue generated along the demand curve.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
If the price is $16, quantity demanded is 2 haircuts per hour.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
If the price is $14, quantity demanded is 3 haircuts per hour.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
Total revenue from two haircuts per hour decreases by $4.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
Total revenue from the additional haircut is $14.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
Marginal revenue from the additional haircut is $10.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
The marginal revenue curve is negatively-sloped and lies below the demand curve. Marginal revenue is less than price at each quantity.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue
MONOPOLY EQUILIBRIUM
The diagram shows the monopolist’s
• marginal cost (MC),• demand (D),• and marginal revenue
(MR).
Profit Maximization by a Monopolist
• average total cost (ATC),
The monopolist maximizes profits or minimizes losses by producing the quantity at which marginal revenue equals marginal cost.
Monopoly23
MONOPOLY EQUILIBRIUM
The equilibrium quantity is 3 haircuts per hour where MR=MC, andthe equilibrium price is $14, shown by the demand at the quantity 3.
The ATC of 3 haircuts is $10.
Profit Maximization by a Monopolist
Because P>ATC at the equilibrium quantity, the monopolist earns a profit of $4 per haircut or $12 per hour.
MONOPOLY EQUILIBRIUM
Profit Maximization by a Monopolist: Numerical Example
The data in the table below verify that 3 haircuts per hour maximizes the monopolist’s profit.
MONOPOLY EQUILIBRIUM
Short-Run and Long-Run Equilibrium
When a monopolist incurs short-run losses
However, if a monopolist incurs economic losses in the short-run, it exits the market in the long-run. The long-run equilibrium quantity is zero.
MONOPOLY EQUILIBRIUM
Short-Run and Long-Run Equilibrium
When a monopolist earns short-run profits
Price Discrimination The monopolist may charge different prices to
consumers to maximize profits. Def: Price discrimination occurs when a seller
charges different prices for the same product that are not justified by cost differences.
Selling a good or service at a number of different prices where the price differences do not reflect differences in cost but instead reflect differences in consumers’ price elasticities of demand.
However, specific conditions must be met before the seller can act in this way.
Conditions for Price Discrimination The seller must be a price maker and
therefore face a downward-sloping demand curve
The seller must be able to segment the market distinguishing between consumers willing to pay different prices
It must be impossible or too costly for customers to engage in arbitrage
How can a producer price discriminate Discriminating among groups of consumers
Different prices for consumers with different elasticities. The market is segmented based on some easily distinguished characteristic of consumers—age, for example.
Discriminating among units of a good
The seller charges the same prices to all consumers but offers each consumer a lower price for a larger number of units bought—volume discounts, for example.
Price Discrimination with Two Groups of Consumers
A monopolist facing two groups of consumers with different demand elasticities may be able to practice price discrimination to increase profit or reduce loss. With marginal cost the same in both markets, the firm charges a higher price to the group in panel (a), which has a less elastic demand than group in panel (b).
D
(a)
LRAC, MC
(b)
400 Quantity per period0 500 Quantity per period0
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uni
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$3.00
1.00LRAC, MC
MRD
olla
rs p
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$1.501.00
D’MR’
Is Price Discrimination Unfair
There is nothing evil or illegal about economic price discrimination. It simply means charging different prices for the same good or service unrelated to differences in cost.
Price discrimination is common in all markets other than perfectly competitive markets.
Is Price Discrimination Unfair
What are its effects: Increase seller’s profit, at least in the short run Enhance economic efficiency Conserve on scarce resources. Many buyers benefit because they are now
paying a lower price Example: Movie Theatres- senior citizen and college
students discounts
How does it increase the sellers profits
Increases seller’s profits By observing different elasticities for the
consumers the following can happen Reduce the price for buyers with elastic demand will
increase TR Increase the price for buyers with inelastic demand
will increase TR When the total quantity is not changing, then costs
are not changing, but revenues are profits are HIGHER
What about efficiency Enhances economic efficiency
We know that under a monopoly the output is under- produced. But price discrimination can fix this underproduction of the good
A price-discriminating monopolist is able to sell a larger quantity than a single-price monopolist by reducing price only on the additional units sold, not on all units sold.
Because the problem with monopoly is underproduction, increasing quantity enhances efficiency. The sum of producer and consumer surplus is higher in a monopoly market with price discrimination than in a market with a single-price monopolist.
MONOPOLY AND COMPETITION
The competitive market equilibrium is where quantity demanded equals quantity supplied.
The market demand curve is D.The market supply curve is S.
Competitive Equilibrium
The competitive equilibrium quantity is QC and the equilibrium price is PC.
MONOPOLY AND COMPETITION
The competitive market supply curve, S, is the monopolist’s marginal cost curve, MC.The monopolist’s marginal revenue curve is MR.
Monopoly Equilibrium
The monopolist’s equilibrium quantity is QM where marginal revenue equals marginal cost. The equilibrium price is PM , shown by the demand at QM.
MONOPOLY AND COMPETITION Competitive and Monopolistic Equilibrium
Monopoly quantity is lower and price is higher
A monopolist supplies a smaller quantity than a competitive market would supply at a higher price.
The higher price allows a monopolist to earn positive long-run economic profits.
MONOPOLY AND COMPETITION Economic Consequences of Monopoly
The absence of competition results in
• Inefficiency and deadweight loss
• Redistribution of wealth
MONOPOLY AND COMPETITION
The competitive equilibrium price, PC, brings consumers’ marginal benefit into equality with producers’ marginal cost. Therefore, the competitive equilibrium quantity, QC, is efficient. The sum of consumer surplus and producer surplus is maximized.
Efficiency of Competitive Equilibrium
MONOPOLY AND COMPETITION
Marginal benefit in the monopoly equilibrium (equals to the monopoly equilibrium price, PM) exceeds marginal cost.
Therefore, the monopoly equilibrium quantity, QM, is inefficient because of underproduction. Monopoly results in a deadweight loss.
Inefficiency of Monopoly
MONOPOLY AND COMPETITION
Economic Consequences of Monopoly
Redistribution of wealth
MONOPOLY AND COMPETITION
The deadweight loss of monopoly arises from a net loss in both consumer and producer surplus compared with the competitive equilibrium.
In addition to the net loss in the total surplus, monopoly also redistributes some of the remaining surplus from consumers to the monopolist.
Monopoly Redistributes Wealth