1. McGraw-Hill/Irwin Chapter 8: Pure Monopoly Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved

2. Characteristics of a Pure Monopoly  Single supplier: the firm is the sole producer of a specific product.  No close substitutes: this product is unique.  Price maker: the firm has considerable control over price, since it controls the total quantity supplied.  Blocked entry: there is no immediate competition, because there are barriers to entry.  Those barriers may be economic (economies of scale create natural monopolies), technological, legal, or of some other type. Examples: local telephone company, local gas and electric company, small town gas station. LO: 8-1 8-2

3. Monopoly Demand and Marginal Revenue  Because monopoly is the only supplier, the monopoly demand is the market demand.  Because market demand slopes downward, in order for a monopolist to increase sales it must lower its price.  If the monopolist increases output by one more unit, the price charged for all units sold will fall.  Each additional unit of output sold increases total revenue by an amount equal to its own price less the sum of the price cuts that apply to all price units of output.  Consequently, marginal revenue is less than price for every level of output except the first. LO: 8-2 8-3

4. 0 123456 $142 132 122 112 102 92 82 D A monopolist is selling 3 units at $142. To sell more (4), price must be lowered to $132. All customers must pay the same price. TR increases $132 minus $30 (3x$10). Gain = $132 Loss = $30 LO: 8-2 Monopoly Demand and Marginal Revenue 8-4

5. 0 123456 $142 132 122 112 102 92 82 D A monopolist is selling 3 units at $142. To sell more (4), price must be lowered to $132. All customers must pay the same price. TR increases $132 minus $30 (3x$10). $102 becomes a point on the MR curve. Try other prices to determine other MR points. Gain = $132 Loss = $30 MR LO: 8-2 Marginal Revenue is Less than Price 8-5

6. Monopolist’s Profit Maximization  Each output is associated with a unique price; by changing the market output, a monopolist is indirectly determining the market price.  To determine the price-quantity combination that will maximize profit, cost data is needed.  A monopolist will employ the MR = MC Rule in order to maximize profit.  A monopolist produces a level of output where MR = MC. This determines the profit maximizing output, Q m.  Price (P m ) is determined by the market demand curve. LO: 8-2 8-6

7. (1) Quantity Of Output (2) Price (Average Revenue) (3) Total Revenue (1) X (2) (4) Marginal Revenue (5) Average Total Cost (6) Total Cost (1) X (5) (7) Marginal Cost (8) Profit (+) or Loss (-) 0 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $0 162 304 426 528 610 672 714 736 738 720 $162 142 122 102 82 62 42 22 2 -18 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00 $100 190 270 340 400 470 550 640 750 880 1030 $90 80 70 60 70 80 90 110 130 150 $-100 -28 +34 +86 +128 +140 +122 +74 -14 -142 -310 Revenue Data Cost Data ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Can you See Profit Maximization? LO: 8-2 Monopolist’s Profit Maximization 8-7

8. 0 $200 175 150 125 25 100 75 50 Price, Costs, and Revenue 12345678910 Quantity D MR ATC MC MR=MC P m =$122 ATC=$94 Economic Profit LO: 8-2 Monopolist’s Profit Maximization Q m =5 8-8

9. Misconceptions about Monopoly  Not Highest Price  The “highest price possible” is not ideal because it results in lower output and reduces total revenue.  Total, Not Unit, Profit  The monopolist seeks to maximize total profit, not unit profit.  Profitability Not Assured  A monopolist may suffer from weak demand, bad market conditions or resource cost increases, and thus experience short-term losses. LO: 8-2 8-9

10. Inefficiency of Monopoly  Compared to pure competition, a monopoly lacks productive efficiency and allocative efficiency.  It is inefficient (compared to pure competitions in which P=MC=minimum ATC).  A monopolist charges a higher price and sells a smaller level of output than firms in a purely competitive industry.  P m exceeds MC  P m exceeds ATC LO: 8-3 8-10

11. Purely Competitive Market Pure Monopoly D D S=MC MC P=MC= Minimum ATC MR PcPc QcQc PcPc PmPm QcQc QmQm a b c LO: 8-3 Pure Competition is Efficient, Monopoly is Inefficient 8-11

12. Other Aspects of Monopoly’s Inefficiency  Monopoly increases income inequality because monopoly profits are not equally distributed.  Monopolists levy a “private tax” on consumers by transferring income from consumers to shareholders who own the monopoly.  Cost may be different in monopoly and pure competition  Economies of scale may make monopoly’s costs lower.  X-inefficiency –prices higher than ATC allow for various costs increases.  Rent-seeking expenditures required to maintain barriers to entry  Monopolists can afford to lag in technological advances. LO: 8-3 8-12

13. Price Discrimination  In order to engage in price discrimination, the firm must:  have monopoly power  be able to segregate the market into difference groups  be able to prevent resale of the product  Price discrimination allows monopoly to increase its profits. LO: 8-4 Price discrimination is the business practice of selling the same good at different prices to different consumers when the price differences are not justified by differences in costs. 8-13

14. Monopoly and Antitrust Policy  Monopoly is not widespread because barriers to entry are seldom completely successful.  If the monopoly appears to be unsustainable over a long period of time, say, because of emerging new technology, society can simply choose to ignore it.  In contrast, the government may want to file charges against a monopoly under the antitrust laws if  the monopoly was achieved through anticompetitive actions,  creates substantial economic inefficiency,  and appears to be long-lasting. LO: 8-5 8-14

15. Antitrust Law  The antitrust law is the Sherman Act of 1890, which has two main provisions:  Section 1 “Every contract, combination in the form of a trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations is declared to be illegal.”  Section 2 “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony...” (as later amended from “misdemeanor”).  The Department of Justice is enforcing the antitrust law in the U.S. LO: 8-5 8-15