2 By the end of this Section, you should be able to: Define monopolies and discuss how they arise.Define and explain the types of monopoliesFind monopolies profit maximizing output and priceEvaluate the welfare cost of a monopolyDefine and discuss an example of price discrimination.
3 Definition of a Monopoly A monopolist is the single supplier of a good or service for which there is no close substitute.The monopolist makes up the entire supply side of the economy.Compare this to our definition of a competitive firm (infinite firms of perfect subsititutes)
4 2 Properties of a Monopoly There exists a barrier for other firms to enter the market.Natural Monopoly: A monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than two or more firms.Ex. Water distillery.Exclusive right: A monopoly arises when the government has given the exclusive right to sell some good to one firmEx. Patent, Licensing FeeOwnership of resources: A monopoly arises when the monopolist has sole access to resources without a close substitute.Ex. Lime Stone
5 2 Properties of a Monopoly 2. Monopolist is a price searcher.Price and quantity changes by the monopolist has a big effect on the market.The monopolist faces the entire industry’s demand.Monopolist Market Demand and Marginal RevenueCompetitive Market Marginal RevenuePricePriceMRDemandMRQuantityQuantityMarginal Revenue is horizontal because price is set by market forces.Because monopolist sets P and Q, demand and marginal revenue is the industry’s curve.
6 Profit maximizing Q and P for a Monopolist: 2 approaches 1. TR – TC ApproachThe Monopolist’s Profit Maximizing P and Q is where Profit = TR – TC is the highest.2. MR = MC ApproachNote: Monopolist MR is ALWAYS < PHere’s an example: Suppose a monopolist supplies 3 units of a good at a price of 8 and 4 units of a good at a price of 7.P1=7, Q1=4 and P2=8, Q2=3MR = TR = P1*Q1 – P2*Q2 = 28 – 24 = 4Q Q1 – Q2 1MR of the 4th unit=4<7=P of selling 4 units
7 Profit maximizing Q and P for a Monopolist MC = MR for a Monopolist graphicallyPrice/CostMCATCMonopolist Profit = TR–TC = (Pm*)Qm*-(ATC at QM*)Qm* = (Pm*-ATC at Qm*)(Qm*)Pm*Economic ProfitATC at Qm*MC=MRMRDemandQm*Quantity
8 Social Cost of a Monopoly as compared to a Competitive Market Price/CostsPrice/CostsMC=SupplyMCATCCSPm*CSP*MRDWLATC at Qm*PSPSDemandMRDemandQ*QuantityQm*Quantity
9 Price DiscriminationOne way a monopolist causes a social cost is by price discrimination. For example: Movie TheatresPrice Discrimination is selling a given product at more than one price, with the price difference being unrelated to differences in cost.A price discriminating monopolist charges some customers more than others based upon personal preferences of the monopolist.Required Conditions for a Monopolist to charge different pricesFirm must face a downward sloping demand curveFirm must be able to separate and identify buyersFirm must be able to prevent resale of the productIn a competitive market, buyers are charged the same price for a couple of reasons:Market sets the PGoods are homogenous between all of the sellersWe assume buyers have full knowledge