1. Economics 2010 Lecture 13 Monopoly

2. Monopoly  How monopoly arises  Single price monopoly

3. How Monopoly Arises  A monopoly is an industry in which there is a single supplier of a good, service, or resource, that has no close substitutes and in which there is a barrier preventing the entry of new firms

4. How Monopoly Arises  Barriers to entry can be: £ legal barriers £ natural barriers

5.  Legal barriers to entry create legal monopolies, examples are:  Public franchise (Canada Post, Royal Mail, in some countries the train companies of the telecomm or the electricity even the tobacco production or the selling of gas)  Government license (in most countries doctors, dentists, architects, bus drivers need a license to operate, sometimes hairdressers too!!!)  Patent (20 years in Canada); copyright is the same idea Barriers to Entry

6.  Natural barriers to entry create natural monopolies  Natural barriers arise if economies of scale are still available when a single firm can meet the entire market demand  The following figure shows this situation Barriers to Entry

7.  The firm’s average total cost curve is ATC  The market demand curve is D

8. Barriers to Entry  Suppose the price is 5 cents per kilowatt- hour and the quantity demanded is 4 million killowatt- hours (per day)

9. Barriers to Entry  1 firm can produce this quantity for 5 cents a kilowatt-hour  But with 2 firms sharing the production, it costs 10 cents

10. Barriers to Entry  And with 4 firms sharing the production, it costs 15 cents per kilowatt- hour  This industry is a natural monopoly

11. Barriers to Entry Knowing about the Minimum Efficient Scale of a type of business and the level of demand will help us predict the number of firms in a market in the long run We can then check whether an industry should be expected to be competitive Now we can check if it is expected to be a monopoly but it is for the same reasons Train services, electricity services, water, gas distributions, telecommunications services: they all have very high fixed costs and they have economies of scale for long ranges

12. Barriers to Entry Therefore it is very easy than when we compare the MES with the demand level we see that one firm should be expected Sometimes even only one firm is too much => losses need to be subsidized if the service is deemed essential: most countries treat the railways this way...

13.  Most real-world monopolies are regulated  You can read a brief intro about regulation at the end of Ch. 13 and a lot more in advanced courses  but we are going to focus on unregulated monopoly so that we can: £ understand why monopoly is regulated, £ understand monopolistic elements in many markets Monopoly and regulation

14. Single-Price Monopoly  A single-price monopoly is a firm that sells all its output for one single price  All the firm’s customers pay the same price for each unit  Many monopolies operate in this way, but many do not: they price-discriminate instead

15.  A price-discriminating monopoly is a firm that sells each unit of output for the highest price it can get by:  Discriminating among customers-- different customers pay different prices  Discriminating across quantities--one customer pays different prices for different quantities Single-Price Monopoly

16.  We’re going to study a single-price monopoly first  What is the price charged by a monopoly and what is the quantity produced?  Monopoly costs are just like those we have seen for competitive industries  But monopoly revenue is special Single-Price Monopoly

17.  A monopolist faces the market demand curve  He sees the big picture (like the astronauts, who can see the Earth round, while the competitive firm could only see the small picture, as we see a flat horizon)  A monopolist’s demand curve is downward- sloping  A monopolist is a price maker, in contrast to a perfectly competitive firm, which is a price taker Demand and Revenue

18.  A monopolist’s marginal revenue is the addition to total revenue from selling one more unit  Recall that in perfect competition, marginal revenue equaled price  In single-pricing monopoly, marginal revenue is always less than price Demand and Revenue

19.  The following table illustrates a monopoly’s demand and revenue schedules Demand and Revenue

20. Price Quantity demanded a 20 0 b 18 1 c 16 2 d 14 3 e 12 4 f 10 5 g 8 6 Single-Price Monopoly Revenue Total revenue 0 18 32 42 48 50 48 Marginal revenue …………18 …………14 …………10 ………… 6 ………… 2 …………–2

21.  This illustrates the demand curve and marginal revenue curve of a single- price monopolist Demand and Revenue

22.  The demand curve is D  The price is cut from $16 to $14  Marginal revenue is $10  The marginal revenue curve is MR Demand and Revenue

23.  A single-price monopoly always charges a price at which demand is elastic  The easiest way to see why is to look again at the demand curve and marginal revenue curve and recall what you learned weeks ago about the elasticity along a linear demand curve Revenue and Elasticity

24.  Look at this monopoly’s demand curve and marginal revenue curve  Check the three elasticity ranges Revenue and Elasticity

25.  At prices above $10, demand is elastic  At prices below $10, demand is inelastic  At $10, demand is unit elastic Revenue and Elasticity

26.  When demand is unit elastic, total revenue is maximized  Marginal revenue becomes negative at prices below $10 Revenue and Elasticity

27.  When demand is unit elastic, total revenue is maximized  Marginal revenue becomes negative at prices below $10

28. Revenue and Elasticity  When demand is unit elastic, total revenue is maximized  Marginal revenue becomes negative at prices below $10

29. Revenue and Elasticity  When demand is unit elastic, total revenue is maximized  Marginal revenue becomes negative at prices below $10

30. Revenue and Elasticity  Producing more than 5 haircuts a day brings in less revenue that producing 5 a day

31. Price and Output Decision  But revenue is not all that matters!!!  A single-price monopoly produces the quantity that maximizes profit  This quantity occurs where total revenue minus total cost is largest

32. Price and Output Decision  Here, economic profit is maximized by producing 3 haircuts an hour

33. Price and Output Decision  The profit-maximizing output also can be found as the quantity at which marginal cost equals marginal revenue (as we know from competition)  The following figure shows this way of looking at the profit-maximizing decision

34. Price and Output Decision  Marginal cost equals marginal revenue at 3 haircuts an hour  Economic profit is $12 an hour

35. Price and Output Decision  This figure also shows how a monopoly sets its price

36. Price and Output Decision  The price is the highest at which the profit- maximizing quantity can be sold

37. Price and Output Decision  Here, that price is $14 per haircut

38. Price and Output Decision  There is no monopoly supply curve  Just a decision about how much to produce and at what price to sell it

39. Next  Price discriminating monopoly  READ THE CHAPTER!!!