MICROECONOMICS: Theory & Applications By Edgar K. Browning & Mark A. Zupan John Wiley & Sons, Inc. 11 th Edition, Copyright 2012 PowerPoint prepared by Della L. Sue, Marist College Chapter 11: Monopoly

Copyright 2012John Wiley & Sons, Inc. 2 Learning Objectives Define monopoly and show what a monopolist’s demand and marginal revenue curves look like. Explain why a monopolist’s profit-maximizing output is where marginal revenue equals marginal cost. Describe why the extent to which a monopolist’s price exceeds marginal cost is larger the more inelastic the demand faced by the monopolist. (continued)

Copyright 2012John Wiley & Sons, Inc. 3 Learning Objectives (continued) Understand why the shutdown condition applies to monopolies as well as to firms operating in a perfectly competitive market. Outline the potential sources of monopoly power: absolute cost advantages, economies of scale, product differentiation, and regulatory barriers. Explore the efficiency effects of monopoly from a static as well as a dynamic perspective. Overview public policy toward monopoly.

Copyright 2012John Wiley & Sons, Inc. 4 Terminology Monopoly – a market with a single seller Monopoly power – some ability to set price above marginal cost Price maker – a monopoly that supplies the total market and can choose any price along the market demand curve that it wants

The Monopolist’s Demand and Marginal Revenue Curves Demand curve market demand average revenue Marginal revenue: effect on total revenue due to change in output decreases as output increases less than price when demand curve slopes downward Copyright 2012John Wiley & Sons, Inc. 5

Copyright 2012John Wiley & Sons, Inc. 6 Figure The Monopolist’s (Desperate Housewives co-stars) Demand Curve

Copyright 2012John Wiley & Sons, Inc. 7 Table 11.1

Profit-Maximizing Output of a Monopoly Marginal revenue is always less than price when the demand curve slopes downward. Profit is maximized where MR=MC: If MR>MC, then profits will increase if output is increased. If MR<MC, then profits will increase if output is decreased. Copyright 2012John Wiley & Sons, Inc. 8

Copyright 2012John Wiley & Sons, Inc. 9 Table 11.2

Figure Profit-Maximization: Total and per-Unit Curves Copyright 2012John Wiley & Sons, Inc. 10

Copyright 2012John Wiley & Sons, Inc. 11 Figure Profit Maximization

Copyright 2012John Wiley & Sons, Inc. 12 The Monopoly Price and Its Relationship to Elasticity of Demand The smaller the demand elasticity, the greater the profit-maximizing price, relative to marginal cost.

Copyright 2012John Wiley & Sons, Inc. 13 Derivation of Price Formula

Copyright 2012John Wiley & Sons, Inc. 14 Figure The Inverse Elasticity Pricing Rule

Copyright 2012John Wiley & Sons, Inc. 15 Further Implications of Monopoly Analysis A monopoly has no supply curve. A monopoly does not necessarily make positive economic profit. A monopoly’s demand curve is elastic where marginal revenue is positive. A profit-maximizing monopolist will always sell at a price where demand is elastic.

Copyright 2012John Wiley & Sons, Inc. 16 Figure Monopoly and the Shutdown Condition

Copyright 2012John Wiley & Sons, Inc. 17 Figure Monopoly Demand, Marginal Revenue, and Total Revenue

Copyright 2012John Wiley & Sons, Inc. 18 Figure Monopoly Power When There are Several Suppliers

Copyright 2012John Wiley & Sons, Inc. 19 Measuring Monopoly Power Lerner Index – a means of measuring a firm’s monopoly power that takes the markup of price over marginal cost expressed as a percentage of a product’s price: Lerner Index = (P – MC)/P (3) The Lerner index varies between zero and one. The larger the Lerner index value, the greater a firm’s monopoly power.

Copyright 2012John Wiley & Sons, Inc. 20 Sources of Monopoly Power What factors determine the extent to which a firm has monopoly power? The elasticity of the market demand curve If the market demand curve is perfectly elastic, any individual supplier has no monopoly power. The elasticity of supply by other firms The monopoly power of any one firm is more limited when there is a greater number of rival firms.

Copyright 2012John Wiley & Sons, Inc. 21 Barriers to Entry Barrier to entry – any factor that limits the number of firms operating in a market and thereby serves to promote monopoly power Categories: Absolute cost advantage A situation in which an incumbent firm’s production cost (long-run average total cost) is lower than potential rivals’ production costs at all relevant output levels Economies of scale A situation in which the long-run average total cost curve for all firms slopes downward over the entire range of market output Natural monopoly – an industry in which production cost is minimized if one firm supplies the entire output. (continued)

Copyright 2012John Wiley & Sons, Inc. 22 Barriers to Entry (continued) Categories (continued): Product differentiation A means by which consumers may perceive the product sold by an incumbent firm to be superior to that offered by prospective rivals. Regulatory barriers Barriers to entry created by the government through vehicles such as patents, copyrights, franchises, and licenses Government purchases from particular firms Limits on nonprice competition, e.g., advertising

Strategic Behavior by Firms: Incumbents and Potential Entrants Factors affecting market power: Elasticity of demand Number of other firms in industry Elasticity of market demand Elasticity of supply of other firms Product homogeneity Nature of the competition between firms Possibility of entry by new firms Copyright 2012John Wiley & Sons, Inc. 23

Copyright 2012John Wiley & Sons, Inc. 24 Figure Potential Entry and Monopoly

The Efficiency Effects of Monopoly Comparison between perfectly competitive industry and monopoly: Perfectly competitive firm - horizontal MR Monopoly – downward-sloping MR Marginal cost curve is horizontal for both industry structures For the same demand and cost conditions, price will be higher and output lower under monopoly than under competition. Copyright 2012John Wiley & Sons, Inc. 25

Copyright 2012John Wiley & Sons, Inc. 26 Figure The Deadweight Loss of Monopoly

A Dynamic View of Monopoly and Its Efficiency Implications Static analysis – a form of economic analysis that looks at the efficiency of a market at any one point in time Monopoly: less efficient than a perfectly competitive industry Dynamic analysis – a form of economic analysis that looks, over time, at the efficiency of a market Monopoly: enhances social welfare in the creation of better products Which approach is more appropriate? It depends: Pricing power provides incentive to innovate Competition increases total surplus Pricing power forestalls benefits of competition Copyright 2012John Wiley & Sons, Inc. 27

Figure A Dynamic View of Monopoly Copyright 2012John Wiley & Sons, Inc. 28

Copyright 2012John Wiley & Sons, Inc. 29 Public Policy Toward Monopoly Antitrust laws – a series of codes and amendments intended to promote a competitive market environment 3 major statutes: Sherman Act (1890) Clayton Act (1914) Federal Trade Commission Act (1914)

Regulation of Price Price ceiling: government-imposed maximum limit on price => restriction on output cannot result n higher price eliminates the monopolist’s reason for restraining output reduces monopoly profit benefits consumers by lowering price increases output to the efficient level, eliminating the deadweight loss from monopoly Limitations: outcome depend upon where price ceiling is set Price should be high enough for profit>=0 Monopoly firm may decrease quality as a result Copyright 2012John Wiley & Sons, Inc. 30

Figure Regulation of Price Copyright 2012John Wiley & Sons, Inc. 31

Copyright 2012John Wiley & Sons, Inc. 32 The Math Behind Monopoly (Slide 1) The Monopolist’s Demand and Marginal Revenue Curves

Copyright 2012John Wiley & Sons, Inc. 33 The Math Behind Monopoly (Slide 1) The Monopolist’s Profit-Maximizing Output Choice

Copyright 2012John Wiley & Sons, Inc. 34 Copyright © 2012 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.