Chapter 10 Monopoly (Part I) © 2004 Thomson Learning/South-Western

2 Monopoly A market is described as a monopoly if there is only one producer. – This single firm faces the entire market demand curve. – The monopoly must make the decision of how much to produce. The monopoly’s output decision will completely determine the good’s price.

3 Causes of Monopoly Barriers to entry which are factors that prevent new firms from entering a market are the source of all monopoly power. There are two general types of barriers to entry – Technical barriers – Legal barriers

4 Technical Barriers to Entry A primary technical barrier is when the firm is a natural monopoly because it exhibits diminishing average cost over a broad range of output levels. – Hence, a large-scale firm is more efficient than a small scale firm. A large firm could drive out competitors by price cutting.

5 Technical Barriers to Entry Other technical barriers to entry. – Special knowledge of a low-cost method of production. – Ownership of a unique resource. – Possession of unique managerial talents.

6 Legal Barriers to Entry Pure monopolies can be created by law. – The basic technology for a product can be assigned to only one firm through a patent. The rational is that it makes innovation profitable and encourages technical advancement. – The government can award an exclusive franchise or license to serve a market. This may make it possible to ensure quality standards

7 APPLICATION 10.1: Should You Need a License to Shampoo a Dog? State governments license many occupations and impose penalties for those who run a business without a license. Specific examples include: – Dry Cleaning in California Perspective dry-cleaners must take a licensing exam which may require attending a school. Profits are higher than in other states. Existing firms are staunch defenders of the law.

8 APPLICATION 10.1: Should You Need a License to Shampoo a Dog? – Liquor Stores Currently 16 states operate liquor-store monopolies. In 34 other states, liquor stores are licensed and subject to restrictions on pricing and advertising. – States with licenses have higher prices. – Existing owners are most stringent supporters. – Taxicabs Many cities limit number of taxicabs. In Toronto, prices are about 225 percent higher. New York city taxi medallions cost about $250,000.

9 Profit Maximization To maximize profits, a monopoly will chose the output at which marginal revenue equals marginal costs. The demand curve is downward-sloping so marginal revenue is less than price. – To sell more, the firm must lower its price on all units to be sold in order to generate the extra demand.

10 A Graphic Treatment A monopoly will produce an output level in which price exceeds marginal cost. Q* is the profit maximizing output level in Figure – If a firm produced less than Q*, the loss in revenue (MR) will exceed the reduction in costs (MC) so profits would decline.

11 Price P* C A E MC MR AC D Quantity per week Q* 0 FIGURE 10.1: Profit Maximization and Price Determination in a Monopoly Market

12 A Graphical Treatment – The increase in costs (MC)would exceed the gain in revenue (MR) if output exceeds Q*. – Hence, profits are maximized when MR = MC. Given output level Q*, the firm chooses P* on the demand curve because that is what consumers are willing to pay for Q*. The market equilibrium is P*, Q*.

13 Monopoly Supply Curve With a fixed market demand curve, the supply “curve” for a monopoly is the one point where MR = MC (point E in Figure 10.1.) If the demand curve shifts, the marginal revenue curve will also shift and a new profit maximizing output will be chosen. Unlike perfect competition, these output, price points do not represent a supply curve.

14 Monopoly Profits Monopoly profits are shown as the area of the rectangle P*EAC in Figure Profits equal (P - AC)Q*, – If price exceeds average cost at Q* > 0, profits will be positive. – Since entry is prohibited, these profits can exits in the long run.

15 Monopoly Rents Monopoly rents are the profits a monopolist earns in the long run. – These profits are a return to the factor that forms the basis of the monopoly. Patent, favorable location, license, etc.. Others might be willing to pay up to the amount of this rent to operate the monopoly to obtain its profits.