The Theory of the Firm Monopoly Profit & Revenue Natural Monopoly Advantages & Disadvantages Most info from Blink & Dorton or Tragakes

Recap: What are the assumptions of monopolies? Reminder: Even if a company may not be a “true monopoly,” it might have monopoly power (e.g. Google outside of China)

Recap: Intro to Monopoly The (one) firm IS the industry! Barriers to entry exist (New firms can’t easily enter) – Examples Economies of scale Branding/Advertising Legal barriers (patents, licenses, copyrights, etc.) – 1 additional barrier: gov’t may only allow one firm Control of essential resources – Leads to what kind of profits in the long run? ABNORMAL!

BARRIERS TO ENTRY: Economies of Scale Leads to ____________ cost advantages? – Average What leads to lower per-unit costs? – Specialization – Division of labour – Bulk-buying – Financial economies (getting larger loans, etc.)

BARRIERS TO ENTRY 3. Legal Barriers Why do patents exist? Encourage invention!!! – If inventions can be copied immediately, then what is the incentive to invest in R & D? Most patents protect for a # of years Extra info: Importance of patents in the TPP

Recap: The Extent of Monopoly Power Key Qs Can the firm set its own prices w/o worrying about other firms? Can the firm keep others out of the industry? Are there no adequate substitutes? – e.g. Underground railway in a city maybe only one, but it competes against buses, taxis, etc.

Recap: UNDERSTANDING TOTAL REVENUE Is this what happens if price is constant? (Note: This is when firms have no control over the price) What happens if price is variable? (Note: This is when firms have control over the price)

Recap: Putting the two together (TR/TC) if firm DOES NOT control (can’t change) price (PERFECT COMPETITION) Where is profit maximized (or loss minimized) in each scenario? Where is normal profit? Where is abnormal profit?

Recap: Putting the two together (TR/TC) if firm DOES control (can change) price (MONOPOLY) Which curve (from previous slide) should change? What was the symbol for profit?

Recap: UNDERSTANDING MARGINAL REVENUE What does the marginal revenue curve look like if the price is constant? (PERFECT COMPETITION) What does the marginal revenue curve look like if the price varies with output? (MONOPOLY, MONOPOLISTIC COMPETITION)

PERFECT COMP., MONOPOLISTIC COMP., MONOPOLY CURVES

Recap: UNDERSTANDING PROFIT MAXIMIZATION: Putting MR & MC together WHERE ON EACH CURVE IS PROFIT MAXIMIZED?

Recap: UNDERSTANDING PROFIT MAXIMIZATION IN A MONOPOLY Why is it not from the exact point where MR = MC? IS PROFIT MAXIMIZED WHERE MC = MR? YES! IT IS ALSO WHERE LOSSES CAN BE MINIMIZED (SEE (b)) It is where AR is compared to AC

Recap : UNDERSTANDING PROFIT MAXIMIZATION IN A MONOPOLY WHAT TYPE OF PROFIT IS DEMONSTRATED IN (A)? ABNORMAL

CAN A MONOPOLIST MAKE ABNORMAL PROFIT IN THE LONG RUN? YES!!! IS THE MONOPOLIST GUARANTEED TO ABNORMAL PROFIT IN THE LONG RUN? NO!!!

MONOPOLIST MAKING LOSSES IN THE LONG RUN

CAN PRODUCTIVE AND ALLOCATIVE EFFICIENCY OCCUR AT THE SAME TIME W/ABNORMAL PROFIT? Does MC = AR (allocative efficiency) where MC = AC (productive efficiency)? No! Q1 = productive Q2 = allocative DOES A MONOPOLY AN EFFICIENT LEVEL? No! It Q (profit- maximizing level where MC = MR)

Efficiency Perfect competition – both productive AND allocative effic. in long run Monopolist – neither productive NOR allocative efficiency Allocative inefficiency = “Welfare loss”. Despite this inefficiency, monopolies may still be desirable: – b/c of their ability to finance R & D from economic (abnormal) profits – b/c they may need to keep innovating to maintain abnormal profit – b/c of the possibility of economies of scale » Remember: monopolies do not have to be big! » Might these 3 points lead to lower prices and/or more consumer benefits than in perfect c.? YES, they MIGHT! (Why?) But they also MIGHT NOT! (Why?)

The benefits of economies of scale: Perfect competition v. monopoly Perfect competitor will P1 w/output of Q1. (Where MC = MR) Monopolist will produce where? P2/Q2 (where MC = MR)

NATURAL MONOPOLY A natural monopoly is a firm that has economies of scale so large that it is possible for the single firm alone to supply the entire market at a lower average cost than 2 or more firms. In other words, there are only enough economies of scale available in the market to support one firm.

NATURAL MONOPOLY

(Ignore the D2 curve for the 1 st 2 Qs) Where can the monopolist make abnormal profits? Between Q1 & Q2 (AR >ATC) Why is shape & position of LRAC where it is? Economies of scale What would happen if a 2 nd firm were to enter the market? Shift to D2 LRAC > every level of output ***Both firms would achieve only losses*** not even normal profit A n.m. is a strong barrier to entry for other possible firms b/c they realize “it would be extremely difficult to attain the low costs of the already existing firm.” (Tragakes 188)

NATURAL MONOPOLY One unique feature of a natural monopoly (not demonstrated on previous page) : AR (P) intersects LRAC curve when average costs are still DECLINING

Best Examples of Natural Monopolies Utilities (Companies that supply…) – Water – Electricity – Gas – Note: Not all utilities are ‘natural’ monopolies

Summary: 3 (possible) problems with monopolies (WHAT DO YOU THINK THEY ARE?) They are productively and allocatively inefficient. They can charge a higher price for a lower level of output. They can exercise anti-competitive behaviour to keep their monopoly power. These potential problems mean that monopolies can act against the public interest. As a result, all governments have laws and policies to limit monopoly power. (ANTI-TRUST LAWS!)

NOT ALL PROBLEMS ARE EQUAL! WHICH IS WORSE: MONOPOLY PROFITS OF… – POST OFFICE? – A GIANT TECH FIRM?

RECAP: COMPETITION THEORIES