WED. 3/9  What is the objective of the board game monopoly?

CH. 7 MARKET STRUCTURES 7.2 Notes “Monopoly”

MONOPOLY  Monopolies form when barriers prevent firms from entering a market that has a single supplier  If buyers are broad in their search they can usually find a substitute  With a monopoly there are no substitutes  The problem w/ monopolies is that they can take advantage of their market power and charge a high price

FORMING A MONOPOLY  Economies of scale  Producers average cost of production to drop as quantity supplied increases  Must meet two conditions: 1. Start-up cost are high 2. Average cost fall for each additional unit produced  Why? Large fixed costs can be spread out among each additional unit produced

 Natural monopoly  Where the market can only support one large firm  If a second firm enters the market, the price per unit will drop drastically forcing one or both out of business  Ie: Public water, electricity  Technology and Change  Innovation sometimes can cut fixed costs making small firms as efficient as large ones  Ie: cell phone companies

GOVERNMENT MONOPOLIES  Sometimes the government creates artificial barriers to entry to allow a firm time to invest and develop a specific technology  Encourages firms to research and develop new products who’s start up costs are very high  Market power established by the patent allows the firm to maximize its profit  Ie: pharmaceutical companies

 Franchise  Where local authorities provide a single firm the right to sell goods within a small market  Ie: soft drink companies in restaurants, bball parks etc.  License  Same as a franchise but on a much larger scale  Ie: radio, television  Industrial Organization  The government restricts the number of firms in a market  MLB (official exemption), NHL, NFL, NBA  All are monopolies because they collude

OUTPUT DECISIONS  Monopolists face a limited choice, either: 1. Output 2. Price  Since a firm usually chooses to maximize its profits, the firm will produce fewer goods at a larger price  Monopolists dilemma  Law of demand  As quantity demanded increases prices decline

 Falling marginal revenue  Marginal revenue: the amount earned from the last unit sold  In a perfectly competitive market marginal revenue is always equal to price  Each firm receives the same price no matter how much it produces, thus revenue grows at a steady rate with production  In a monopoly firms have some control over price  Marginal revenue is less than price  Setting Price  If the motivation for a firm is profit then….  The firm will choose the output that yields the highest profit regardless of demand  Profit  Calculate the profit with the production set at 9,000 doses Perfectly Competitive Market Copy the demand schedule in fig. 7.6 from your text.

PRICE DISCRIMINATION 1. Discounted airline fares  Business travelers vs vacationing families.  Buy tickets in advance vs short notice.  Higher price for Friday flights vs Saturday flights 2. Manufacture rebate offers  Appeals to people who are unwilling to pay full price. 3. Senior citizen or student discount  Lower income, unable to pay full price 4. Children fly or stay free  Families spend more money on food, clothing, school less money for vacation  Firms willing to make less profit to have their business by offering discount

 Limits of Price Discrimination (Must have all 3) 1. Some market power  Must have some control over price, this is why you don not see them in highly competitive markets 2. Distinct customer groups  Based on their sensitivity to price  Ie: students, senior citizens 3. Difficult resale  Works best if consumed on the spot, eliminates chance of resale  Theme parks, restaurants

CHECKING FOR UNDERSTANDING 1. List the characteristics of a monopoly. 2. What can a firm with market power do? 3. Why does govt. usually approve of natural monopolies?