Part 7 Monopoly Many markets are dominated by a single seller with market power The economic model of “pure monopoly” deals with an idealized case of a market with only one seller A monopoly has no competition and requires - No close substitutes - Barriers to entry Barriers to entry can be legal, natural (economies of scale), or created by the monopoly itself (limit pricing, predatory pricing)

Natural Monopoly Natural monopoly arises due to economies of scale over outputs that are large relative to the size of the market $ LAC D Q

Monopoly Pricing As the only firm in the market the monopoly faces the market demand curve To sell more means lowering the price – Monopoly is constrained by the demand conditions Single price monopoly – sells all units at the same price Price discriminating monopolist – sells different units at different prices (must be restrictions on resale)

Single Price Monopoly Faces the market demand curve and can has to sell all units at the same price P What happens to P x Q as price is reduced? P P’ P” D Q Q’ Q” Q

Revenue Curves for a Single Price Monopolist MR = ΔTR/ΔQ E = 1 E <1 D = AR Q MR $ $ TR max TR (P x Q) Q

Price and Output Decision Monopolist will never produce in the inelastic range of the demand curve (MR is negative) Monopolist will produce where the difference between TR and TC is the greatest Monopolist will produce where MC = MR Profit maximizing condition is MC = MR, but MR < P

Price and Output: TC and TR $ TC TR Max economic Profit Q Q*

Price and Output: MC and MR ATC D = AR Economic profit MR Q Q*

Single Price Monopoly and Competition Compare single price monopoly equilibrium with perfect competition—assuming similar cost conditions P Monopoly MC Comp S curve P” P’ D Monopoly MR Q” Q’ Q

Efficiency Comparison Perfect Competition P S CS P’ PS D Q Q’ P Monopoly S CS P” PS Deadweight loss MR D Q Q”

Efficiency Comparison Monopoly creates allocative inefficiency measured by the deadweight loss. How significant is this? Monopoly might gain large economies of scale. Are large firms lower cost? Monopolies capture consumers’ surplus and redistribute income from consumer to the monopoly

Price Discrimination Price discrimination involves selling different units of the good for different prices for reason unconnected with production costs Based on differences in willingness to pay between units of the good or between different buyer types or groups Prevent resale between types or groups Attempt to capture consumers’ surplus Price discrimination is illegal but rarely prosecuted—only when used for anti-competitive purposes

Price Discrimination Market segmentation P Monopoly revenue P’ P” Q Q”

Perfect Price Discrimination Monopoly charges the maximum willingness to pay for each unit. D curve then becomes the MR curve. Q’ is the same as the output under perfect competition. There is no deadweight loss. P MC PS D=MR Q’ Q

Policy Issues Possible Advantages of monopoly - Economies of scale and scope - Incentives to innovate Policy towards Monopoly - Breaking up monopolies - Regulation of monopoly prices - Public Ownership - Don’t worry, be happy Pricing rules for regulating a natural monopoly - Marginal cost pricing - Average cost pricing

Regulating a natural Monopoly P & Q are with no regulation. P’ & Q’ are with MC pricing which creates a loss. P” & Q” are with price = ATC P P” ATC MC P’ D MR Q Q” Q’ Q