MICROECONOMICS: Theory & Applications Chapter 11 Monopoly By Edgar K. Browning & Mark A. Zupan John Wiley & Sons, Inc. 9th Edition, copyright 2006 PowerPoint prepared by Della L. Sue, Marist College

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) John Wiley & Sons, Inc. Copyright 2006

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. John Wiley & Sons, Inc. Copyright 2006

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 John Wiley & Sons, Inc. Copyright 2006

The Monopolist’s Demand Curve and Total Revenue [Figure 11.1] John Wiley & Sons, Inc. Copyright 2006

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. Figure 11.2 John Wiley & Sons, Inc. Copyright 2006

The Monopoly Price and Its Relationship to Elasticity of Demand P = MC/[1 – (1/η)] The smaller the demand elasticity, the greater the profit-maximizing price, relative to marginal cost. John Wiley & Sons, Inc. Copyright 2006

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. John Wiley & Sons, Inc. Copyright 2006

Monopoly and the Shutdown Condition [Figure 11.5] John Wiley & Sons, Inc. Copyright 2006

Monopoly Demand, Marginal Revenue, and Total Revenue [Figure 11.6] John Wiley & Sons, Inc. Copyright 2006

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 The Lerner index varies between zero and one. The larger the Lerner index value, the greater a firm’s monopoly power. John Wiley & Sons, Inc. Copyright 2006

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. John Wiley & Sons, Inc. Copyright 2006

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 (Continued) John Wiley & Sons, Inc. Copyright 2006

Barriers to Entry (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 John Wiley & Sons, Inc. Copyright 2006

Strategic Behavior by Firms: Incumbents and Potential Entrants [Figure 11.8] John Wiley & Sons, Inc. Copyright 2006

The Efficiency Effects of Monopoly [Figure 11.9] John Wiley & Sons, Inc. Copyright 2006

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 Dynamic analysis – a form of economic analysis that looks, over time, at the efficiency of a market Figure 11.10 John Wiley & Sons, Inc. Copyright 2006

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) John Wiley & Sons, Inc. Copyright 2006

Regulation of Price Price ceiling – eliminates the monopolist’s reason for restraining output Figure 11.11 John Wiley & Sons, Inc. Copyright 2006

Copyright 2006 John Wiley & Sons, Inc. All rights reserved Copyright 2006 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. John Wiley & Sons, Inc. Copyright 2006