Monopoly - Characteristics A firm is considered a monopoly if . . . . . . it is the sole seller of its product. . . . its product does not have close substitutes. . . . it has some ability to influence the market price of its product. 2 2 2 2

Why Monopolies Arise The fundamental cause of monopoly is barriers to entry. Barriers to entry have three sources: ä Ownership of key resource ä Legal barriers by government ä Large economies of scale Exclusive ownership of an important resource that cannot be readily duplicated is a potential source of monopoly. 5 4 4 4

Government-Created Monopolies Patent and copyright laws are a major source of government-created monopolies. Governments also restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. 10 6 6 6

Natural Monopolies An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. Because of economies of scale, the minimum efficient scale of one firm’s plant is so large that only one firm can supply the market efficiently. 11 8 8 8

Monopoly versus Perfect Competition ä Is the sole producer ä Has a downward-sloping demand curve ä Is a price maker ä Reduces price to increase sales Competitive Firm ä Is one of many producers ä Has a horizontal demand curve ä Is a price taker ä Sells as much or as little at same price

NB : - MR does not equal AR Monopoly’s Revenue Total Revenue P x Q = TR Average Revenue TR/Q = AR = P Marginal Revenue DTR/DQ = MR NB : - MR does not equal AR 15 14 14 14

Monopoly’s, Total, Average, and Marginal Revenue 18 15 15 15

Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less than the price of its good. ä The demand curve is downward sloping. ä When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases. 15 16 16 16

Monopoly’s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). ä The output effect—more output is sold, so Q is higher. ä The price effect—price falls, so P is lower. 18 17 17 17

Monopoly’s Demand and Marginal Revenue Curves Price The marginal revenue curve lies below its demand curve. £11 10 9 8 7 6 5 4 3 Demand (average revenue) 2 Marginal revenue 1 -1 1 2 3 4 5 6 7 8 Quantity of Water -2 -3 -4 16 22 22 22

Profit Maximization of a Monopoly A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity. 19 23 23 23

Profit Maximization of a Monopoly Costs and Revenue Marginal cost Average total cost Demand Marginal revenue Quantity 20 26 26 26

Profit Maximization of a Monopoly Costs and Revenue Marginal cost Average total cost A Demand Marginal revenue Quantity 20 27 27 27

Profit Maximization of a Monopoly Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Average total cost A Demand Marginal cost Marginal revenue Quantity 20 28 28 28

Profit Maximization of a Monopoly Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity 20 29 29 29

Profit Maximization of a Monopoly Costs and Revenue 2. ...and then the demand curve shows the price consistent with this quantity. 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... B Monopoly price Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity 20 30 30 30

Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC 23 31 31 31

Calculating Monopoly Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q 40 32 32 32

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price Average total cost Demand Marginal revenue QMAX Quantity 27 37 37 37

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price Average total cost Average total cost Demand Marginal revenue QMAX Quantity 27 38 38 38

The Monopolist’s Profit Costs and Revenue Marginal cost Monopoly price E B Monopoly profit Average total cost Average total cost D C Demand Marginal revenue QMAX Quantity 27 39 39 39

The Monopolist’s Profit The monopolist will receive economic profits as long as price is greater than average total cost. 23 40 40 40

The Welfare Cost of Monopoly A monopoly leads to an inefficient allocation of resources and a failure to maximize total economic well-being. The monopolist produces less than the socially efficient quantity of output. Because a monopoly charges a price above marginal cost, consumers who value the good at more than its marginal cost but less than the monopolist’s price won’t buy it. 31 42 42 42

The Welfare Cost of Monopoly Monopoly pricing prevents some mutually beneficial trades from taking place. 31 45 45 45

The Deadweight Loss Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. ä This wedge causes the quantity sold to fall short of the social optimum. 33 47 47 47

The Deadweight Loss Price Marginal cost Monopoly price Marginal revenue Demand Monopoly quantity Quantity 34 51 51 51

The Deadweight Loss Price Marginal cost Monopoly price Marginal revenue Demand Monopoly quantity Efficient quantity Quantity 34 52 52 52

The Deadweight Loss Price Deadweight loss Marginal cost Monopoly price revenue Demand Monopoly quantity Efficient quantity Quantity 34 53 53 53

Public Policy Toward Monopolies Government responds to the problem of monopoly in one of four ways. ä Making monopolized industries more competitive. ä Regulating the behaviour of monopolies. ä Turning some private monopolies into public enterprises. ä Doing nothing at all. 39 54 54 54

Creating a Competitive Market and Regulation Government may implement and enforce antitrust laws to make the industry more competitive. Government may regulate the prices that the monopoly charges. ä The allocation of resources will be efficient if price is set to equal marginal cost. There are two practical problems with marginal-cost pricing. ä Price may be less than average total cost, and the firm will lose money. ä It gives the monopolist no incentive to reduce cost. 39 56 56 56

Public Ownership Government can turn the monopolist into a government-run enterprise. Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies. 39 64 64 64

Price Discrimination Price discrimination is the practice of selling the same good at different prices to different customers. ä Not possible in a competitive market. Two important effects of price discrimination: ä It can increase the monopolist’s profits. ä It can reduce deadweight loss. 41 68 68 68

Examples of Price Discrimination Movie tickets Airline tickets Discount coupons Financial aid Quantity discounts 42 74 74 74

The Prevalence of Monopoly How prevalent are the problems of monopolies? ä Monopolies are common. ä Most firms have some control over their prices because of differentiated products. ä Firms with substantial monopoly power are rare. ä Few goods are truly unique. 44 77 77 77

Conclusion A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product. Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost. 78 78

Conclusion A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. A monopoly causes deadweight losses similar to the deadweight losses caused by taxes. 80 80

Conclusion Policymakers can try to remedy the inefficiencies of monopolies with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. If the market failure is small, policymakers may decide to do nothing at all. 81 81

Conclusion Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. Price discrimination can raise economic welfare and lessen deadweight losses. 82 82

Figure 15-2 (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve’ Price Price Demand Demand Quantity of Output Quantity of Output Figure 15-2 2 86 86

Quantity of Water Price £11 10 9 8 7 6 5 4 3 2 1 -1 -2 -3 -4 Demand -1 -2 -3 -4 Demand (average revenue) Marginal revenue Figure 15-3 3 87 87

1. The intersection of the marginal-revenue curve Monopoly price Quantity Q1 Q2 QMAX Costs and Revenue Demand Average total cost Marginal revenue Marginal cost B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... A 2. ...and then the demand curve shows the price consistent with this quantity. Figure 15-4 4 88 88

Monopoly price Average total cost Quantity QMAX Costs and Revenue Costs and Revenue Demand Marginal cost Marginal revenue B C E D profit Average total cost Figure 15-5 5 89 89

Price during patent life Price after patent expires Quantity Monopoly Competitive Costs and Revenue Demand Marginal cost revenue Figure 15-6 6 90 90

Value to buyers is greater than cost to seller. Value to buyers Quantity Price Demand (value to buyers) Efficient quantity Marginal cost Value to buyers is greater than cost to seller. is less than Cost to monopolist Value to buyers Figure 15-7 7 91 91

Quantity Price Efficient quantity Monopoly price Deadweight loss Price Efficient quantity Monopoly price Deadweight loss Demand Marginal revenue Marginal cost Figure 15-8 8 92 92

Price Average total cost Average total cost Loss Regulated Quantity Loss Price Demand Marginal cost Average total cost Figure 15-9 9 93 93

Figure 15-10 (a) Monopolist with Single Price (b) Monopolist with Perfect Price Discrimination Price Price Consumer surplus Deadweight Monopoly loss price Profit Profit Marginal cost Marginal cost Marginal Demand Demand revenue Quantity sold Quantity Quantity sold Quantity Figure 15-10 10 94 94