©2002 South-Western College Publishing Chapter 9 Monopoly Key Concepts Summary Practice Quiz Internet Exercises ©2002 South-Western College Publishing

What is a monopoly? Single seller Unique product Impossible entry into the market

What are the most common monopolies? Local monopolies are more common real-world approximations of the model than national or world market monopolies

What does it mean to have a unique product? There are no close substitutes for the monopolists product

What are some examples of impossible entry? Owner of a vital resource Legal barriers Economies of scale

What is a natural monopoly? An industry in which the long-run average cost of production declines throughout the entire market

What is unique about a natural monopoly? A single firm will produce output at a lower per-unit cost than two or more firms in the industry

What is a price maker? A firm that faces a downward-sloping demand curve

What is the difference between monopoly and perfect competition? The D and MR curves of the monopolist are downward sloping; in perfect competition they are horizontal

What is unique about the demand curve for a monopolist? The monopolist demand curve and the industry demand curve are one in the same

Minimizing Costs in a Natural Monopoly Cost per Unit (dollars) 40 35 30 25 5 firms Cost per Unit (dollars) 20 2 firms 15 1 firm 10 5 Quantity of Output 100 20 40 60 80

What determines price for a monopolist? Demand

Why is MR < P for all but the first unit of output? To sell additional units, the price has to be lowered; this price-cut applies to all units, not just the last unit

Price & Marginal Revenue $100 Monopoly $75 Demand $50 $25 Price & Marginal Revenue $-25 $-50 Marginal Revenue $-75 $-100 Q 2 4 6 8 10 12 14 16 18

Monopoly $400 $300 Total Revenue $200 $100 Q 2 4 6 8 10 12 14 16 18

Where does a monopolist produce to maximize profit or minimize losses? MR = MC

P D Q Profit MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 Profit $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

P D Q Loss MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

Can a monopolist make a profit in the long-run? If the positions of a monopolist’s demand and cost curves give it a profit and nothing disturbs these curves, it can make a profit in the long-run

What is price discrimination? The practice of a seller charging different prices for the same product not justified by cost differences

What is arbitrage? The practice of earning a profit by buying a good at a low price and reselling the good at a higher price

Is price discrimination unfair? Many buyers benefit from the discrimination by not being excluded from purchasing the product

Is monopoly efficient? A monopolist is inefficient because resources are underallocated to the production of its product

Price Discrimination Market for average students MR=MC T1 MC D MR Q Q1

Price Discrimination Market for Superior Students Monopolist MR=MC Price Discrimination Market for Superior Students MC T2 D MR Q Q2

Is perfect competition efficient? A perfectly competitive firm that produces where P = MC achieves an efficient allocation of resources

P Perfect Competition MR=MC MC MR, D Pc Q Qc

P Monopolist MR=MC MC Pm D MR Q Qm

How does monopoly harm consumers? It charges a higher price and produces a lower quantity than would be the case in a perfectly competitive situation

Impact of Monopolizing and Industry MR=MC MC Pm Pc MR D Q Qm Qc

What is the case against monopoly? Higher price Charges a Price > MC Long-run economic profit Alters the distribution of income to favor monopolist

Key Concepts

Key Concepts What is a monopoly? What is a natural monopoly? What is unique about a natural monopoly? What is a price maker? What is the difference between monopoly and perfect competition? Why is MR < P for all but the first unit of output?

Key Concepts cont. Where does a monopolist produce to maximize profit or minimize losses? Can a monopolist make a profit in the long-run? What is price discrimination? How does monopoly harm consumers?

Summary

Monopoly is a single seller facing the entire industry demand curve because it is the industry. The monopolist sells a unique product, and extremely high barriers to entry protect it from competition.

Barriers to entry that prevent new firms from entering an industry are (1) ownership of an essential resource, (2) legal barriers, and (3) economies of scale. Government franchises, licenses, patents, and copyrights are the most obvious legal barriers to entry.

A natural monopoly arises because of of economies of scale in which the LRAC curve falls as production increases.

Without government restrictions, economies of scale allow a single firm to produce at a lower cost than any firm producing a smaller output. Thus, smaller firms leave the industry, new firms fear competing with the monopolist, and the result is that a monopoly emerges naturally.

Minimizing Costs in a Natural Monopoly Cost per Unit (dollars) 40 35 30 25 5 firms Cost per Unit (dollars) 20 2 firms 15 1 firm 10 5 Quantity of Output 100 20 40 60 80

A price-maker firm faces a downward-sloping demand curve A price-maker firm faces a downward-sloping demand curve. It therefore searches its demand curve to find the price-output combination that maximizes its profit and minimizes its loss.

The marginal revenue and the demand curves are downward-sloping for a monopolist. The marginal revenue curve for a monopolist is below the demand curve, the total revenue curve reaches its maximum where marginal revenue equals zero.

Price elasticity of demand corresponds to sections of the marginal revenue curve. When MR is positive, price elasticity of demand is elastic, Ed > 1. When MR is equal to zero, price elasticity of demand is unit elastic, = 1. When MR is negative, price elasticity of demand is inelastic, Ed < 1.

The short-run-profit-maximizing monopolist, like the perfectly competitive firm, locates the profit-maximizing price by producing the output where the MR and the MAC curves intersect. If this is less than the AVC curve, the monopolist shuts down to minimize losses.

P D Q Profit MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 Profit $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

P D Q Loss MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $200 $175 $150 $125 $100 $75 AVC $50 D $25 MR Q 1 2 3 4 5 6 7 8 9

The long-run-profit-maximizing monopolist earns a profit because of barriers to entry. If demand and cost conditions prevent the monopolist from earning a profit, it will leave the industry.

Price discrimination allows the monopolist to increase profits by charging buyers different prices, rather than a single price.

Three conditions are necessary for price discrimination: (1) the demand curve must be downward-sloping, (2) buyers in different markets must have different price elasticities of demand, and (3) buyers must be prevented from reselling the product at a higher price than the purchase price.

Price Discrimination Market for average students MR=MC T1 MC D MR Q Q1

Price Discrimination Market for superior students Monopolist MR=MC MC T2 D MR Q Q2

Monopoly disadvantages are these: (1) A monopolist charges a higher price and produces less output than a perfectly competitive firm, (2) resource allocation is inefficient because the monopolist produces less than if competition existed, (3) monopoly produces higher long-run profits than if competition existed, and (4) monopoly transfers income from consumers to producers to a greater degree than under perfect competition.

P Perfect Competition MR=MC MC MR, D Pc Q Qc

P Monopolist MR=MC MC Pm D MR Q Qm

©2002 South-Western College Publishing Chapter 9 Quiz ©2002 South-Western College Publishing

1. A monopolist always faces a demand curve that is a. perfectly inelastic. b. perfectly elastic. c. unit elastic. d. the same as the market demand curve. D. A monopoly is the only seller, so there is no distinction between the market demand curve and the individual demand curve.

2. A monopoly sets the a. price at which marginal revenue equals zero. b. price that maximizes total revenue. c. highest possible price on its demand curve. d. price at which marginal revenue equals marginal cost. D. Profits are always maximized if the firm produces at the point where MR = MC.

P D Q Profit MC ATC AVC MR MR=MC 1 2 3 4 5 6 7 8 9 $80 $70 $60 $50 $40 $30 AVC $20 D $10 MR Q 1 2 3 4 5 6 7 8 9

3. A monopolist sets a. the highest possible price. b. a price corresponding to the minimum average total cost. c. a price equal to marginal revenue. d. a price determined by the point on the demand curve corresponding to the level of output at which marginal revenue equals marginal cost. D. Demand determines price in all market forms.

4. Which of the following is true for the monopolist? a. Economic profit is possible in the long-run. b. Marginal Revenue is less than the price charged. c. Profit-maximizing or loss-minimizing occurs when marginal revenue equals marginal cost. d. All of the above. D. All of the above are characteristics of a monopoly.

P Exhibit 8 $40 MC $30 ATC $20 AVC $10 D MR Q 100 200 300 400

5. As shown in Exhibit 8, the profit-maximizing or loss-minimizing output for this monopolist is a. 100 units a day. b. 200 units a day. c. 300 units a day. d. 400 units a day. B. 200 units is the point at which MR = MC.

6. As shown in Exhibit 8, this monopolist a. should shut down in the short-run. b. should shut down in the long-run. c. earns zero economic profit. d. earns positive economic profit. D. At the point where MR = MC (on the vertical line), P is greater than ATC; therefore, total revenue is greater than total cost and an economic profit is being made.

7. To maximize profit or minimize loss, the monopolist in Exhibit 8 should set its price at a. $30 per unit. b. $25 per unit. c. $20 per unit.. d. $10 per unit. B. Maximum profit or minimized losses are found by drawing a vertical line where MR = MC. This line intersects the demand curve at $25.

8. If the monopolist in Exhibit 8 operates at the profit-maximizing output, it will earn total revenue to pay about what portion of its total fixed cost? a. None. b. One-half. c. Two-thirds. d. All fixed costs. D. Since the monopolist is making a profit, it can pay all of its fixed costs.

9. For a monopolist to practice effective price discrimination, one necessary condition is a. identical demand curves among groups of buyers. b. differences in the price elasticity of demand among groups of buyers. c. that the product is homogeneous. d. none of the above. B. Price discrimination takes place when a monopolist is faced with buyers that are widely different; therefore, the buyers elasticity of demand for the product will be different.

10. What is the act of buying a commodity in one market at a lower price and selling it in another market at a higher price? a. Buying short. b. Discounting. c. Tariffing. d. Arbitrage. D. The practice of earning a profit by buying a good at a low price and reselling the good at a higher price

11. Under both perfect competition and monopoly, a firm a. is a price taker. b. is a price maker. c. will shut down in the short urn if price falls short of average total cost. d. always earns a pure economic profit. e. sets marginal cost equal to marginal revenue. E. The profit maximizing output for any firm is where MR = MC.

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