Monopoly

A firm that is the sole seller of a product No close substitutes Many barriers to entry Sources of market power: – Firm owns a key resource – Government gives a firm exclusive selling rights (patents) – The costs of production make a single producer more efficient than a larger number of producers

Natural Monopoly Market that run most efficiently when one large firm provides all of the output Firm’s costs continuously decrease with increased output when providing for entire market. What resources do you need for public water?

How do Monopolies Maximize Profits?

Let’s pretend that I wrote an economics book that explains the concepts of economics SO well that you are GUARANTTEED to score a 5 on the A.P. Microeconomics exam. Also, it only takes one hour to read!!! Lastly, lets assume I was able to obtain a patent for this amazing book.

Figure 3 Demand and Marginal-Revenue Curves for a Monopoly Quantity of Vespernomics Textbooks Price $ –1 –2 –3 – First, lets review: What would my firm’s demand look like if the book sold in a competitive market?

In reality, do you think the demand for my book would really look like that? PQdTRMR

In reality, do you think the demand for my book would really look like that? PQdTRMR

Graph demand and MR for my books Quantity of Vespernomics Price $ –1 –2 –3 –4 Demand (average revenue) Marginal revenue If a monopoly wants to sell more, it must lower price. Price falls for ALL units sold. This is because monopolies are STILL impacted by the law of demand.

The dilemma for monopolies As a monopoly produces more, the price and revenue of their goods will fall WHY?????

So let’s go back to the main question, how do I maximize my profits!?!?

Remember profit maximization is where MR = MC Quantity of Vespernomics Price $ –1 –2 –3 –4 Demand (average revenue) Marginal revenue MC - My profit maximization quantity is 5, where my MR = MC - But, at that quantity, the five people who will buy the book are willing to spend $6 So, the firm would sell the good for $6

Inefficiency of Monopolies FIRMS BUYERS

The Deadweight Loss A monopoly sets a price above its MC – Price is higher than the market price – Quantity is lower than the market quantity – This causes markets to be inefficient Deadweight loss

Figure 8 The Inefficiency of Monopoly Quantity 0 Price Deadweight loss Demand Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity

Review: Monopoly Key Concepts Monopoly's are able to charge a higher price because they have high market power MR is below demand The price that a monopoly sets is equal to the demand at the profit maximizing production level (MR=MC) P > MC Monopolies cause inefficient markets – Produce less and a higher price

Price Discrimination

Selling the same good at different prices to different customers

Price Discrimination Selling the same good at different prices to different customers This can be done only if a firm: – Has market power – Can separate consumers into groups – Can prevent resale between consumers

Lets say I want to start selling the critically acclaimed book: Vespernomics Let’s also assume that it costs me $5 to produce one book of Vespernomics

Now assume that there are two types of people who want to buy Vespernomics Type 1: These are the die hard readers. There are currently two type 1 people and are willing to spend $50 for the book Type 2: These are the, “I just want to make Mr. Vesper happy so I can pass” readers. There are currently five type 2 people and are willing to spend $10 for the book I can sell the book for $50 and make a profit of $90. But, there would be 5 students who don’t have the book. I can sell the book for $10 and make a profit of $25. Obviously, a much smaller profit.

Now assume I can price discriminate Type 1: The die hard readers I can sell them the books for $50 and make a profit of $90 Type 2: The “just want to pass” readers I can sell them the book for $10 and make a profit of $25 So, as a firm, I make the most profit possible of $115 AND everyone who wanted the book will be able to obtain it.

THE BIG IDEA Contrary to popular belief, price discrimination actually makes a market more efficient! More consumers are able to purchase the product and there is less surplus lost (deadweight loss). The monopoly firm will just share most of the surplus.

Final Question If a firm can PERFECTLY price discriminate, who would obtain all of the surplus?

Natural Monopolies

All of you used a good/service today produced by a natural monopoly…

Natural Monopoly A monopoly that exists because it would be most efficient for the market A natural monopoly provides a good/service to the entire market at a smaller cost than two or more firms – Natural monopoly is always in economies of scale – The firm’s ATC is still decreasing when it earns normal profit (where ATC = D)

Natural Monopoly

Regulating Natural Monopolies The government sets the price and quantity The regulated price is where the natural monopoly earns normal profit – When price = ATC

Regulating Natural Monopolies MC