Chapter 12 Monopoly

Basic Definitions Imperfect Competition: Occurs when firms in a market or industry have some control over the price of their output. –Monopoly, Oligopoly, and Monopolistic Competition Pure Monopoly:An industry with a single firm that produces a product for which there are no close substitutes, and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

Barriers to Entry Government franchises Patents Economies of scale and other cost advantages Ownership of a scarce factor of production

There are now four firm decisions that must be characterized: –How much output to produce –How to produce output –How much to demand in each input market –What price to charge for output

Similarities and differences - Monopoly and Competition Similarities: –Both know exactly what the demand curve and price will be Differences: –Competitor has no control over price –Monopolist has total control over price

Price and Output Decisions in Pure Monopoly Markets Basic assumptions: –Entry to the market is strictly blocked. –Firms act to maximize profits. –The monopolistic firm cannot price discriminate. –The monopoly faces a known demand curve.

Consider this hypothetical data for a monopolist’s demand curve

Example-Demand/MR $$$ Quantity

Example -Demand/MR/TR

The monopolist’s profit- maximizing output and price: D MR Q $ ATC MC Pm=$4 ATC=$ Profit = $1*4000 = $4000 MC=$1.5 Maximizing profit at MR=MC

Details... The monopolist has no supply curve; there is no unique relationship between price and quantity supplied. Since entry is blocked, the monopolist can earn economic profits in the long run. Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high.

Comparison of monopoly and perfectly competitive market solutions: D MR Q $ Pm=$ Ppc=MCc=MCm=$2 MC=MR=P=ATC 2000 Monopoly: MC=MR

Comparison of monopoly and perfectly competitive market solutions: D MR Q $ Pm=$ Ppc=MCc=MCm=$2 MC=MR=P=ATC 2000 Monopoly Perfectly competitive market

Losses from Monopoly LESS output is produced than would be produced in a competitive industry. If we look at the diagram, we see that output stops short of where Mgl. Benefits = Mgl. Costs. Buyers must pay MORE than they would pay in a competitive market Figure 13.6

The Social Costs of Monopoly Prices are higher when a market is monopolized than when it is perfectly competitive. Output is lower when a market is monopolized than when it is perfectly competitive. Some consumer surplus is reallocated to producers when a market is monopolized. Some consumer surplus is lost when a market is monopolized.

Consumer Surplus The difference between the market price and what people are willing to pay for a unit of output

Consumer Surplus Millions of hamburgers per month Price ($) 17 $2.50 $5.00 Demand A E 23 B C Price ($) 17 $2.50 $5.00 Demand E 23 Total consumer surplus

Consumer surplus in a perfectly competitive market: D MR Q $ Pm=$ Ppc=MCc=MCm=$2 MC=MR=P=ATC 2000 Monopoly Perfectly competitive market Consumer surplus of PC

Consumer surplus in a monopoly market D MR Q $ Pm=$ Ppc=MCc=MCm=$2 MC=MR=P=ATC 2000 Monopoly Perfectly competitive market Consumer surplus of Monopoly

Consumer surplus in a monopoly market: D MR Q $ Pm=$ Ppc=MCc=MCm=$2 MC=MR=P=ATC 2000 Net loss of social welfare Consumer surplus of Monopoly CS reallocated to producer

Rent-Seeking Behavior (1) Rent-seeking behavior: Actions taken by households or firms to preserve positive profits. Suppose someone is in a competitive market, but would like, somehow, to be a monopolist and earn monopoly rents.

Rent-Seeking Behavior (2) Actions taken by households or firms to acquire or preserve extra normal profits Lobbying gov’t officials; asking for licensure. Some argue that many medical professionals lobby for licensure in order to earn monopolistic rents.

Natural Monopoly An industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

Natural Monopoly Economies of scale must be realized at a scale that is close to total demand in the market. Figure 13

There are several ways to regulate natural monopoly The government sets a monopoly’s price equal to marginal cost. The government sets a monopoly’s price to cover average cost per unit.

Summary Monopolies exist when there is a single seller of a unique product and significant entry barriers. The monopolist will produce where MR=MC and determine its price from demand.

Review questions Application –Decide the output level for monopoly –Calculate consumer surplus Definitions: –Imperfect competition –Pure monopoly –Natural monopoly