McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Pure Monopoly Chapter 10

Chapter Objectives Characteristics of pure monopoly Profit-maximizing output and price Economic effects of monopoly Charging different prices in different markets 10-2

Characteristics of Monopoly Single seller No close substitutes “Price maker” Blocked entry Nonprice competition 10-3

Examples of Monopoly Regulated or natural monopolies –electricity Near monopolies –Western Union –Frisbee –De Beers Geographic monopolies –Professional sport teams Dual objectives of study 10-4

Output Long-run ATC curve where costs are lowest only when large numbers are participating Average Total Costs Economies Of Scale Diseconomies Of Scale Long-Run ATC Long-Run ATC Shapes 8-5

Barriers to Entry Economies of scale Legal barriers to entry –Patents (Pharmaceuticals) –Licenses (LCB, taxis) Ownership or control of essential resources (NFL) Pricing and other strategic barriers to entry (Netscape vs IE) 10-6

Monopoly Demand Assumptions: –Monopoly status is secure –No government regulation –Single-price monopolist Face down-sloping demand –Entire market demand 10-7

$ Price and Marginal Revenue Marginal revenue is less than price D A monopolist is selling 3 units at $142 To sell 4, price must be lowered to $132 All customers must pay the same price TR increases $132 minus $30 (3x$10) Gain = $132 Loss = $

$ D A monopolist is selling 3 units at $142 To sell 4, price must be lowered to $132 All customers must pay the same price TR increases $132 minus $30 (3x$10) $102 becomes a point on the MR curve Try other prices to determine other MR points Gain = $132 Loss = $30 The Constructed Marginal Revenue Curve Must Always Be Less Than the Price MR Price and Marginal Revenue Marginal revenue is less than price 10-9

Down-Sloping Demand Marginal revenue < price –To increase sales, must lower price Firm is a price maker –Choose P,Q combination Operate in the elastic region –Marginal revenue > 0 –Total-revenue test (recall) 10-10

Profit Maximization Output-price determination –Marginal revenue = marginal cost rule –Same cost definitions No supply curve 10-11

Monopoly Revenue and Costs – pg. 205 (1) Quantity Of Output (2) Price (Average Revenue) (3) Total Revenue (1) X (2) (4) Marginal Revenue (5) Average Total Cost (6) Total Cost (1) X (5) (7) Marginal Cost (8) Profit (+) or Loss (-) $ $ $ $ $ $ $ Revenue Data Cost Data ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Can you See Profit Maximization? 10-12

$ $ Price Total Revenue Monopoly Revenue and Costs ElasticInelastic Demand and Marginal-Revenue Curves Total-Revenue Curve D MR TR 10-13

Profit Maximization 0 $ Price, Costs, and Revenue Quantity D MR ATC MC MR=MC P m =$122 A=$94 Economic Profit 10-14

Determining P and Q for a Monopolist

Misconceptions Not the highest price Total, not unit, profit Possibility of losses 10-16

Loss Minimization 0 Price, Costs, and Revenue Quantity D MR ATC MC MR=MC Loss AVC PmPm QmQm V A 10-17

Economic Effects Purely Competitive Market Pure Monopoly D D S=MC MC P=MC= Minimum ATC MR PcPc QcQc PcPc PmPm QcQc QmQm Pure competition is efficient Monopoly is inefficient a b c 10-18

Pure competition is efficient –Productive efficiency –Allocative efficiency –CS+PS maximized Monopoly is inefficient –Charge P>MC –Deadweight loss Income transfer - inequality Economic Effects 10-19

Inefficiency in Monopoly

Cost Complications Economies of scale –Simultaneous consumption – low MC iPhone vs. Snapchat Other example? –Network effects – popularity/ease Twitter or Excel Other example? Cyberdust 10-21

Cost Complications X-inefficiency –Lowest ATC not achieved – why? –Poor management, lack of competition –Example? –PENN-DOT!!!! Rent seeking behavior – survival –How?How? Technological advance –More likely with monopoly? –Depends… are they motivated?

Policy Options Use antitrust laws –Divide the firm 10-23

Policy Options Natural monopoly –Regulate price Ignore –Unstable in long run

Price Discrimination Three forms –Charge each customer max willingness to pay Example? –Charge one price for first unit and a lower price for subsequent units Example? –Charge different customers different prices Example? 10-25

Conditions –Monopoly power over price/output –Market segregation – elasticities Software Example – pg. 216 –No resale - duh Examples –Airfares –Electric utilities –Theaters & golf courses Price Discrimination 10-27

Regulated Monopoly Natural monopolies Rate regulation Socially optimum price P = MC Fair return price P = ATC 10-28

0 Price and Costs (Dollars) Quantity Dilemma of Regulation Monopoly Price Fair-Return Price Socially Optimal Price PrPr D r f b a PfPf PmPm QmQm QfQf QrQr MR MC ATC Regulated Monopoly What is the problem with the socially optimal price? Why does this problem exist? Economies of Scale…

How do you think this process plays out in the real world?

De Beers Diamonds 66 years of monopoly pricing –Independent producers went along Mid-2000 abandoned monopoly –New discoveries –Independent producers withdrew –Political considerations New strategy –“The diamond supplier of choice” 10-31

Key Terms pure monopoly barriers to entry simultaneous consumption network effects X-inefficiency rent-seeking behavior price discrimination socially optimal price fair-return price 10-32

Next Chapter Preview… Monopolistic Competition and Oligopoly 10-33