1. Chapter Ten
Monopolies

2. A Model of Monopoly
Monopoly: One firm in an industry selling a product for which there are no close substitutes
Barriers to Entry: Anything that prevents firms from entering a market.
Monopoly will choose level of output that maximizes profit
Difference between monopoly and competitive firm is how actions affect market price.
Monopoly has MARKET POWER: Firm’s power to set its price without losing its entire share of the market
Monopoly is a PRICE-MAKER: A firm that has the power to set its price, rather than taking the price set by the market
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3. Market Power There is no one to undercut the monopolist’s price
Monopoly
Market Power
There is no one to undercut the monopolist’s price
The impact of quantity decisions on the price
Competitive firm cutting production has very little impact on market price. Monopoly cutting production has large impact on market price.
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4. Figure 10.1: How the Market Power of a Monopoly and a Competitive Firm Differ
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5. Revenue, Costs, and Profits for a MonopolyQ P TR MR TC MC
PROF
160
---- 70
---
-70 1
150 79 9 71 2
140
280
130 84 5
196 3
390
110 94 10
296 4
120
480 90
114 20
366
550
148 34
402 6
100
600 50 48
404 7
630 30
261 65
369 8 80
640
351
289
-10
481
149 60
-30
656
175
-56
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6. Figure 10.2: Total Revenue, Marginal Revenue, and Demand
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7. Maximizing Profits
As long as marginal revenue is greater than marginal cost, a monopoly should keep producing to maximize profits.
The monopolist should produce up to the level of production where marginal cost = marginal revenue (MC=MR)
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8. Figure 10.3: Finding a Quantity of Output to Maximize Profits
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9. Figure 10.4: Marginal Revenue and Marginal Cost
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10. MC = MR vs. MC = P
For a competitive firm, TR = Q x P where the firm cannot affect the price
MC = MR is virtually the same as MC = P
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11. Figure 10.5: Profit Maximization for a Monopoly and a Competitive Firm
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12. Figure 10.6: The Generic Diagram for a Monopoly
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13. Figure 10.7: A Monopoly with Negative Profits
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14. Figure 10.8: Deadweight Loss from Monopoly
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15. The Monopoly Price is Greater than Marginal Cost
The price with a monopoly is higher than with competition (since a monopoly can withhold production and drive the price up)
The loss to society can be measured as the difference between price and marginal cost
The size of the difference (or of the loss) can be measured by the elasticity of the monopoly’s demand curve.
If the demand curve is highly elastic then the difference between price and marginal cost is small
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16. Monopoly price is greater than marginal cost
Price-cost margin: The difference between price and marginal cost divided by the price.
Indicates market power: 0 is no market power
Price – Marginal Cost
Price
Price-cost margin of a competitive firm is 0
1 / Price Elasticity of Demand
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17. Why Monopolies Exist
If big firms are needed in order to produce at a low cost, it may be natural for a few firms or only one firm to exist.
Economies of scale – decreasing long run ATC – can lead to a monopoly.
Minimum efficient scale of a firm is the minimum size of the firm for which ATC is lowest. If minimum efficient scale is a small fraction of the market then there will be many firms.
Water Company: Large fixed costs to lay pipes, but connecting each house has low cost. As connect more houses, ATC declines. (Electricity and Local Telephone Service)
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18. Monopolies, con’t.
Natural monopoly: A single firm in an industry in which ATC is declining over the entire range of production and the minimum efficient scale is larger than the size of the market.
Usually regulated by the government to keep the price below the monopoly price and closer to the competitive price, reducing the deadweight loss
Nationwide telephone service no longer a natural monopoly due to advances in technology
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19. Patents and Copyrights
Another way monopolies arise is through the granting of patents and copyrights by the government.
Intel had a patent on computer chips
If granted a patent, can have a monopoly for 20 years
Pharmaceutical drugs are another example
Provides good incentive for innovation
Government could lower prices on drugs, but would not be an incentive to create new and improved products
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20. Attempts to create barriers
Licenses
The government can create a monopoly by giving or selling to one firm a license to produce the product.
U.S. Postal Service
Attempts to create barriers
Adam Smith encouraged free trade between countries to try to eliminate monopolies
De Beers, Standard Oil
Contestable Market: A market in which the threat of competition is enough to encourage firms to act like competitors.
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21. Price Discrimination is partly determined by the elasticity of demand
Price Discrimination: A situation in which different groups of consumers are charged different prices for the same good.
Senior citizen discounts, Foreign Markets, Quantity Discounts
Price Discrimination is partly determined by the elasticity of demand
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22. Figure 10.9: Price Discrimination Targeted at Different Groups
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23. Quantity Discounts
By charging higher fees for lower quantities, monopolies increase their profits and also increase consumer surplus, thereby reducing deadweight loss.
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24. Figure 10.10: Price Discrimination Through Quantity Discounts or Premiums
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