2 Monopoly Assumptions One seller and many buyers Barriers to Entry Implication: The seller is a price maker and the buyers are price takers.Barriers to EntryOwnership of a unique resource (Diamonds)Government granted rights for exclusive production (e.g. patents, copyrights, licenses, concessions)Economies of scale and declining long-run average costsImplication: Monopolist faces the entire market demand curve and profits can persist in the short and long-run.
3 Limits to MonopolySize of the market (Pavarotti versus Joe, uncongested bridge)Definition of market and close substitutes (ornamental versus industrial diamonds, bottled water).Potential competition
4 Production Decisions Monopolist versus competitive firm. CF is a price taker who faces a perfectly elastic demand curve MR=PM is a price maker who faces the entire market demand curve MR<PIntuitive proof – to sell another unit the monopolist must lower the price. This means lowering the price not only on the extra unit sold, but also all the other units the monopolist was selling. So MR = Price of the additional unit – the sum of the decreases in all the units previously sold ( e.g. selling 4 to sell the 5 unit the price must be lowered to $90, so the monopolist’s MR = $90 – 4X$10=$50)Tabular proof – see next table and handoutGraphical proof
5 A Monopoly’s Revenue Total Revenue P Q = TR Average Revenue TR/Q = AR = PMarginal RevenueDTR/DQ = MR
9 Profit MaximizationA monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.It then uses the demand curve to find the price that will induce consumers to buy that quantity.
10 Profit Maximization –Set MR = MC to find Q that maximizes profits.Use the market demand curve to find the P that the Q bringsFind ATC and AVC cost to determine profits, losses, or shutdown.Difference between the monopolist decision and the competitive firms decisionThe monopolist does not have a supply curve like the CF, rather they pick a single price and quantityMonopolists produce where P>MR and P>MCversus CFs who produce where P=MR and P=MC.
18 Monopoly profit is not usually a social cost but a transfer of surplus from consumer to producer. Profit can be a social cost if extra costs are incurred to maintain it, such as political lobbying, or if the lack of competition leads to costs not being minimized (X-inefficiency again!)
19 Public Policy and Monopolies Working towards P=MC Attempts to increase competition through anti-trust legislationSherman Antitrust Act of 1890Examples: Breakup of Standard Oil and turning MA Bell into Baby BellsRegulation – Natural MonopoliesP=MC doesn’t work with extensive economies of scaleRegulated forms have little incentive to minimize costsPublic OwnershipPublic utilities and the Postal ServiceHands-off ApproachMonopolies contribute to inefficiency because:P>MCLess than the socially optimal level of output is producedIncentives for cost reduction may diminishToo many resources may be spent on political protection.
20 Price-Discriminating Monopolist Price discrimination occurs when different prices are charged to different consumer that do no reflect differences in the cost of providing th goodPerfect Price Discrimination – charging each customer their maximum willingness to pay.Imperfect Price Discrimination – segmenting the market into different consumer groups.Parable – Hardcopy versus paperback copyAllows firms to increase profitsRequires separating customers into different groups and minimize arbitrageResults in greater economic welfare than single-pricing monopolists.
21 Basis for Price Descrimination Different consumers have different willingness to pay different price elasticities of demandRule: segment the market according to price elasticity of demand and charge the consumers will less elastic demand more than those with more elastic demandExamples: (remember the smaller the % of income or the greater the number of close substitutes the less price elastic the demand,)Movie TicketsAirline TicketsDiscount CouponsFinancial AidQuantity Discounts
22 Summary Monopolies contribute to inefficiency because: P>MC DWWLLess than the socially optimal level of output is producedIncentives for cost reduction may diminishToo many resources may be spent on political protectionHowever, discriminating monopolist can help reduce DWWL.