1. Copyright © 2004 South-Western Monopoly vs. Competition While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered a monopoly if... it is the sole seller of its product. its product does not have close substitutes. No competition (lollipop game). Monopoly power arises from barriers to entry.

2. Copyright © 2004 South-Western WHY MONOPOLIES ARISE Barriers to entry have three sources: Ownership of a key resource. The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers.

3. Copyright © 2004 South-Western WHY MONOPOLIES ARISE Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. Diamonds, Oil

4. Copyright © 2004 South-Western WHY MONOPOLIES ARISE Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.

5. Copyright © 2004 South-Western WHY MONOPOLIES ARISE A natural monopoly arises when a single firm can supply a good or service to an entire market at a smaller cost than many competing firms. A natural monopoly arises when there are economies of scale over a large range of output.

6. Economies of Scale as a Cause of Monopoly Copyright © 2004 South-Western Quantity of Output Average total cost 0 Cost

7. Copyright © 2004 South-Western HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS Monopoly versus Competition Monopoly Sole producer Unique product Price maker Positive Economic Profit (entry/exit) Competitive Firm Many producers Identical product Price taker Zero economic profit (entry/exit)

8. Copyright © 2004 South-Western Profit Maximization A monopoly maximizes profit by producing the quantity at which MR = MC. Restrict Q below where Demand intersects MC. It then uses the demand curve to find the P that will induce consumers to just buy that Q. Market power, price maker, mark-up (P > MC).

9. Copyright © 2004 South-Western Profit Maximization Profit equals total revenue minus total costs. Profit = TR - TC The monopolist will receive economic profits as long as the P the market is willing to pay results in TR > TC. This can be a long run equilibrium (entry barrier).

10. Copyright © 2004 South-Western THE WELFARE COST OF MONOPOLY A monopolist restricts Q and marks-up P. For consumers, this combination of low Q and high P makes monopoly undesirable. However, for the firm, this monopoly power is very desirable (positive economic profit).

11. Copyright © 2004 South-Western Inefficiency of Monopoly Because a monopoly restricts the quantity and marks the price up above marginal cost, it places a wedge between the consumer’s willingness to pay (D) and the producer’s cost of production (MC). This outcome is inefficient compared to perfect competition. Units not produced and consumed that could benefit society.

12. The Efficient Level of Output Copyright © 2004 South-Western Quantity 0 Price Demand (value to buyers) Marginal cost Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller. Cost to monopolist Cost to monopolist Value to buyers Value to buyers Efficient quantity

13. Copyright © 2004 South-Western Figure 10 Welfare with Single Price Monopolist Copyright © 2004 South-Western Profit (a) Monopolist with Single Price Price 0 Quantity Deadweight loss Demand Marginal revenue Consumer surplus Quantity sold Monopoly price Marginal cost

14. Copyright © 2004 South-Western Monopoly: Good or Bad? Good – new innovative products Prescription drugs, technology (R&D) Bad Restricted output, higher prices Government subsidy…..higher taxes Patents…..higher prices You Choose!

15. Copyright © 2004 South-Western PRICE DISCRIMINATION Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. Perfect price discrimination occurs when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.

16. Copyright © 2004 South-Western Figure 10 Welfare with Monopoly Price Discrimination Copyright © 2004 South-Western Profit (b) Monopolist with Perfect Price Discrimination Price 0 Quantity Demand Marginal cost Quantity sold

17. Copyright © 2004 South-Western PRICE DISCRIMINATION More likely lower degree of price discrimination. Segment markets Prevent re-sale from low WTP to high WTP markets Two important effects of price discrimination: Increase the monopolist’s profits Lessen inefficiency (more output)

18. Copyright © 2004 South-Western PRICE DISCRIMINATION Examples of Price Discrimination Movie tickets Airline tickets Discount coupons Quantity (volume) discounts Financial aid Prescription drugs If airlines sold paint

19. Copyright © 2004 South-Western CONCLUSION: THE PREVALENCE OF MONOPOLY How prevalent are monopolies? Monopoly power is relatively common. Most firms have some control over their prices because of differentiated products. Firms with substantial monopoly power are rare. Few goods are truly unique. The story of Cooperatives.

20. Copyright © 2004 South-Western Summary A monopoly firm is the only seller in its market. Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal (MR = MC). Unlike a competitive firm, market power allows a mark-up of price above marginal cost (P > MC).

21. Copyright © 2004 South-Western Summary A monopolist’s profit-maximizing output is below the level that maximizes the sum of consumer and producer surplus (where D intersects MC). In this respect, monopoly power is bad for consumers, but good for the monopolist. Welfare economics suggests monopoly power is undesirable for society.

22. Copyright © 2004 South-Western Summary Monopoly power can also be considered good for society in the following ways. Natural monopoly results in lower price than competition, but must be regulated. Patents give incentive to produce goods that may otherwise never be produced, but at high prices.

23. Copyright © 2004 South-Western Summary Monopoly profits can be increased by charging different prices to different buyers based on their willingness to pay. Price discrimination lessens inefficiency, but gives most of the gains to monopolist.