Chapter 14 in Economics and Microeconomics

Monopo ly

Chapter Objectives: In this chapter, students will learn: - the significance of monopoly, an industry in which a single monopolist is the only producer of a good - how a monopolist determines its profit-maximizing output and price - the difference between monop oly and perfect competition, and the effects of that difference on society s welfare - how policy makers address the problem s posed by monopo ly - what price discrimination is, and why it is so prevalent when producers have market power Chapter Outline Opening Ex: DeBeers, the world s main supplier of diamonds, is a successful monopolist that limits the quantity of diamonds supplied to the market. By so doing, DeBeers drives up the price of diamonds.

A. Types of Market Structure - four principal models of market structure: - perfect competition => many producers sell an identical product - monopolistic competition => many producers each sell a differentiated product - oligopoly => a few producers (small number, more than one) sell products that may be identical or may be differentiated - monopoly, a single producer sells a single, undifferentiated product - these models are used to develop principles and make predictions about markets and how producers will behave in them - market structure is based on two dimensions: - the number of producers in the market (one, few, or many), and - whether the goods offered are identical or differentiated

B. The Mean ing of Mon opoly - monopolist is a firm that is the only producer of a good that has no close substitutes -characteristics: -one seller (firm & industry are the same) -there are substantial barriers to entry -firm is price maker (i.e., great control over price) - when an industry is controlled by a mono polist, it is known as a monop oly - true monopolies are hard to find because of legal obstacles: antitrust laws help prevent monopolies from emerging - monopolies play an impo rtant role in some sectors of the econo my such as pharmaceutical m arkets What monopolists do - monopolies raise price above the perfectly competitive price and restrict output - market power is the ability of a firm to raise prices - under perfect competition, economic profits normally vanish in the long run => not the case for monopolists Why do mon opolies exist? - to ea rn m ono poly p rofit s, a fir m mu st ha ve ba rrier s to e ntry (m eans of pr even ting o ther firm s from ente ring t he in dust ry) - types of barriers to entry are: - economies of scale: large firms with lower unit costs drive out smaller firms - a natural monopoly exists when economies of scale yield a large cost advantage to having all of an industry s output produced by a single firm - control of a scarce resource or input - legal (Govt-created) barriers such as patents, licenses and copyrights - network externalities - situation where the value of a good rises as more people use it (MS Windows, VHS video tape) - product pricing - may be used by any firm with significant market power to dissuade other firms from entering a market - capital requirements How a Mono polist Maximizes Profit - the monopolist s demand curve and marginal revenue (MR) -assumes a single price monopolist that is not regulated by government - demand curve for a monopolist is downward sloping, whereas the demand curve for a perfectly competitive firm is horizontal - for a monopolist, the firm s demand curve is the m arket demand curve - the added revenue a mono polist earns as output is increased by one u nit is less than the price of the unit MR < P - for a monopolist, an increase in production has two opposing effects on revenue: - quantity effect: as one more unit is sold, it increases total revenue (T R) by the price at which the unit is sold - at low levels of output, the quantity effect is larger than the price effect - price effect: in order to sell the last unit, the monopo ly must cut the price on all units sold - at higher output levels, the price effect is stronger than the quantity effect

charges a higher price.the total profit for a monopolist = (P M × Q M) (ATCM × Q M) = (P M ATC M) × QM . a monopolist producing & selling 2 units of output must reduce price in order increase the demand from 2 to 3 units so => MR on sale of unit #3 = Price unit #3 decline in Revenueunits #1 & #2 when: MR > 0 MR = 0 MR < 0 total revenue (TR) will rise and demand is elastic (i.the MR curve always lies below its demand curve see text F ig 14-5 -why is price > MR given a downward sloping demand curve.this price is found on a graph by going vertically up from the optimal output level (MC = MR) to the demand curve and then moving to the left to the price axis see text F ig 14-6 Monopolist s Profit-Maximizing Output and Price Monopoly vs Perfect Competition (PC) .a monopolist that faces a market with very elastic deman d will behave more like a perfectly competitive firm Monopoly: The gen eral picture .price will be > marginal revenue (MR) ..there are welfare losses from monop oly => the loss to consume rs is greater than the gain in profits for the monop oly .compa red to a fir m und er PC.for a monopolist: P > MR = MC at the profit-maximizing quantity of output .dealing with natural monopo ly . Monopoly and Public Policy .will likely be more unequal than would be the case with a competitive producer why? economic (rather than normal) profits are collected these economic profits are then distributed to stockholders who tend to have higher incomes Preventing monop oly .e.e.for a firm with market power: . and Marginal Revenue (MR ) Curves .if the monopoly is not a natural monopoly.monopolies can earn profits in the short run & the long run see text F ig 14-7 D. price reduction causes TR to fall) -monopolist will expand production only within the elastic portion of demand curve (why? because TR will rise only here) C. no t jus t mo nop oly) .price regulation of natural monopolies does not lead to shortages as long as price is above marginal cost .antitrust laws prevent or eliminate monopolies . .e.generally..allocative efficiency is not achieved because: P > MC . the good is supplied by the government or by a firm owned by the government . Total Revenue (TR). price reduction causes no change in TR) total revenue will fall and demand is inelastic (i.price regulation limits the price that a monopo list is allowed to charge .a smalle r quanti ty..that is: P(what product is worth to consumers) > MC (what the resources used to make the product are worth) Income distribution .welfare effects of monopoly .in public ownership of a monopoly.. a m onopo list prod uces . Monopolist s Demand.earns a positive economic pro fit .mon opo list h as no real s upp ly curv e (in s ense that s upp ly curv e rep resen ts a u niqu e rela tion ship betw een p rice & quan tity) .there are two major public policies toward natural monopolies: public ownership or regulation . it is best to prevent its existence or break it up . price reduction causes TR to rise) total revenue is at maximum and demand is unit elastic (i. and .the price a monopolist charges is what consumers are willing to pay for that output level .productive (technological) efficiency not achieved because: P > min ATC monopoly output < output where ATC is minimized .the monopolist maximizes profit at an output level where MR = MC (this hold und er an y mark et str uctu re. a monopolist will have an upward-slopin g MC curve .total surplus is less under monopoly than under perfect competition Efficiency .for a firm under PC: P = MC = MR at the profit-maximizing quantity of output .

have market power . but to maximize profits . discounted ticket) .be able to segment the market.sellers engage in price discrimination when they charge different prices to different consumers for the same good .price discrimination occurs because it will increase p rofits see text Fig 14-11 .the larger the number of prices charged => the lower the minimum price will be (so.a single-price monopolist offers its product to all consumers at the same price .examples include student or senior citizen discounts. some consumers pay price that approach MC) => the more mon ey firm will extract from consumers .. the rest of the market) .E.a firm with market power will raise price on customers with inelastic demand & lower price on customers with elastic demand . divide the market into different groups which have a different willingness or ability to pay (e.perfect price discrimination takes place when a monopolist charges each consumer the maximum that he or she is willing to pay .it is better for a theater to sell a ticket at a reduced rate to someone who is likely to be more price sensitive than to have a seat empty during a show .is generally legal as long as it does not create monopoly or lessen competition . students vs. Price Discrimination .g. phone rates that drop at night ..is not done as an act of charity.g.prevent the resale of the good (e. in other words.to work the firm must: . airline super saver fares.

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