Chapter 15

Chapter 15 Monopoly
Outline Why Monopolies Arise How Monopolies Make Production and Pricing Decisions The Welware Cost of Monopolies Price Discrimination Public Policy Toward Monopolies
Part V: Firm Behavior and the Organization of Industry 13. The Cost of Production 14. Competitive Markets 15. Monopoly 16. Monopolistic Competition 17. Oligopoly
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Chapter 15 Monopoly
Chapter 15 Monopoly
2012.12.7.
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Chapter 15 Monopoly
1 Why Monopolies Arise 2 How Monopolies Make Production and Pricing Decisions 3 The Welware Cost of Monopolies 4 Price Discrimination 5 Public Policy Toward Monopolies
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Monopoly
A rm is considered a monopoly if it is the sole seller of its product. its product does not have close substitutes.
While a competitive rm is a price taker, a
monopoly rm is a price maker.
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Why Monopolies Arise

The fundamental cause of monopoly is barriers
to entry. Barriers to entry have three sources:
Monopoly resources: A key resource required for production is owned by a single rm. Government regulation: The government gives a single rm the exclusive right to produce some good or service. The production process: A single rm can produce output at a lower cost than can a larger number of products.
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Monopoly Resources
Although exclusive ownership of a key resource
is a potential source of monopoly, in practice monopolies rarely arise for this reason.
Economies are large, and resources are owned
by many people.
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Government-Created Monopolies
Governments may restrict entry by giving a
single rm 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.
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Natural Monopolies
An industry is a natural monopoly ()
when a single rm can supply a good or service to an entire market at a smaller cost than could two or more rms.
A natural monopoly arises when there are
economies of scale () over the relevant range of output.

An example of natural monopoly is the
distribution of water.
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How Monopolies Make Production and Pricing Decisions

We want to consider how a monopoly rm
decides how much of its product to make and what price to charge for it.
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Chapter 15 Monopoly
Monopoly versus Competition Monopoly

is the sole producer. faces a downward-sloping demand curve. is a price maker. reduces price to increase sales.

Competitive rm is one of many producers. faces a horizontal demand curve. is a price taker. sells as much or as little at same price.
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A Monopolys Revenue
Total Revenue
P Q =TR
Average Revenue
TR = AR = P Q
Marginal Revenue
TR = MR Q
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A monopolists marginal revenue is always less
than the price of its good.

The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
When a monopoly increases the amount it sells,
it has two effects on total revenue ( P Q ).
The output effect: More output is sold, so Q is higher, which tends to increase total revenue. The price effect: The price falls, so P is lower, which tends to decrease total revenue.
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Prot Maximization
A monopoly maximizes prot by producing
the quantity at which marginal revenue equals marginal cost.

It then uses the demand curve to nd the price
that will induce consumers to buy that quantity.
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Comparing Monopoly and Competition

For a competitive rm, price equals marginal
cost. P = M R = MC
For a monopoly rm, price exceeds marginal
cost. P > M R = MC Remember, all prot-maximizing rms set M R = MC .
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A Monopolys Prot
Prot equals total revenue minus total costs.
Prot = T R T C T R TC = ( ) Q Q Q = ( P AT C ) Q
The monopolist will receive economic prots
as long as price is greater than average total cost.
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Case Study: Monopoly Drugs Versus Generic Drugs ()
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The Welfare Cost of Monopolies

In contrast to a competitive rm, the
monopoly charges a price above the marginal cost.

From the standpoint of consumers, this high
price makes monopoly undesirable.

However, from the standpoint of the owners of
the rm, the high price makes monopoly very desirable.

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The Efcient Level of Output
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The Deadweight Loss Because a monopoly sets its price above marginal cost, it places a wedge between the consumers willingness to pay and the producers cost.
This wedge causes the quantity sold to fall short of the social optimum. The monopolist produces less than the socially efcient quantity of output.
The Inefciency of Monopoly
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The inefciency of monopoly can be measured
with a deadweight loss triangle, as illustrated in Figure 8.

The deadweight loss caused by monopoly is
similar to the deadweight loss caused by a tax.

The difference between the two cases is that the
government gets the revenue from a tax, whereas a private rm gets the monopoly prot.
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Chapter 15 Monopoly
The Monopolys Prot: A Social Cost?

The monopoly prot itself represents not a
reduction in the size of the economic pie but merely a bigger slice for producers and a smaller slice for consumers.
The problem in a monopolized market arises
because the rm produces and sells a quantity of output below the level that mazimizes total surplus.
The problem stems from the inefciently low
quantity of output.
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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.
Price discrimination is not possible when a
good is sold in a competitive market since there are many rms all selling at the market price. In order to price discriminate, the rm must have some market power.
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Chapter 15 Monopoly
A Parable about Pricing

Readalot Publishing Company (RPC) has just pusblished a novel for a best-selling author. It pays the author a at $2 million, and assume that the cost of printing the book is zero. How would RPC decide the books price? The book will appeal to the authors 100,000 die-hard fans who are willing to pay as much as $30. In addition, the book will appeal to about 400,000 less enthusiastic readers who will pay up to $5. If RPC charges a single price to all customers, what price maximizes prot?
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Chapter 15 Monopoly
At a price of $30, RPC sells 100,000 copies, has revenue of $3 million, and makes prot of $1 million. At a price of $5, RPC sells 500,000 copies, (why?) has revenue of $2.5 million, and makes prot of $0.5 million. RPC maximizes prot by charging $30 and forgoing the opportunity to sell to the 400,000 less enthusiastic readers. This causes a deadweight loss of $2 million. Now suppose that these two groups of readers are in seperated markets. The die-hard fans live in Australia, and the other readers live in the United States. Can RPC change its pricing strategy and increase prots?
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To the 100,000 Australia readers, RPC can charge $30 for the book. To the 400,000 American readers, RPC can charge $5 for the book. In this case, revenue is $3 million in Australia and $2 million in the U.S., for a total of $5 million. Prot is then $3 million. RPC will follow this strategy of price discrimination. There is no deadweight loss. The increase in total surplus (decrease in deadweight loss) accrues to RPC in the form of $2 million higher prot.
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Three facts about price discrimination: Price discrimination is a rational strategy for a prot-maximizing monopolist. Price discrimination requirs the ability to separate customers according to their willingness to pay. Price discrimination can raise economic welfare.
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Perfect Price Discrimination
Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
Two important effects of price discrimination. It can increase the monopolists prots. It can reduce deadweight loss.
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Examples of Price Discrimination

Movie tickets Airline prices Discount coupons Financial aid Quantity discounts
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Public Policy Toward Monopolies

Government responds to the problem of
monopoly in one of four ways.

Making monopolized industries more competitive. Regulating the behavior of monopolies. Turning some private monopolies into public enterprises. Doing nothing at all.
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Chapter 15 Monopoly
Increasing Competition with Antitrust Laws

Antitrust laws are a collection of statutes aimed
at curbing monopoly power. Antitrust laws give government various ways to promote competition.
They allow government to prevent mergers. They allow government to break up companies. They prevent companies from performing activities that make markets less competitive.
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Chapter 15 Monopoly
Regulation Government may regulate the prices that the monopoly charges.
The allocation of resources will be efcient if price is set to equal marginal cost.
In practice, regulators will allow monopolists
to keep some of the benets from lower costs in the form of higher prot, a practice that requires some departure from marginal-cost pricing.
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Public Ownership
Rather than regulating a natural monopoly
that is run by a private rm, the government can run the monopoly itself (e.g. in the United States, the government runs the Postal Service).
The key issue is how the ownership of the rm
affects the costs of production. Doing Nothing

Government can do nothing at all if the market
failure is deemed small compared to the imperfections of public policies.

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Chapter 15 Monopoly
Conclusion: The Prevalence of Monopoly

How prevalent are the problems of monopolies?
Monopolies are common. Most rms have
some control over their prices because of differentiated products.

Firms with substantial monopoly power are
rare. Few goods are truly unique.
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Chapter 15 Monopoly
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Chapter 15

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Chapter 15 Monopoly

While a competitive rm is a price taker, a

monopoly rm is a price maker.

Why Monopolies Arise

to entry. Barriers to entry have three sources:

single rm the exclusive right to sell a particular good in certain markets.

examples of how government creates a monopoly to serve the public interest.

economies of scale () over the relevant range of output.

How Monopolies Make Production and Pricing Decisions

Monopoly versus Competition Monopoly

A monopolists marginal revenue is always less

than the price of its good.

When a monopoly increases the amount it sells,

it has two effects on total revenue ( P Q ).

the quantity at which marginal revenue equals marginal cost.

that will induce consumers to buy that quantity.

Comparing Monopoly and Competition

cost. P > M R = MC Remember, all prot-maximizing rms set M R = MC .

as long as price is greater than average total cost.

Case Study: Monopoly Drugs Versus Generic Drugs ()

The Welfare Cost of Monopolies

monopoly charges a price above the marginal cost.

price makes monopoly undesirable.

the rm, the high price makes monopoly very desirable.

The Efcient Level of Output

The Inefciency of Monopoly

The inefciency of monopoly can be measured

with a deadweight loss triangle, as illustrated in Figure 8.

similar to the deadweight loss caused by a tax.

The Monopolys Prot: A Social Cost?

A Parable about Pricing

Perfect Price Discrimination

Examples of Price Discrimination

Public Policy Toward Monopolies

monopoly in one of four ways.

Increasing Competition with Antitrust Laws

In practice, regulators will allow monopolists

affects the costs of production. Doing Nothing

failure is deemed small compared to the imperfections of public policies.

Conclusion: The Prevalence of Monopoly

some control over their prices because of differentiated products.

rare. Few goods are truly unique.

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