TOPIC 8: MONOPOLY

MONOPOLY
 Characteristics

of Monopoly

seller: There is only one firm supplies a
product for the whole market.
 Unique product: There are no close substitutes
for the product.
 Blocked entry: The barriers to entry are
extremely high that prevent other firms to
enter the market.
 Price setter: The monopolist has the ability to
set the price for its product.
 Single

strong barriers to entry effectively block all potential competition.  Barriers to entry may include   Legal barriers  Economies of scale  Exclusive ownership of a necessary resource .BARRIERS TO ENTRY: A KEY TO UNDERSTANDING MONOPOLY Barriers to entry are the factors that prohibit firms from entering an industry.  In pure monopoly.

 Patent: The exclusive right of an inventor to use. Public franchise: A right granted to a firm by government that permits the firm to provide a particular good or service and exclude all others from doing the same. his or her invention.  Licenses: Entry to some industries or occupations requires a government-granted license.LEGAL BARRIERS  Legal barriers created by the government which include public franchises. Patents aim to protect the inventor from rivals who would use the invention but at the same time provide the inventor with a monopoly position for the life of the patent. Government may limit entry into an industry or occupation through licensing. patents and licenses. or to allow other to use.  .

 Natural monopoly: the condition where economies of scale are so pronounced that only one firm can survive.ECONOMIES OF SCALE Economies of scale exists when a firm’s long run average cost declines as level of output increases.  If a monopoly enjoys economies of scale then this economies of scale will serve as an entry barrier and will protect the monopolist from competition.  .

 A firm that owns or controls a resource essential to the production process can prohibit the entry of rival firms.EXCLUSIVE OWNERSHIP OF ESSENTIAL RESOURCES A monopolist can use private property as an obstacle to potential rivals.  .

MONOPOLIST’S DEMAND AND MARGINAL REVENUE  Total Revenue TR = P  Q  Average Revenue AR =TR / Q = P  Marginal Revenue MR = ∆TR / ∆Q .

EXAMPLE: MONOPOLIST’S DEMAND AND MARGINAL REVENUE Quantity (Q) Price (P) Total Revenue (TR) Average Revenue (AR) Marginal Revenue (MR) 0 1 2 3 4 5 6 7 8 9 10 10 9 8 7 6 5 4 3 2 1 0 0 9 16 21 24 25 24 21 16 9 0 9 8 7 6 5 4 3 2 1 - 9 7 5 3 1 -1 -3 -5 -7 -9 .

 At any level of output.  The monopolist’s marginal revenue curve lies below its demand curve. price is higher than marginal revenue P > MR. .  The monopoly only operates in the elastic region of demand.MONOPOLIST’S DEMAND AND MARGINAL REVENUE  The monopolist’s demand and marginal revenue curves are not the same.

MONOPOLY PRICING AND OUTPUT DECISION  Profit  To maximizing condition maximize profit. the monopolist will choose the level of output where its marginal revenue equals its marginal cost. MR = MC .

MONOPOLY PRICING AND OUTPUT DECISION Costs and Revenue Marginal cost Monopoly E price B Monopoly profit Average total D cost Average total cost C Demand Marginal revenue 0 QMAX Quantity Copyright © 2004 South-Western .

.MONOPOLY PRICING AND OUTPUT DECISION A monopolist firm has no supply cure.  There is only one combination of price and quantity that the monopolist chooses to supply to maximize its profit.  At the profit-maximizing level of output   MR = MC  P > MC: The price that the monopolist charges for its product is higher than its marginal cost.

 If demand is week and costs are high then the monopoly may incur loss.  .POSSIBILITY OF LOSSES BY MONOPOLY Monopoly does not guarantee profit.

PERFECT COMPETITION AND MONOPOLY  For perfectly competitive firm P = MR → The perfectly competitive firm’s demand curve is its marginal revenue curve. P > MR = MC → The monopolist charges a price greater than marginal cost.  Consumer surplus in perfect competition is greater than in monopoly. .  P = MR = MC The perfectly competitive firm charges a price equal to marginal cost.  For the monopolist  P > MR → The monopolist’s demand curve lies above its marginal revenue curve.

.THE CASE AGAINST MONOPOLY A monopoly creates a deadweight loss  Monopolist price > competitive price  Monopolist quantity < competitive quantity  The sum of consumer surplus and producer surplus in monopoly market is less than the maximum level → Loss in total surplus or the deadweight loss.

THE DEADWEIGHT LOSS OF MONOPOLY Price Deadweight loss Marginal cost Monopoly price Marginal revenue 0 Monopoly Efficient quantity quantity Demand Quantity Copyright © 2004 South-Western .

.THE CASE AGAINST MONOPOLY  Rent seeking  Actions of individuals and groups who spend resources to influence public policy in the hope of redistributing (transferring) income to themselves from others.  X-inefficiency  The increase in costs in a monopoly resulting from the lack of competitive pressure to push costs down to the lowest possible level.  In monopoly. part of consumer surplus that is loss to buyers becomes profit for the monopolist.

 Regulating the behavior of monopolies.  Making monopolized industries more competitive.  Turning some private monopolies into public enterprises.PUBLIC POLICY TOWARD MONOPOLY  Government responds to the problem of monopoly in several ways. .

PRICE DISCRIMINATION Price discrimination: the practice of selling the same product at different prices and when the price differences do not reflect cost differences.  Third-degree price discrimination: the seller charges different prices to different groups of customers.  Second-degree price discrimination: the seller charges a uniform price per unit for one specific quantity. and so on. a lower price for an additional quantity.  Perfect .  There are three types of price discrimination  price discrimination: the seller charges the highest price that each consumer is willing to pay for the product.

 Reselling the goods to other buyers must be impossible. .PRICE DISCRIMINATION  Conditions of price discrimination  The seller must exercise some control over price.  The seller must be able to divide among buyers. it must be price setter. that is.