Microeconomics Ch. 14: Powerpoint Produced by Brian Cowan Med

MICROECONOMICS Ch.
14
• LO 14.1 List several reasons that
monopolies exist, and explain how each
causes barriers to entry.
• LO 14.2 Explain why a monopolist is
constrained by demand.
• LO 14.3 Calculate the profit-maximizing
production price and quantity for a
monopolist.
• LO 14.4 Calculate the loss in total social
welfare associated with a monopoly.
• LO 14.5 Describe the pros and cons of
common public policy responses to
monopoly.
• LO 14.6 Explain why a firm has an
incentive to use price discrimination when
possible.
PowerPoint produced by Brian Cowan MEd
© 2020 McGraw-Hill Education Ltd.
MICROECONOMICS Ch. 14
MONOPOLIES
• monopoly - firm has no competition and is able to
totally control what it charges for its products
• key characteristic of monopoly market is barriers
preventing firms other than the monopolist from
entering the market
• perfect monopoly - controls 100 percent of the market
in a product
• firms can still have a large degree of monopoly
power if they control slightly less than 100 percent of
the market
© 2020 McGraw-Hill Education Ltd. 2

MONOPOLIES
Barriers to Market Entry
• main cause of barriers is scarcity in some key resource
or input into the production process
• economies of scale can lead to one firm establishing a
natural monopoly (market where a single firm can
produce, at a lower cost than multiple firms)
• governments get involved in natural monopolies
to try to protect the public from abuse
• government may create or sustain monopolies
where they would not otherwise exist
• patents/copyright give inventor/creator exclusive
right to produce/sell it for a period of time
MONOPOLIES
Barriers to Market Entry
• aggressive tactics:
• exclusivity agreements
• buying out competition
• aggressive persuasion
• predatory pricing - temporarily slashing prices
until rival local stores are forced out of business
• buying innovation

MONOPOLIES
Monopolies and the Demand Curve

MONOPOLIES
Monopoly Revenue
• competitive market firm can sell as much as it wants
without changing the market price
• marginal revenue is equal to price
• monopoly’s choice to produce an additional unit
drives down the market price; producing additional
outputs has two separate effects on total revenue:
• quantity effect - total revenue increases due to
money brought in by the sale of more units
• price effect - total revenue decreases as all units
sold now bring in a lower price
MONOPOLIES
Monopoly Revenue
• as monopolist increases
the price, total revenue
(TR) increases and then
decreases
• TR maximized when
marginal revenue (MR)
equals zero
• average revenue (AR)
always greater than
marginal revenue

MONOPOLIES
Monopoly Revenue
• monopolist can choose
quantity/price at which
to produce
• maximize profit by
producing quantity
where MC = MR
• sets the price based on
the demand for that
quantity

MONOPOLIES
Monopoly Revenue
• in competitive market, marginal revenue equals price
• monopolist price is greater than marginal revenue;
therefore, price is also greater than marginal cost at
the optimal production point
Profit = (P − ATC) × Q
• monopolist can achieve lower costs of production
than multiple competing producers would, but even a
natural monopoly chooses to produce at a price that
is higher than marginal cost, causing deadweight loss

MONOPOLIES
Monopoly Revenue
• monopolist sets price
at point A on demand
curve, which matches
profit-maximizing
quantity
• profit = difference
between price and
average total cost
(point B), multiplied
by the quantity sold

MONOPOLY PROBLEMS
• monopolies are great for the monopolist and not so
great for everyone else
• this description of the costs of monopoly is a positive
statement (how things are)
• normative judgment - a statement about how
things should be
• can be cases where people believe the advantages to
maintaining a particular monopoly outweigh the total
welfare costs due to lost surplus

MONOPOLY PROBLEMS

PUBLIC POLICY
Policy makers developed several policy responses to
monopolies to break up monopolies, prevent new ones,
and ease the effect of monopoly power on consumers.
Competition Act - administered and enforced by the
federal Competition Bureau to
1. promote efficiency/adaptability in Canadian
economy
2. expand opportunities for Canadian participation in
world markets
3. ensure small/medium companies have equitable
opportunity to participate in the Canadian economy
4. provide competitive prices and product choices
PUBLIC POLICY
• bid rigging - collusion of the bidders to win a bid
• pyramid selling - business model that recruits
members via a promise of payments or services for
enrolling others into the scheme, rather than
supplying investments or sale of products
• price maintenance - manufacturer and distributors
agree that the distributors will sell the manufacturer’s
product at certain prices
• tied selling - illegal practice of a company providing a
product or service on the condition that a customer
purchases some other product or service

PUBLIC POLICY
• exclusive marketing - distribution arrangement when
only certain retailers are given the option of carrying
a product in its store
• abuse of dominance - when a dominant firm in a
market, or a dominant group of firms, engages in
conduct that is intended to eliminate or discipline a
competitor or to deter future entry by new
competitors, with the result that competition is
prevented or lessened substantially
• possible solution for governments is to run natural
monopolies as public agencies

PUBLIC POLICY
Public Ownership

PUBLIC POLICY
Public Ownership
• politicians may feel pressure to lower prices below
the level of competitive market
• create shortages
• people will demand more than it makes sense for
the producer to supply at that price
• publicly owned companies may make business
decisions on basis of political concerns
• loss of the profit motive could reduce the publicly
owned monopolist’s motivations to improve
efficiency and provide better service or lower costs
PUBLIC POLICY
Public Regulation
• common intermediate step is to regulate the
behaviour of natural monopolies (e.g., controls on the
prices natural monopolies are allowed to charge as in
utilities)
• privatizing natural monopolies creates incentives:
more motivation than a public monopoly to increase
profits by innovating and reducing costs, resulting in
lower prices for consumers
• if price is capped too low, firm will have no incentive
to reduce costs or even go out of business

PUBLIC POLICY
Public Regulation
• vertical splits - split an industry vertically to introduce
competition into parts of it
• vertical split divides the original firm into
companies that operate at different points in the
production process
• doing nothing might be preferable if regulation is too
difficult to create or manage effectively
• if government interventions are subject to corruption
or political mishandling, it might be better not to act

MARKET POWER AND PRICE
• price discrimination - practice of charging customers
different prices for the same good
• involves discriminating between customers on basis
of their willingness to pay
• perfectly competitive markets sell at price equal to
average total cost and earn zero economic profit
• unable to afford to offer discounted prices; doing
so would result in negative profit
• charging others higher prices would force them to
the competition
• moving from model of perfect competition makes
price discrimination possible
MARKET POWER AND
PRICE
• more monopoly power
means greater ability for
price discrimination
• simplified demand curve
shows the demand for
MS Office in a perfectly
segmented market
• all members of each
group have the same
willingness to pay but at
different prices
Perfect Price Discrimination

Perfect Price Discrimination
• one problem with price discrimination in the real
world is defining categories of customers
• second problem facing the firm that tries to price
discriminate is that many products can easily be
resold
• to practise perfect price discrimination, challenges are
forbidding
• need to read the minds of each individual customer
and form accurate impression of how much that
customer would be willing to pay (big data)
SUMMARY
1. The key characteristic of a monopoly market is that there are
barriers that prevent firms other than the monopolist from
entering the market. Barriers to entry take four main forms:
scarce resources, economies of scale, government
intervention, and aggressive business tactics on the part of
market-leading firms. Scarcity in some key resource or input
into the production process means that firms may have
difficulty accessing the resources they need to enter the
market. When there are large economies of scale in a market,
firms have no incentive to enter; they would face higher costs
of production than the monopoly. Some monopolies are
created or sustained by the power of government, through
public ownership or protection of intellectual property. Finally,
some monopolies use their size and various aggressive tactics
to keep smaller firms from getting a toehold in the market.
SUMMARY
2. As the only firm in the market, a monopoly is
constrained in the price–quantity combinations it
can sell by the market demand curve. All else equal,
quantity demanded falls as price rises. The
monopoly can choose any price–quantity
combination on the demand curve, but it is unable
to choose points that are not on the curve, because
it can’t force customers to buy more or less than
they demand at any given price.

SUMMARY
3. A monopoly chooses the profit-maximizing quantity
the same way a firm in a competitive market
would: by producing at the quantity for which
marginal revenue is equal to marginal cost. Price is
the price that corresponds to that quantity on the
demand curve. Unlike a firm in a competitive
market, however, the monopoly price is higher than
marginal revenue, and therefore also higher than
marginal cost at the profit-maximizing point. This
means that a monopoly earns positive economic
profits.
SUMMARY
4. The equilibrium price and quantity in a competitive
market maximize total surplus. A monopoly’s profit-
maximizing quantity, however, is lower than the
efficient quantity that would prevail in a
competitive market. This tells us that total surplus
is not maximized, and that producer surplus is
higher than competitive levels while consumer
surplus is lower. The deadweight loss caused by a
monopoly is equal to total surplus under perfect
competition minus total surplus under a monopoly.
SUMMARY
5. The equilibrium price and quantity in a competitive
market maximize total surplus. A monopoly’s profit-
maximizing quantity, however, is lower than the
efficient quantity that would prevail in a
competitive market. This tells us that total surplus
is not maximized, and that producer surplus is
higher than competitive levels while consumer
surplus is lower. The deadweight loss caused by a
monopoly is equal to total surplus under perfect
competition minus total surplus under a monopoly.
SUMMARY
6. Policy makers have developed a range of policy tools aimed
at breaking up existing monopolies, preventing new ones
from forming, and mitigating the effect of monopoly power
on consumers. Antitrust laws allow the government to sue
firms that engage in anti-competitive practices and to block
mergers that would result in too much market power. Public
ownership of natural monopolies maintains the cost
advantages of economies of scale, but removes the profit
motive that might drive quality improvements and cost
reductions. Price regulation may also preserve the cost
advantages of natural monopoly while holding down price,
but in practice it is difficult to set price at the right level. In
some cases, doing nothing may actually be the best policy
response to monopoly.
SUMMARY
7. Price discrimination is the practice of charging
customers different prices for the same good. Price
discrimination allows a firm to charge each
customer a price closer to his or her willingness to
pay, turning consumer surplus into producer
surplus and increasing the firm’s profits.

End of Ch. 14
© 2020 McGraw-Hill Education Ltd.

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