Monopoly

1. Monopoly Chapter 12

2. Introduction • Monopoly is a market structure in which a single firm makes up the entire supply side of the market. • Monopoly is the polar opposite of perfect competition.

3. Introduction • Monopolies exist because of barriers to entry into a market that prevent entry by new firms. • Barriers to entry include legal barriers such as a patent, and natural barriers such as the size of the market that can support only one firm.

4. The Key Difference Between a Monopolist and a Perfect Competitor • A competitive firm is too small to affect the price. • It does not have to take into account the effect of its output decision on the price it receives.

5. The Key Difference Between a Monopolist and a Perfect Competitor • A competitive firm's marginal revenue is the market price. • A monopolistic firm’s marginal revenue is not equal to its price – it takes into account that in order to sell more it has to decrease the price of its product.

6. The Key Difference Between a Monopolist and a Perfect Competitor • Monopolist as the only supplier faces the entire market demand curve. • Therefore, monopoly demand is downward sloping, and to increase output the firm must decrease its price.

7. A Model of Monopoly • How much should a monopoly produce to maximize its profit? • The monopolist employs a two-step profit maximizing process; it chooses quantity and price.

8. The Monopolist’s Price and Output • As in perfect competition, profit for the monopolist is maximized at a point where MC = MR. • What is different for a monopolist – marginal revenue does not equal price; marginal revenue is below price.

9. The Monopolist’s Price and Output • If a monopolist deviates from the output level at which marginal cost equals marginal revenue, profits will fall.

10. Profit Maximization for a Monopolist, Table 12-1, p 257

11. The Monopolist’s Price and Output Graphically • The marginal revenue curve tells us the additional revenue the firm will get from an additional unit of output. • The marginal cost curve is a graph of the change in firm’s total cost as it changes output.

12. The Monopolist’s Price and Output Graphically • To determine the profit-maximizing price and quantity: • one first finds output (whereMC = MR), and then • extends a vertical line for that output, up to the demand curve to find the price.

13. The Monopolist’s Price and Output Graphically • If MR > MC, the monopolist gains profit by increasing output. • If MR < MC, the monopolist gains profit by decreasing output. • If MC = MR, the monopolist is maximizing profit.

14. The Monopolist’s Price and Output Graphically • The MR = MC condition determines the quantity a monopolist produces. • That quantity determines the price the monopolist will charge.

15. Comparing Monopoly and Perfect Competition • Profit-maximizing output for the monopolist, like profit maximizing output for the competitor in a perfectly competitive market is where MC = MR.

16. Comparing Monopoly and Perfect Competition • Because the monopolist’s marginal revenue is below its price, its equilibrium output is less than, and price is higher than that of a perfectly competitive market.

17. MC Monopolist price and output 20.50 D 1 2 3 4 5 6 7 8 9 10 MR 5.17 The Monopolist’s Price and Output Graphically, Fig.12-1, p 259 Price $36 30 Perfectly competitive price and output 24 18 12 6 0 6 12

18. Finding the monopolist’s price and output • Draw the firm's marginal revenue curve. • Determine the output the monopolist will produce by the intersection of the MC and MR curves.

19. Finding the monopolist’s price and output • Determine the price the monopolist will charge for that output by finding where the quantity line intersects the demand curve.

20. Price MC D MR Quantity Finding the monopolist’s price and output, Fig. 12-2a and b, p 260

21. Price MC D Quantity Finding the monopolist’s price and output, Fig. 12-2 c and d, p 260 PM MR QM

22. Finding the Monopolist’s Profit • Determine the average cost at the profit-maximizing level of output. • Determine the monopolist's profit (loss) by subtracting average total cost from average revenue (P) at that level of output and multiply by the chosen output.

23. Monopoly • A monopolist can make a profit, it can break even, or it can incur a loss.

24. MC ATC A PM Profit B CM D MR QM A Monopolist Making a Profit, Fig. 12-3, p 261 Price 0 Quantity

25. MC ATC PM D MR QM A Monopolist Breaking Even, Fig. 12-4a, p 262 Price 0 Quantity

26. MC ATC Loss B CM A PM D MR QM A Monopolist Making a Loss Fig. 12-4b, p 262 Price 0 Quantity

27. The Welfare Loss from Monopoly • A single price monopoly creates welfare losses. • Welfare losses can be illustrated by the area of consumer and producer surplus that is lost due to smaller output produced, compared to output produced in perfect competition.

28. The Welfare Loss from Monopoly • Compare the normal monopolist's equilibrium to the equilibrium of a perfect competitor. • Equilibrium in both market structures is determined by the MC = MR condition.

29. The Welfare Loss from Monopoly • But the monopolist's MR is below its price, thus its equilibrium output is different from a competitive market. • The welfare loss of a monopolist is represented by the triangles B and D.

30. MC PM C D PC B A MR D QM QC The Welfare Loss from Monopoly, Fig. 12-5, p 262 Price 0 Quantity

31. The Welfare Loss from Monopoly • Welfare loss is often called the deadweight loss or welfare loss triangle. • It is the geometric representation of the welfare cost in terms of misallocated resources that are caused by monopoly.

32. The Price-Discriminating Monopolist • Price discrimination is the ability to charge different prices to different customers.

33. The Price-Discriminating Monopolist • In order to price discriminate, a monopolist must be able to: • Identify groups of customers who have different elasticities of demand; • Separate them in some way; and • Limit their ability to resell its product between groups.

34. The Price-Discriminating Monopolist • A price-discriminating monopolist can charge customers with more inelastic demands a higher price. • It can charge customers with more elastic demands a lower price.

35. The Price-Discriminating Monopolist • A perfect price discriminating monopoly can extract the most consumers are willing to pay for each unit of the product it sells. • All consumer surplus is transferred to the monopolist.

36. The Price-Discriminating Monopolist • A perfect price discriminating monopoly will stop expanding its output when MR = MC, which corresponds to the perfectly competitive output. • The deadweight loss is therefore eliminated under perfect price discrimination.

37. Perfect Price Discrimination, Fig. 12-6, p 265 Price 10 9 8 7 6 5 4 3 2 1 MC D=MR Quantity (number of consumers) 1 2 3 4 5 6 7 8 9 10 11 MR

38. Barriers to Entry and Monopoly • What prevents other firms from entering the monopolist’s market in response to profits the monopolist earns? • Monopolies exist because of barriers to entry.

39. Barriers to Entry and Monopoly • In the absence of barriers to entry, the monopoly would face competition from other firms, which would erode its monopoly position .

40. Barriers to Entry and Monopoly • Some important barriers to entry are: • Economies of scale, • Set-up costs, • Legislation.

41. Barriers to Entry and Monopoly • Economies of scale: • When production is characterized by increasing returns to scale, the larger the firm becomes, the lower its per unit costs become.

42. Barriers to Entry and Monopoly • Economies of scale: • If significant economies of scale are possible, it is inefficient to have two producers because if each produced half of the output, neither could take advantage of economies of scale.

43. Barriers to Entry and Monopoly • Economies of scale: • A natural monopoly is an industry in which one firm can produce at a lower cost than can two or more firms.

44. Barriers to Entry and Monopoly • Economies of scale: • In cases of natural monopoly, technology is such that minimum efficient scale is so large that average total costs fall within the range of potential output.

45. Price, Cost PM CM CC ATC MC PC Quantity QM MR QC D A Natural Monopoly, Fig. 12-7b, p 267

46. Barriers to Entry and Monopoly • Set-up costs: • In many industries high set-up costs characterize production. • The industry may be highly capital-intensive, requiring a large investment in expensive but highly specialized capital. • Examples are an oil refinery or a diamond mine.

47. Barriers to Entry and Monopoly • Set-up costs: • In some industries a lot of money may be spent on advertising. • Heavy advertising creates a barrier to entry in those cases, such as in the perfume industry or the automobile industry.

48. Barriers to Entry and Monopoly • Legislation: • Monopolies can also exist as a result of government charter. • Patents are another way in which government can grant a company a monopoly.

49. Barriers to Entry and Monopoly • Legislation: • A patent is a legal protection of technical innovation that gives the inventor a monopoly on using the invention. • To encourage research and development of new products, government gives out patents for a wide variety of innovations.

50. Barriers to Entry and Monopoly • Other barriers to entry: • Sometimes one company can gain ownership of some essential aspect of the production process – a unique input, or control over a resource. • An example is DeBeers. By controlling the world-wide distribution network for diamonds, the company enjoys monopoly in the diamond industry.