Foundations of Economics 4e Chapter 12: Monopoly

1. Foundations of Economics 4eChapter 12: Monopoly Andrew Gillespie

2. Monopoly Occurs when one firm dominates a market The firm determines the price in the market rather than accepting the industry price. It is a “price maker” rather than a “price taker”

3. Monopoly A monopolist faces a downward sloping demand curve Marginal revenue is below and diverges from the demand curve Profit maximizes where marginal revenue = marginal cost

4. Long-run equilibrium in monopoly • A profit maximizing monopolist produces where marginal revenue = marginal costs (MR=MC). • It will be • Productively inefficient because it is not producing at the minimum of the average cost • Allocatively inefficient because it is not producing where price = marginal cost

5. Monopoly

6. Comparison of perfect competition and monopoly

7. Case against monopoly Against Higher price and less output than a competitive market with same cost and demand conditions Welfare loss X inefficiency: higher costs than a competitive market Lack of incentive e.g. to innovate Dynamic inefficiency Productive inefficiency Allocative inefficiency

8. Case for monopoly For Monopolists achieve monopoly position through innovation Encourages others to innovate (Schumpeter) Will invest profits or pay out as dividends Prevent wasteful duplication May offset another market failure e.g. negative externality

9. Summary table for monopoly

10. UK Competition Policy In the UK the Competition and Markets Authority has the powers to: prevent takeovers or mergers that would lead to a monopoly position if it can show that it would act against the public interest investigate any firm with more than 25% market share and force it to sell off parts of its business or reduce its prices

11. Barriers to entry The monopoly power of a firm or group of firms can only be sustained if there are barriers to entry Enable abnormal profits in the long run

12. Examples of barriers to entry Legislation The learning effect Technology Internal economies of scale Entry costs Fear of retaliation Brand loyalty and product differentiation Control of supplies or distribution

13. Price discrimination Occurs when a firm offers the same product to different customers at different prices e.g. nightclubs By price discriminating a firm can increase its own producer surplus and profits; at the same time it reduces the amount of consumer surplus (utility that is not paid for)

14. Price discrimination To price discriminate effectively a firm must be able to identify different demand conditions, e.g. demand may be different between different groups of customers A higher price is charged where demand is price inelastic and a lower price when demand is price elastic. This leads to different prices in different market segments

15. Price discrimination Markets can be separated in many ways such as: Time Age Region Status Income

16. Price discrimination To profit maximize in two markets (A and B) a firm produces where Marginal Revenue in market A = Marginal Revenue in market B = Marginal Cost Perfect price discrimination occurs when a different price is charged for every single unit of the product. Consumer surplus is then zero.

17. Price discrimination

18. Price discrimination

19. Perfect price discrimination

20. Key learning points A monopoly is a dominant firm in an industry In a monopoly it is possible to earn abnormal profits even in the long run due to barriers to entry A monopolist faces a downward sloping demand curve; the marginal revenue curve is below the demand curve and diverges from the demand curve

21. Key learning points In the long run monopolies may be allocatively and productively inefficient Barriers to entry enable firms to make abnormal profits even in the long run When analysing the market it may be important to consider the possibility of entry in the future as well as the existing levels of competition Price discrimination occurs when different prices are charged for the same product

22. Key learning points Barriers to entry enable abnormal profits to be earned in the long run Price discrimination reduces consumer surplus but increases producer surplus

23. Key learning points Price discrimination may enable some products to be produced that it would not be financially feasible to produce otherwise With perfect price discrimination consumer surplus is reduced to zero