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Unit Three: Product Markets. Topic: Pure Monopoly. Learning Targets. I will be able to demonstrate how a monopoly firm is a price-maker, and how it determines output in order to maximize profits or minimize losses.
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Unit Three: Product Markets Topic: Pure Monopoly
Learning Targets • I will be able to demonstrate how a monopoly firm is a price-maker, and how it determines output in order to maximize profits or minimize losses. • I will be able to explain the differing conditions for a price-discriminating monopolist and a regulated monopoly.
Characteristics • Single seller • No close substitutes • “Price-maker” • Barriers to entry • Economies of scale (decreasing ATC) • Patents, licenses, etc. • Ownership or control of resources • Strategy pricing • Little or no advertising
“Price-Maker” • Def: the firm determines its price because it is the industry. • Demand curve follows the law of demand (downward-sloping). • MR < P (b/c monopoly can only increase sales by decreasing price), therefore, MR < D. (draw) • Will set price in the elastic region of demand in order to affect TR.
Misconceptions • Monopolies charge the highest price. • Not true, b/c monopolies want the highest profit, and some prices will yield lower profits. • Monopolies don’t have losses. • Not true, b/c some prices will yield lower (negative) profits.
SR Profit-Maximization: MR/MC Approach • The optimum quantity to produce (Q1) is where MR = MC. (draw) • P1 at demand curve (at level of Q1) • The area of profit is from where the Q1 crosses the ATC up to the price. (draw) • No supply curve (b/c no unique relationship between price and QS due to the fact that P does not equal MR).
Other SR Situations • Loss-minimization: use the MR/MC approach. (draw) • Shut-down: same; P < AVC • Long-run equilibrium: n/a
Compared to Pure Competition • Monopolist charges higher price and produces a smaller output. • Monopolist is less efficient. • Costs differ because of: • Economies of scale (specialization easier in monopoly) • X-inefficiency (monopoly chooses not to operate at lowest ATC, which reduces profits) • Rent-seeking behavior (removing excesses from competition) • Technological advances (little incentive for monopolist or they use it as a barrier)
Efficiency • Productive: least-cost occurs when P = minimum ATC. • Allocative: best-mix occurs when P = MC (if P > MC, resources are being underallocated to the good; if P < MC, resources are being overallocated to the good) • A monopolist is inefficient; it has neither type of efficiency (P > min. ATC and P > MC).
Price-Discriminating Monopolist • Monopolist charges different prices to different groups of buyers. • This means that the MR curve is on the D curve because the monopolist will charge each group the highest possible price. • Conditions for discrimination: monopoly power and no option for re-sale. • They can earn more profits and can produce more.
Regulated Monopoly • Gov’t can regulate monopolies (or dissolve them completely). • Two ways to regulate (draw): • Fair-return price: P (demand curve) = ATC • Socially-optimal price: P (demand curve) = MC • Dilemma of regulation: • Fair-return price allows monopolies to cover costs, but does not allow for a significant increase in production or allocative efficiency. • Socially-optimal creates losses, but does allow for allocative efficiency and increased production.
YOU MUST REMEMBER: • Price-maker; MR lies below demand curve. • Q1 is at MR=MC. • P1 is at the demand curve for Q1. • Profit/loss is at Q1 between D and ATC. • NO efficiency! • Produces less at a higher price than a purely competitive firm.
