Part 7 Monopoly

1. Part 7Monopoly • Many markets are dominated by a single seller with market power • The economic model of “pure monopoly” deals with an idealized case of a market with only one seller • A monopoly has no competition and requires - No close substitutes - Barriers to entry • Barriers to entry can be legal, natural (economies of scale), or created by the monopoly itself (limit pricing, predatory pricing)

2. Natural Monopoly • Natural monopoly arises due to economies of scale over outputs that are large relative to the size of the market $ LAC D Q

3. Monopoly Pricing • As the only firm in the market the monopoly faces the market demand curve • To sell more means lowering the price – Monopoly is constrained by the demand conditions • Single price monopoly – sells all units at the same price • Price discriminating monopolist – sells different units at different prices (must be restrictions on resale)

4. Single Price Monopoly • Faces the market demand curve and can has to sell all units at the same price P What happens to P x Q as price is reduced? P P’ P” D Q Q” Q Q’

5. Revenue Curves for a Single Price Monopolist P E > 1 MR = ΔTR/ΔQ E = 1 E <1 D = AR Q MR $ $ TR max TR (P x Q) Q

6. Price and Output Decision • Monopolist will never produce in the inelastic range of the demand curve (MR is negative) • Monopolist will produce where the difference between TR and TC is the greatest • Monopolist will produce where MC = MR • Profit maximizing condition is MC = MR, but MR < P

7. Price and Output: TC and TR $ TC TR Max economic Profit Q Q*

8. Price and Output: MC and MR P MC P* ATC D = AR Economic profit MR Q Q*

9. Single Price Monopoly and Competition • Compare single price monopoly equilibrium with perfect competition—assuming similar cost conditions P Monopoly MC Comp S curve P” P’ D Monopoly MR Q” Q’ Q

10. Efficiency Comparison Perfect Competition P S CS P’ PS D Q Q’ P Monopoly S CS P” Deadweight loss PS MR D Q Q”

11. Efficiency Comparison • Monopoly creates allocative inefficiency measured by the deadweight loss. How significant is this? • Monopoly might gain large economies of scale. Are large firms lower cost? • Monopolies capture consumers’ surplus and redistribute income from consumer to the monopoly

12. Price Discrimination • Price discrimination involves selling different units of the good for different prices for reason unconnected with production costs • Based on differences in willingness to pay between units of the good or between different buyer types or groups • Prevent resale between types or groups • Attempt to capture consumers’ surplus • Price discrimination is illegal but rarely prosecuted—only when used for anti-competitive purposes

13. Price Discrimination • Market segmentation P Monopoly revenue P’ P” Q Q” Q’

14. Perfect Price Discrimination Monopoly charges the maximum willingness to pay for each unit. D curve then becomes the MR curve. Q’ is the same as the output under perfect competition. There is no deadweight loss. P MC PS D=MR Q’ Q

15. Policy Issues • Possible Advantages of monopoly - Economies of scale and scope - Incentives to innovate • Policy towards Monopoly - Breaking up monopolies - Regulation of monopoly prices - Public Ownership - Don’t worry, be happy • Pricing rules for regulating a natural monopoly - Marginal cost pricing - Average cost pricing

16. Regulating a natural Monopoly P P & Q are with no regulation. P’ & Q’ are with MC pricing which creates a loss. P” & Q” are with price = ATC P P” ATC MC P’ D MR Q Q Q” Q’