Monopoly

1. Monopoly © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2. Barriers to Entry • Monopoly • Sole supplier of a product with no close substitutes • Barrier to entry • Any impediment that prevents new firms • From entering an industry • And competing on an equal basis with existing firms © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3. Barriers to Entry • Barriers to entry • Legal restrictions • Economies of scale • Control of essential resources © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. Barriers to Entry • Legal restrictions • Patents and invention incentives • Exclusive right to sell a product for 20 years from the date the patent application is filed • Incentive for innovation • Licenses and other entry restrictions • Government awarding an individual firm the exclusive right to supply a particular good or service • Federal and state license © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5. Barriers to Entry • Economies of scale • Natural monopoly • Downward-sloping long-run average cost curve • One firm can supply market demand at a lower average cost per unit than could two firms © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6. Exhibit 1 Economies of Scale as a Barrier to Entry $ A monopoly sometimes emerges naturally when a firm experiences economies of scale as reflected by a downward-sloping long-run average cost curve. One firm can satisfy market demand at a lower average cost per unit than could two or more firms, each operating at smaller rates of output. Cost per unit Long-run average cost Quantity per period © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. Barriers to Entry • Control of essential resources • Firm’s control over some resource critical to production • Alcoa (aluminum) • Control the supply of bauxite • Professional sports leagues • China (pandas) • DeBeers Consolidated Mines (diamonds)

8. Barriers to Entry • Supplying something that other producers can’t match • Unique experience • Monopolies • Local, national, international • Long-lasting monopolies • Rare - economic profit attracts competitors • Technological change

9. Revenue for the Monopolist • Monopoly • Supplies the market demand • Downward-slopping (law of demand) • To sell more: must lower the price on all units sold • Total revenue TR=pˣQ • Average revenue AR=TR/Q • For monopolist: p=AR • Demand curve = average revenue curve

10. Exhibit 2 A Monopolist’s Gain and Loss in Total Revenue from Selling a Fourth Unit If De Beers increases quantity supplied from 3 to 4 diamonds per day, the gain in revenue from the fourth diamond is $6,750. But the monopolist loses $750 from selling the first 3 diamonds for $6,750 each instead of $7,000 each. Marginal revenue from the fourth diamond equals the gain minus the loss, or $6,750 $750 $6,000. Thus, the marginal revenue of $6,000 is less than the price of $6,750. Loss $7,000 6,750 Gain D = Average revenue Dollars per diamond 1-carat diamonds per day 0 3 4

11. Revenue for the Monopolist • Marginal revenue MR=∆TR/∆Q • For monopolist: MR<p • Declines, can be negative • Marginal revenue curve • Downward sloping • Below the demand curve (average revenue curve)

12. Exhibit 4 Monopoly Demand, Marginal Revenue, and Total Revenue • Demand and marginal revenue Where demand is price elastic, marginal revenue is positive, so total revenue increases as the price falls. Where demand is price inelastic, marginal revenue is negative, so total revenue decreases as the price falls. Elastic Unit elastic $3,750 Dollars per diamond Inelastic 0 MR D=Average revenue 1-carat diamonds per day 16 32 (b) Total revenue Where demand is unit elastic, marginal revenue is zero, so total revenue is at a maximum, neither increasing nor decreasing. $60,000 Total revenue Total dollars 1-carat diamonds per day 0 16 32

13. Revenue for Monopolist • Total revenue curve • Reaches maximum where MR=0 • Demand curve: p=AR • Where demand is elastic, as price falls • Total revenue increases • MR>0

14. Revenue for Monopolist • Where demand is inelastic, as price falls • Total revenue decreases • MR<0 • Where demand is unit elastic • Total revenue is maximized • MR=0

15. Costs and Profit Maximization • Monopolist • Choose the price • OR the quantity • ‘Price maker’ • Price maker • Firm with some power to set the price • Demand curve for its output slopes downward • Firms with market power

16. Costs and Profit Maximization • Profit maximization • Profit = total revenue minus total cost • Supply the quantity where • Total revenue exceeds total cost by the greatest amount • Marginal revenue equals marginal cost

17. Monopoly & Allocation of Resources • Monopoly • Marginal benefit (p) > marginal cost • Restrict quantity below what would maximize social welfare • Smaller consumer surplus • Economic profit • Deadweight loss of monopoly • Allocative inefficiency

18. Monopoly & Allocation of Resources • Deadweight loss of monopoly • Net loss to society • When a firm with market power restricts output and increases the price

19. Exhibit 8 Perfect Competition and Monopoly Compared A perfectly competitive industry would produce output QC, determined by the intersection of the market demand curve D and the market supply curve SC. The price would be pC. A monopoly that could produce output at the same minimum average cost as a perfectly competitive industry would produce output Qm, determined at point b, where marginal cost intersects marginal revenue. The monopolist would charge price pm. Thus, given the same costs, output is lower and price is higher under monopoly than under perfect competition. a c m b pm Dollars per unit Sc=MC=ATC pc D MRm Quantity per period 0 Qm Qc

20. Estimating Deadweight Loss • Deadweight loss of monopoly might be lower • Substantial economies of scale • Lower cost per unit • Keep price below the profit maximizing value • Public scrutiny, political pressure • Avoid attracting competition

21. Estimating Deadweight Loss • Deadweight loss of monopoly might be higher • Secure and maintain monopoly position • Use resources; social waste • Influence public policy (Rent seeking) • Inefficiency • Slow to adopt new technology • Reluctant to develop new products • Lack innovation

22. Price Discrimination • Price discrimination • Increasing profit • Charging different groups of consumers • Different prices • For the same product

23. Price Discrimination • Conditions for price discrimination • Downward sloping demand curve • Some market power • At last two groups of consumers • With different price elasticity of demand • Ability to charge different prices • At low cost • Prevent reselling of the product

24. A Model of Price Discrimination • Two groups of consumers • One group (a): less elastic demand • The other (b): more elastic demand • Maximize profit • MR=MC in each market • Lower price for group (b)

25. Exhibit 9 Price Discrimination with Two Groups of Consumers • Consumer group with less elastic demand (b) Consumer group with more elastic demand Dollars per unit Dollars per unit $3.00 $1.50 LRAC, MC LRAC, MC 1.00 1.00 MR’ MR 0 400 Quantity per period 0 500 Quantity per period D’ D A monopolist facing two groups of consumers with different demand elasticities may be able to practice price discrimination to increase profit or reduce loss. With marginal cost the same in both markets, the firm charges a higher price to the group in panel (a), which has a less elastic demand than group in panel (b).

26. Examples of Price Discrimination • Airline travel • Businesspeople (business class) • Less elastic demand • Higher price • Even within the same class • Different prices • Discount fares • Weekend stay

27. Examples of Price Discrimination • Amusement parks • Out-of-towners: less elastic demand • Higher prices • Locals: more elastic demand • Discount coupons available at local businesses

28. Perfect Price Discrimination • Perfectly discriminating monopolist • Monopolist who charges a different price • For each unit sold • The monopolist’s dream • Charge different price for each unit sold • D curve becomes MR curve • Convert consumer surplus into economic profit • Allocative efficiency: No deadweight loss

29. Exhibit 10 Perfect Price Discrimination a Dollars per unit c Profit Long-run average cost = Marginal cost c D=Marginal revenue Q Quantity per period 0 If a monopolist can charge a different price for each unit sold, it may be able to practice perfect price discrimination. By setting the price of each unit equal to the maximum amount consumers are willing to pay for that unit (shown by the height of the demand curve), the monopolist can earn a profit equal to the area of the shaded triangle. Consumer surplus is zero. Ironically, this outcome is efficient because the monopolist has no incentive to restrict output, so there is no deadweight loss.