Monopoly

1. Monopoly

2. Monopoly is a situation in which there is a single seller of a product for which there are no good substitutes.

3. When a monopoly exists, there are generally high barriers to entry into the industry. What are the reasons for these barriers?

4. (1) Legal Barriers • patent - grant of an exclusive right to use a specific process or produce a specific product for a period of time (17 years in the U.S.) • licenses and franchises - permission, granted by a government, to enter an industry or occupation

5. (2) A single firm has sole control of a resource essential to an industry.

6. (3) Economies of Scale Costs per unit in an industry may be low only when a firm produces a lot of output. Consequently, small firms will be unable to enter the industry because costs are too high.

7. Market Demand Curve Because the monopoly firm is the only seller of a good, the market demand curve for the good is the same as the demand curve for the firm’s product. price Demand quantity

8. Remember for a perfectly competitive firm: MR = P. This is not true for the monopolist.

9. For a monopolist, MR < P.So the MR curve lies below the demand curve. QuantityPriceTRMR 10 20 200 --- 11 19 209 9

10. Drawing the MR curve when the demand curve is a straight line: MR has the same Y-intercept and is twice as steep as the demand curve . $ Demand MR quantity

11. Determining the optimal output and price, and the maximum profit: 7 Steps

12. Step 1 a. Draw and label the axes. $ quantity

13. Step 1 b. Draw and label the ATC and MC curves. MC $ ATC quantity

14. Step 1 c. Draw and label the D and MR curves. MC $ ATC MR D quantity

15. Step 2: Find the profit-maximizing output where MR = MC MC $ ATC MR D Q* quantity

16. Step 3: Determine the price from the demand curve, above Q*. MC $ ATC P* MR D Q* quantity

17. Step 4: Determine the cost per unit from the ATC curve, above Q*. MC $ ATC P* ATC* MR D Q* quantity

18. Step 5: Determine the TR = PQ box. MC $ ATC P* ATC* MR D Q* quantity

19. Step 6: Determine the TC = ATC . Q box. MC $ ATC P* ATC* MR D Q* quantity

20. Step 7: Find profit p = TR - TC. MC $ ATC P* ATC* profit MR D Q* quantity

21. In the previous set of graphs, the monopolist was earning a positive economic profit.It is also possible for the monopolist to have a loss or to breakeven.Let’s look at a monopolist with a loss.

22. Step 1: Draw and label the axes and curves. (For a loss, the ATC curve must be entirely above D.) ATC MC $ AVC MR D quantity

23. Step 2: Find the profit-maximizing (or loss-minimizing) output where MR = MC ATC MC $ AVC MR D Q* quantity

24. Step 3: Determine the price from the demand curve, above Q*. ATC MC $ AVC P* MR D Q* quantity

25. Step 4: Determine the cost per unit from the ATC curve, above Q*. ATC MC $ AVC ATC* P* MR D Q* quantity

26. Step 5: Determine the TR = PQ box. ATC MC $ AVC ATC* P* MR D Q* quantity

27. Step 6: Determine the TC = ATC . Q box. ATC MC $ AVC ATC* P* MR D Q* quantity

28. Step 7: Find profit or loss p = TR - TC. ATC MC $ AVC ATC* P* loss MR D Q* quantity

29. A Monopolist Breaking Even (Zero Economic Profit)

30. Step 1: Draw and label the axes and curves. (To break even, D must be tangent to the ATC curve.) MC $ ATC MR D quantity

31. Step 2: Find the profit-maximizing output where MR = MC MC $ ATC MR D Q* quantity

32. Step 3: Determine the price from the demand curve, above Q*. MC $ ATC P* MR D Q* quantity

33. Step 4: Determine the cost per unit from the ATC curve, above Q*. MC $ ATC ATC* = P* MR D Q* quantity

34. Step 5: Determine the TR = PQ box. MC $ ATC ATC* = P* MR D Q* quantity

35. Step 6: Determine the TC = ATC . Q box. MC $ ATC ATC* = P* MR D Q* quantity

36. Step 7: Find profit p = TR - TC. Since TR = TC, p = 0 MC $ ATC ATC* = P* MR D Q* quantity

37. Monopoly Possibilities short run: positive profits, losses, or breaking even. long run: positive profits, or breaking even.

38. What is bad about monopoly? • Consumer options are limited. • Profits do not signal firms to enter the industry. (They can’t get in because of the barriers to entry.) • There is allocative inefficiency. ( P > MC ) The monopolist does not produce all units that consumers value more than it costs to make them.

39. Allocative Inefficiency ( P* > MC* ) MC $ ATC P* ATC* MC* MR D Q* quantity

40. Natural Monopoly a situation in which ATC declines continually with increased output. So a single firm would be the lowest cost producer of the output demanded.

41. ATC doesn’t turn upward until a very high output level, beyond the amounts that consumers will buy. $ ATC quantity

42. Remember: the MC curve is below the ATC curve when ATC is sloping downward. $ MC ATC quantity

43. Draw the demand and MR curves. $ D MR MC ATC quantity

44. What can the government do about a natural monopoly? • government take over the industry • let it operate freely • government regulation of monopolist

45. Natural Monopoly: operating freely $ D P* MR MC ATC Q* quantity

46. Regulation • marginal cost pricing (P = MC) • average cost pricing (P = ATC)

47. Natural Monopoly: marginal cost pricing regulation $ D MR MC ATC Pm Qm quantity

48. Natural Monopoly: marginal cost pricing regulation P < ATC Firm has a loss! So this won’t work. $ D MR MC ATC Pm Qm quantity

49. Natural Monopoly: Average Cost Pricing Regulation $ D MR Pa ATC MC Qa quantity

50. Natural Monopoly: Average Cost Pricing Regulation Zero economic profits: this can work. $ D MR Pa ATC MC Qa quantity