Monopoly - Characteristics • A firm is considered a monopoly if . . . . . . it is the sole seller of its product. . . . its product does not have close substitutes. . . . it has some ability to influence the market price of its product.
Why Monopolies Arise • The fundamental cause of monopoly is barriers to entry. • Barriers to entry have three sources: ä Ownership of key resource ä Legal barriers by government ä Large economies of scale • Exclusive ownership of an important resource that cannot be readily duplicated is a potential source of monopoly.
Government-Created Monopolies • Patent and copyright laws are a major source of government-created monopolies. • Governments also restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
Natural Monopolies • An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. • Because of economies of scale, the minimum efficient scale of one firm’s plant is so large that only one firm can supply the market efficiently.
Monopoly ä Is the sole producer ä Has a downward-sloping demand curve ä Is a price maker ä Reduces price to increase sales Competitive Firm ä Is one of many producers ä Has a horizontal demand curve ä Is a price taker ä Sells as much or as little at same price Monopoly versus Perfect Competition
Monopoly’s Revenue • Total Revenue P x Q = TR • Average Revenue TR/Q = AR = P • Marginal Revenue DTR/DQ = MR NB : - MR does not equal AR
Monopoly’s Marginal Revenue • A monopolist’s marginal revenue is always less than the price of its good. ä The demand curve is downward sloping. ä When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
Monopoly’s Marginal Revenue • When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). ä The output effect—more output is sold, so Q is higher. ä The price effect—price falls, so P is lower.
Demand (average revenue) Marginal revenue Monopoly’s Demand and Marginal Revenue Curves Price The marginal revenuecurve lies below its demand curve. £11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 Quantity of Water -1 -2 -3 -4
Profit Maximization of a Monopoly • A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. • It then uses the demand curve to find the price that will induce consumers to buy that quantity.
Costs and Revenue Marginal cost Profit Maximization of a Monopoly Average total cost Demand Marginal revenue 0 Quantity
Costs and Revenue Marginal cost Profit Maximization of a Monopoly Average total cost A Demand Marginal revenue 0 Quantity
Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Marginal cost Profit Maximization of a Monopoly Average total cost A Demand Marginal revenue 0 Quantity
Costs and Revenue 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... Marginal cost Profit Maximization of a Monopoly Average total cost A Demand Marginal revenue 0 QMAX Quantity
Costs and 2. ...and then the demand Revenue 1. The intersection of the curve shows the price marginal-revenue curve consistent with this quantity. and the marginal-cost curve determines the profit-maximizing Monopoly quantity... price Marginal cost Profit Maximization of a Monopoly B Average total cost A Demand Marginal revenue 0 QMAX Quantity
Comparing Monopoly and Competition • For a competitive firm, price equals marginal cost. P = MR = MC • For a monopoly firm, price exceeds marginal cost. P > MR = MC
Calculating Monopoly Profit • Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q
Costs and Revenue Monopoly price The Monopolist’s Profit Marginal cost Average total cost Demand Marginal revenue 0 QMAX Quantity
Costs and Revenue Monopoly price Average total cost The Monopolist’s Profit Marginal cost Average total cost Demand Marginal revenue 0 QMAX Quantity
Costs and Revenue Monopoly price Monopoly profit Average total cost The Monopolist’s Profit Marginal cost E B Average total cost D C Demand Marginal revenue 0 QMAX Quantity
The Monopolist’s Profit • The monopolist will receive economic profitsas long as price is greater than average total cost.
The Welfare Cost of Monopoly • A monopoly leads to an inefficient allocation of resources and a failure to maximize total economic well-being. • The monopolist produces less than the socially efficient quantity of output. • Because a monopoly charges a price above marginal cost, consumers who value the good at more than its marginal cost but less than the monopolist’s price won’t buy it.
The Welfare Cost of Monopoly • Monopoly pricing prevents some mutually beneficial trades from taking place.
The Deadweight Loss • Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. • ä This wedge causes the quantity sold to fall short of the social optimum.
Monopoly price Marginal revenue The Deadweight Loss Price Marginal cost Demand 0 Monopoly quantity Quantity
Monopoly price Marginal revenue The Deadweight Loss Price Marginal cost Demand 0 Monopoly quantity Efficient quantity Quantity
Deadweight loss Monopoly price Marginal revenue The Deadweight Loss Price Marginal cost Demand 0 Monopoly quantity Efficient quantity Quantity
Public Policy Toward Monopolies • Government responds to the problem of monopoly in one of four ways. ä Making monopolized industries more competitive. ä Regulating the behaviour of monopolies. ä Turning some private monopolies into public enterprises. ä Doing nothing at all.
Creating a Competitive Market and Regulation • Government may implement and enforce antitrust laws to make the industry more competitive. • Government may regulate the prices that the monopoly charges. ä The allocation of resources will be efficient if price is set to equal marginal cost. • There are two practical problems with marginal-cost pricing. ä Price may be less than average total cost, and the firm will lose money. ä It gives the monopolist no incentive to reduce cost.
Public Ownership • Government can turn the monopolist into a government-run enterprise. • Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.
Price Discrimination • Price discrimination is the practice of selling the same good at different prices to different customers. ä Not possible in a competitive market. • Two important effects of price discrimination: ä It can increase the monopolist’s profits. ä It can reduce deadweight loss.
Examples of Price Discrimination • Movie tickets • Airline tickets • Discount coupons • Financial aid • Quantity discounts
The Prevalence of Monopoly • How prevalent are the problems of monopolies? ä Monopolies are common. ä Most firms have some control over their prices because of differentiated products. ä Firms with substantial monopoly power are rare. ä Few goods are truly unique.
Conclusion • A monopoly is a firm that is the sole seller in its market. • It faces a downward-sloping demand curve for its product. • Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. • Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.
Conclusion • A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. • A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.
Conclusion • Policymakers can try to remedy the inefficiencies of monopolies with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. • If the market failure is small, policymakers may decide to do nothing at all.
Conclusion • Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. • Price discrimination can raise economic welfare and lessen deadweight losses.
(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve’ Price Price Demand Demand 0 Quantity of Output 0 Quantity of Output Figure 15-2
Price £11 10 9 8 7 6 5 4 3 Demand Marginal (average revenue) 2 revenue 1 0 1 2 3 4 5 6 7 8 Quantity of Water -1 -2 -3 -4 Figure 15-3
Costs and 2. ...and then the demand Revenue 1. The intersection of the curve shows the price marginal-revenue curve consistent with this quantity. and the marginal-cost curve determines the profit-maximizing B Monopoly quantity... price Average total cost A Demand Marginal cost Marginal revenue 0 Q1 QMAX Q2 Quantity Figure 15-4
Costs and Revenue Marginal cost Monopoly E B price Monopoly Average total cost profit Average D C total cost Demand Marginal revenue 0 QMAX Quantity Figure 15-5
Costs and Revenue Price during patent life Price after Marginal patent cost expires Demand Marginal revenue 0 Monopoly Competitive Quantity quantity quantity Figure 15-6
Price Marginal cost Value to buyers Cost to monopolist Demand (value to buyers) Cost to monopolist Value to buyers 0 Quantity Value to buyers Value to buyers is greater than is less than cost to seller. cost to seller. Efficient quantity Figure 15-7
Price Marginal cost Deadweight loss Monopoly price Marginal revenue Demand 0 Monopoly quantity Efficient quantity Quantity Figure 15-8
Price Average total cost Average total cost Loss Regulated Marginal cost price Demand 0 Quantity Figure 15-9
(a) Monopolist with Single Price (b) Monopolist with Perfect Price Discrimination Price Price Consumer surplus Deadweight Monopoly loss price Profit Profit Marginal cost Marginal cost Marginal Demand Demand revenue 0 Quantity sold Quantity 0 Quantity sold Quantity Figure 15-10