Chapter 24: Pure Monopoly

1. Chapter 24:Pure Monopoly

2. Pure Monopoly • I. INTRODUCTION • A. Main Characteristics • Single Seller: only one firm is the sole producer of the product in the market (the firm and the industry are the same). • No Close Substitutes: the monopolist sells a unique product that has no close substitutes. • Price Making: the monopolist controls total quantity supplied to the market and thus has control over the price.

3. Blocked Entry: the monopolist has no immediate competitors because certain barriers prevent potential competitors from entering the market. • Non-price Competition: monopolists that sell standardized products engage mainly in public relations advertising, whereas those with differentiated products sometimes advertise their products’ attributes.

4. B. Monopoly Examples • Pure Monopoly: the existence of one producer. • Near Monopolies: the existence of more than one producer, but one of them has a very large market share.

5. II. BARRIERS TO ENTRY • Economies of Scale (Natural Monopoly): some industries require producing large output to achieve lower average total cost. Thus, economies of scale serve as entry barrier.

6. THE NATURAL MONOPOLY CASE $20 15 ATC Average Total Cost 10 If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly 0 50 100 200 Quantity

7. Legal Barriers to Entry: • Patents: a patent is the exclusive right of an inventor to use, or allowing others, to use its invention. Patents provide the inventor with a monopoly position for the life of the patent (i.e. 20 years). • Licenses: the government blocks entry to an industry through the control of issuance of licenses. • Ownership or Control of Essential Resources • Pricing and Other Strategic Barriers to Entry

8. III. MONOPOLY DEMAND • Basic Assumptions: • Monopoly Status is Secured • 2) No Governmental Regulation • 3) Firm Charges the Same Price for all Units Sold

9. NOTES: • Market Demand Curve is the Firm’s Demand Curve • The monopolist sets the price in the elastic region of demand. • In the elastic region of demand, lower price leads to higher total revenue. • The monopolist avoids the inelastic region in the demand curve. • Profit maximization and loss minimization rule of monopolist: MR = MC • Note that price > MR

10. MONOPOLY REVENUES & COSTS Elastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

11. MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

12. The monopolist has no supply curve. • The monopolist equates MR and MC to determine output. • The monopolist does not set the highest possible price. • Monopolist’s goal is maximum profit not maximum price. • Higher price may lead to less profit.

13. MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost - x 0 $172 $ 0 $100 - $100 = =

14. ] ] MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 0 1 0 $172 $172 162 $ 0 162 $ 0 $100 $100 190 - $100 - $100 - 28 90 $162 - x = = $190.00 MC = $190 – 100 = $90 MR = $162 – 0 = $162 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

15. ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 0 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 90 80 70 60 70 80 90 110 130 150 $162 142 122 102 82 62 42 22 2 - 18 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

16. ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost Can you see profit maximization? 0 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 MR > = MC 90 80 70 60 70 80 90 110 130 150 $162 142 122 102 82 62 42 22 2 - 18 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

17. IV. OUTPUT AND PRICE DETERMINATION • Cost Data • MR = MC Rule • No Monopoly Supply Curve • Monopoly Pricing Misconceptions: • Not Highest Price • Total, Not Unit, Profit • Possibility of Losses Graphically…

18. OUTPUT AND PRICE DETERMINATION 200 175 150 125 100 75 50 25 Price, costs, and revenue Q 0 1 2 3 4 5 6 7 8 9 10 Case 1: Profit Maximization Under Monopoly Remember the MR=MC Rule? Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

19. OUTPUT AND PRICE DETERMINATION Since Pmexceeds AVC, the firm will produce 200 175 150 125 100 75 50 25 Price, costs, and revenue Q 0 1 2 3 4 5 6 7 8 9 10 Case 2 :Loss Minimization Under Monopoly Loss Per Unit MC ATC A Loss AVC Pm V D MR = MC MR Qm

20. V. Economic Effects of Monopoly What are the Economic Effects of Monopoly? • Monopoly pricing effectively creates an income transfer from buyers to the seller! • X-Inefficiency: When the cost of producing is more than the lowest possible cost Monopolists are likely to experience X inefficiency than pure competition producers (who are under pressures) • Rent-Seeking Behavior: using the monopolistic position to make more profits. • Technological Advance: monopolists are less likely to care about Research & Development.

21. INEFFICIENCY OF PURE MONOPOLY An industry in pure competition sells where supply and demand are equal P S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Q Qm Qc

22. X ATCx Average Total Costs X’ ATC1 Average total costs ATCx’ ATC2 Q2 Q1 Quantity Inefficient internal operation leads to higher-than- necessary costs

23. VI. PRICE DISCRIMINATION • Definition: the sale of a specific product at more than one price, and price differences are not justified by cost differences. • Conditions: • Monopoly Power: the seller must be a monopolist or at least have some monopoly power (ability to control P&Q). • Market Segregation: the seller is able to segregate buyers into distinct classes based on different demand elasticities. • No Resale: the buyer cannot resell the good or service. • Consequences: • More Profit: monopolist can gain more profits. • More Production: monopolist is willing to produce more

24. MC Economic profits with a single MR=MC price P ATC Price and Costs D MR Q Q1

25. MC A perfectly discriminating monopolist has MR=D, producing more product and more profit! P ATC Price and Costs MR=D D Q Q1 Q2

26. VII. REGULATED MONOPOLY • Natural Monopolies: they are subject to rate (price) regulation. • Socially Optimum Price: if the objective is achieving allocative efficiency, the regulator should set a legal (ceiling) price equals the MC: P = MC • Fair-Return Price: because optimum price may lead to losses, price must be set where no losses occur, that’s at ATC: P = ATC

27. Dilemma of Regulation: Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr