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Monopoly. Eco 2023 Chapter 10 Fall 2007. Monopoly. A market with a single seller with a product that is differentiated from other products. Characteristics. Single seller Firm and industry are synonymous No close substitutes Price maker Blocked entry

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  1. Monopoly Eco 2023 Chapter 10 Fall 2007

  2. Monopoly • A market with a single seller with a product that is differentiated from other products.

  3. Characteristics • Single seller • Firm and industry are synonymous • No close substitutes • Price maker • Blocked entry • Barriers to entry keep competitors out of the market • Standardized or differentiated

  4. Barriers to Entry • Any impediment that prevents new firms from entering an industry and competing on an equal basis with existing firms • Types • Economies of scale • Legal restrictions • Control over essential resource

  5. Economies of Scale • Declining average total cost with added firm size are extensive • Long run average total cost will decline over a wide range of output • Only a single large firm can achieve low average total costs • Protects the firm from competitors • Natural monopoly • the market demand curve cuts the long-run ATC curve where average total costs are still declining

  6. Legal Restrictions • Patent • A legal barriers to entry that grants its holder the exclusive right to sell a product for 20 years from the date the patent application is filed • Innovation • The process of turning an invention into a marketable product • Licenses • Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service

  7. Control over Essential Resource • Firms owns all sources of a resource • ALCOA – aluminum • DeBeers – diamonds

  8. Monopoly Demand • Three assumptions • Patents, economies of scale or resource ownership secure our monopolist’s status • No unit of government regulates the firm • Single price monopolist, • Demand curve • Downward sloping demand curve • Quantity demanded increases as price decreases

  9. Implications • Marginal revenue is less than price • The downward sloping demand curve means that it can increase sales by charging a lower price • Marginal revenue is less than price for every level of output • Marginal revenue curve is below the demand curve • Marginal revenue is positive while total revenue is increasing. • When total revenue is decreasing, marginal revenue is negative

  10. Price Elastic Unit Elastic Inelastic Demand = Average Revenue Monopoly Marginal Revee

  11. Monopoly • Where demand is price elastic, marginal revenue is positive • Therefore: • TR increases as Price decreases • Where demand is price inelastic, marginal revenue is negative • TR decreases as Price increases • Where demand is unit elastic, marginal revenue is zero, • TR is at a maximum, neither increasing nor decreasing

  12. Implications • Price Maker • When monopolist decides on output level, he determines price. • Elastic Region • Monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease • Marginal revenue is NEGATIVE

  13. Example

  14. Monopoly • Profit Maximization • A firm that must find the profit maximizing price when the demand curve for its output slopes downward • Monopolist produces the quantity at which total revenue > total cost by greatest amount • Marginal revenue = Marginal cost

  15. Price Profit Marginal Cost Average Total Cost P Demand = Average Revenue Monopoly – short run Marginal Revenue Q

  16. Monopoly • Short run • Economic profits can exist • Losses • Can exist • If the price covers average variable cost, the firm will produce • If not, the firm will shut down at least in the short run

  17. Long run Profit Maximization • Long run efficiency in pure competition is • P = MC = Minimum ATC • Monopoly • MR < P, monopolist will sell smaller output at a higher price than pure competition • An efficiency loss occurs because • P > MC • P > minimum ATC

  18. Long-Run Profit Maximization • If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run.

  19. Monopoly • Allocation of Resources • If monopolists are no greedier than perfect competitors because both maximize profit • What is the problem with monopoly? • Lower output • Higher price • Than perfect competition

  20. Monopoly • Price Discrimination • Increasing profits by charging different groups of consumers different prices when the price differences are not justified by differences in production costs

  21. Monopoly • Conditions • Demand must be downward sloping • At least to separate groups of consumers • Each with different price elasticity of demand • Firm must be able to charge each group a different price for essentially the same product • The firmmust be able to prevent those who pay the lower price from reselling the product to those who pay the higher price • Each market, the firms equates marginal revenue with marginal cost

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