Economics Principles and Applications

1
Im the only one
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Perfect competitionFirm demand is unlimited at
the market priceMRPdemand curve

• Firm Industry

S
P
P
MC
P0
P0
D
q
Q
1000
100
3
What Is A Monopoly?

• A monopoly firm is the only seller of a good or
  service with no close substitutes

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The Sources of Monopoly

• What barrier prevents additional firms from
  entering the market?
• Economies of scale
• Large minimum efficient scale relative to market
  size
• Natural monopoly
• Local monopoly
• Networks (More subscribers raise the value of
  existing subscribers)

5
A Natural Monopoly the local cable company
Fee
Minimum Efficient Scale
A
40
LRATC
DMarket
75,000
50,000
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The Sources of Monopoly

• What barrier prevents additional firms from
  entering the market?
• Legal barriers
• Govt. Mandated Monopoly
• Post Office, Federal government
• Special exemptions from anti-trust
• Professional Sports
• Patents
• Govt. regulations that restrict entry

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The Sources of Monopoly

• What barrier prevents additional firms from
  entering the market?
• Ownership of Scarce Resource
• No close substitutes
• No reuse possible
• Alcoa and bauxite mines
• Recycleable aluminum
• Textbooks
• New
• Used
• De Beers diamonds
• 50 of diamond mining
• 90 of sales in the 1980s
• 60 share now (Russia)

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Monopolist Goal Maximize Profit

• Difference from perfectly competitive firm
• Monopolists demand curve slopes downward (market
  demand)
• To sell more, monopolist must lower the price
• Price is not equal marginal revenue
• Monopolist produces at below the perfectly
  competitive level
• Monopolist produces at below the social optimum
  output level.

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Monopolist faces the downward sloping market
demand curve Major implications for marginal
revenue
Price
P1
P2
Demand
Q1
Q11
Quantity
Q2
10
Price
Consider the change in revenue between Q1 and
(Q1 1).
TR1 P1 Q1 TR2 P2 Q2
P1
P2
Demand
Q1
Q11
Quantity
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Computation of Marginal Revenue

• Marginal revenue is the change in revenue from
  the last unit of output produced
• TR1 P1Q 1
• TR2 P2Q 2 P2(Q1 1)
• MR (?TR)/(?Q) (TR2 - TR1)/(Q11 -Q1)
• P2 (P2 - P1)Q1 lt P2

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Handout

• Compare marginal revenue for a perfectly
  competitive firm and a monopolist

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The Profit-Maximizing Output Level

• To maximize profit, the firm should produce level
  of output where MC MR and
• MR P MC is the solution for perfectly
  competitive firms
• For a monopolist, MR MC lt P
• MC MR gt 0 implies producing where demand is
  elastic

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Monopoly Price and Output Compared to perfect
competition, monopolist sets higher price and
produces less output
MC
Perfectly competitive solution
E
20
D
10,000
30,000
MR
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Marginal Revenue always positive at optimum, so
monopolist will produce in the elastic range of
demand
MC
60
Demand
30,000
MR
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Example of competition and cable fees
Des Moines Register, March 31, 2002
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Profit And Loss

• A monopoly earns a profit whenever P gt ATC
• A monopoly suffers a loss whenever P lt ATC

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Figure 4 Monopoly Profit and Loss
ATC
MC
ATC
MC
AVC
50
E
E
40
40
32
Total Loss
Total Profit
D
D
10,000
10,000
MR
MR
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Long-Run Equilibrium

• Perfectly competitive firms cannot earn a profit
  in long-run equilibrium
• Monopolies may earn economic profit in long-run
• A privately owned monopoly suffering an economic
  loss in long-run will exit the industry
• Public may subsidize monopoly
• Prairie Meadows Horse Track