Monopoly

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 monopolists 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
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 gt total cost by greatest amount
• Marginal revenue Marginal cost

15
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 lt P, monopolist will sell smaller output at a
  higher price than pure competition
• An efficiency loss occurs because
• P gt MC
• P gt 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