Monopoly

1
Monopoly

• Outline
• Characteristics of a monopoly
• Why monopolies arise?
• Production and pricing decision of monopolies
• Monopoly and societal well- being
• Government policy and monopolies
• Price discrimination

2
What is a monopoly?

• Monopoly is a firm that is the sole seller of a
  product without close substitutes
• Monopoly has market power and this alters
  relationship between a monopoly firms price and
  its costs.
• A monopoly is a price maker
• Characteristics of a monopoly
• Product has no close substitutes
• There are barriers to entry

3
Barriers to entry

• Barriers to entry arise from three sources
• Monopoly over key resources
• Government gives a firm exclusive right to
  produce
• Natural monopoly due to costs of production
• Natural monopoly arises because a single firm can
  supply a good or service to an entire market at a
  smaller cost than could two firms (when a firms
  ATC continually declines)

4
Production and Pricing Decisions

• Monopoly versus Competition
• Monopoly has market power and perfect competition
  has no market power
• Monopoly is a price maker and competitive firm is
  a price taker
• Demand curve faced by the competitive firm is
  perfectly elastic
• Demand curve faced by the monopoly is downward
  sloping
• Market demand curve is a constraint on the
  monopolists profit

5
Production and Pricing Decisions Monopolys
Revenue
6
Monopoly's Revenue

• TRPQ
• ARP
• MRltP (demand curve is down-ward sloping)
• There are two effects when a monopoly increases
  the amount it sells
• Output effect Q is higher
• Price effect P is lower
• MR0, positive, negative (depending on the price
  effect on TR)

7
Monopoly's Profit Maximization

• A monopoly maximizes profit by producing output
  at the point where MRMC
• The price for the profit maximizing output is
  determined using the demand curve
• For a monopoly firm
• PgtMRMC
• For a competitive firm
• PMRMC

8
Monopoly's Supply Curve

• Since a monopoly is a price maker, the
  monopolists decision to supply a particular
  quantity is linked to its demand curve
• The demand curve determines MR, which in turn
  determines the profit maximizing quantity to be
  sold

9
Welfare Cost of Monopoly

• PgtMC and therefore this affects the well-being of
  the society by imposing a social cost on them
• Socially efficient quantity maximizing total
  surplus occurs at the intersection of the demand
  and MC curves
• Monopolys chosen level of output occurs at the
  intersection of the MC and MR curves

10
Welfare Cost of Monopoly

• Monopolist produces less than the socially
  efficient quantity of output thus minimizing
  total surplus
• PgtMC implies that some potential consumers do not
  buy the good due to the deadweight loss imposed
  by the monopoly price (similar to a tax)
• The welfare cost cost of rent seeking
  activities deadweight loss

11
Public Policy Toward Monopolies

• Policy makers respond to the problem of monopoly
  in 4 ways
• Competition law problem of synergies
• Regulation problems with MC and ATC pricing
• Public ownership problem with bureaucratic
  methods
• Leaving it to market forces

12
Price Discrimination

• The practice of selling the same good at
  different prices to different consumers is known
  as price discrimination
• Firms must have market power in order to price
  discriminate
• Price discrimination is a rational strategy for a
  profit-maximizing monopolist
• Price discrimination requires ability to
  distinguish consumers according to their
  willingness to pay

13
Price Discrimination

• Certain market forces (arbitrage) can prevent
  firms from price discriminating
• Price discrimination can eliminate the
  inefficiency inherent in monopoly pricing
• Increase in welfare is reflected as an increase
  in producer surplus (profit) and there is no dead
  weight loss
• Conclusion monopoly power is a matter of degree
  and is usually limited