Monopoly

1
Monopoly
2
Monopoly

• Only one firm
• By law
• Legally granted monopoly (Post-office)
• Patent (for a specified time)
• By opportunity
• Input control (DeBeers and diamonds)
• Combat entry (sue)
• Advertising
• By nature
• Large entry costs (electrical grid, knowledge)
• Economies of scale (bigger is just better)

3
Baffled by BeijingThe Guardian, Tuesday August
19 2008

• Why are we so good at sailing, rowing and
  cycling, but useless at track and field?
• The Australians like to joke that we Brits are
  good at sitting-down sports. Unfortunately,
  they're right. The 3,000m steeplechase, the pole
  vault, weightlifting, not a hope. But give us a
  seat on a bike, in a boat or on a horse and we're
  potential world-beaters.
• Part of the reason may be our innate laziness -
  the weather in the UK is bad and we spend most of
  our time indoors watching TV or playing online
  Scrabble - but the real key is the number of
  countries that participate in each sport. In
  three-day eventing, at which we are traditionally
  strong (and where we usually manage to find a
  member of the royal family able to compete),
  there are just 75 competitors. In athletics there
  are 2,000. To succeed in eventing you would need
  a fantastic horse, probably worth 250,000 or
  more, and the means to transport it to Beijing
  in athletics you need a strong pair of lungs.
  Ethiopia, Morocco and Kenya are very good at
  athletics, but they are absolute crap at
  three-day eventing.
• The key to winning medals at the Olympics is to
  think small. Don't target sports that everyone
  can be good at - athletics, boxing, football. Go
  for technologically complicated and expensive
  sports that hardly anyone can afford, such as
  yachting. Or, better still, sports that are both
  mind-blowingly dull and need expensive
  facilities, such as cycling and rowing. Britain
  should press for formula one motor racing to be
  included in 2012. Then let's see Jamaica find
  someone to rival Lewis Hamilton and his McLaren.
  SM

4
THE RULE

• IN EQUILIBRIUM
• MR MC

5
Perfect Competition
P MR AR D
MC
P
P
ATC
S
P
D
D
Q
q
Q
Q
6
Monopoly
MC
P
P
S
ATC
P
D
q
Q
q
Q
MC
P
If you only have 1 firm, it faces the market
demand curve
ATC
D
q
7
Monopoly
MC
P
P
S
ATC
P
D
q
Q
q
Q
MC
P
But the rule is, MC MR So, you have to use the
market demand curve to find the monopolists
marginal revenue curve.
ATC
D
q
8
Demand to Marginal Revenue

• Suppose the firm wanted to sell its first unit
  and could do so at a price of 10. What is the
  marginal revenue?
• Suppose it then wanted to sell a second unit, but
  the next person would only buy it at 8.
• If the firm lowers the price to 8, it receives 8
  from the second sale.
• But it has to give 2 back to the person who
  bought it at 10.
• Marginal revenue is 8 2 6.

9
Calculus Trick

• If demand is a straight-line, then the marginal
  revenue curve is twice as steep as the demand
  curve.

10
Monopoly
MC
P
P
S
ATC
P
D
q
Q
q
Q
MC
P
We find where MC MR. That determines the
amount produced.
ATC
MR
D
q
q
11
Monopoly
MC
P
P
S
ATC
P
D
q
Q
q
Q
MC
P
To find the price charged, we find the P on the
demand curve that has a quantity demanded q
ATC
MR
D
q
q
12
Profit
MC
P
TR PQ TC ATC Q Monopolist makes
positive profit.
ATC
MR
P
a
D
q
q
13
Inefficiency
MC
P
The triangle a represents beneficial exchanges
that dont take place under monopoly That is,
someone is willing to pay more than the marginal
cost of production. Deadweight loss The
monopolist produces less than is socially optimal
and charges too high a price.
ATC
MR
P
a
D
q
q
14
Inefficiency
MC
P
If the firm produced where MC D, consumer
surplus is the red triangle. The consumer loses
with monopoly. Under monopoly, the producer
absorbs some of the lost consumer surplus. The
producer benefits. Overall, society is worse off
Monopoly profit
ATC
MR
P
D
q
q
15
When is Monopoly Good?
P
P
ATC AVC AFC
MC AVC
D
MR
Here, MC is constant. If MC is constant, AVC is
constant. ATC is falling because AFC is falling.
q
q
16
Natural Monopoly
Suppose you wanted to produce q If you used 1
firm, it would cost the purple rectangle.
P
P
ATC
q
q
2q
17
Natural Monopoly
Suppose you wanted to produce q If you used 1
firm, it would cost the purple rectangle.
P
P
ATC
q
q
2q
If you used 2 firms, each producing q, it would
cost each firm the dashed box. So the total cost
would be two of those boxes.
18
Natural Monopoly
P
A natural monopoly arises when it is cheaper for
1 firm to do all the production
P
ATC
q
q
2q
19
Consumer Surplus
P
P
ATC
MC AVC
D
MR
q
q
20
When is Monopoly Good?
Suppose you forced the monopoly to produce where
MC D?
P
ATC
P
MC AVC
D
MR
q
q
21
When is Monopoly Good?
Profit is negative P MC lt ATC Firm shuts down
so there is no production and no surplus at all!
P
ATC
MC AVC
P
D
MR
q
q
22
When is Monopoly Good?
Profit is negative P MC lt ATC Firm shuts down
so there is no production and no surplus at all!
P
ATC
MC AVC
P
D
MR
q
q
In general, natural monopoly is when ATC is
falling, which means MC lt ATC
23
Possible Solution
Government says you must price where ATC D!
P
ATC
P
MC AVC
D
MR
q
q
24
Average Cost Pricing
Government says you must price where ATC D!
P
PM
ATC
P
MC AVC
D
MR
q
q
qM
ATC P, so firm makes zero profit (willing to
stay in market) P is lower than under monopoly
and q is higher. Short of efficiency, but better
than the firm not producing at all.
25
Possible Solution II
Government says you must price where MC D, but
taxes consumers and gives it to producers.
P
ATC
MC AVC
P
D
MR
q
q
26
The Case for Patents
MC
P
Suppose this firm has a monopoly on a drug it
developed. The firm is making positive profit,
producing too little at too high a price. But
suppose the costs of developing the drug are very
high and any firm could copy it.
ATC
MR
P
a
D
q
q
27
The Case for Patents
MC
P
YEAR 1
ATC
Generics enter in the second year and firms no
longer make any profit. If the profit in the
first year is smaller than the costs of drug
research and development, the drug never comes
about.
MR
P
D
q
q
MC
YEAR 2
P
ATC
P
D P MR
q
q
28
The Case for Patents
MC
P
YEAR 1
ATC
The government grants a patent, establishing a
legal monopoly. Intended to allow firms with
high research costs to recoup these costs.
MR
P
D
q
q
MC
YEAR 2
P
ATC
P
D P MR
q
q