Monopoly

1
Monopoly
2
Monopoly

• A market structure in which only one producer
  or seller exists for a product that has no close
  substitutes

3
Characteristics of Monopoly

• Barriers to entry preventing new firms from
  entering the market
• Degree of control over price that is held by the
  monopolist
• Individual supply of the monopolist coincides
  with the market supply
• Firms demand equals the market demand for the
  product/service
• Monopolist is a price maker

4
Sources of Monopoly

• Economies of scale
• natural monopolies
• public utilities
• Control of raw materials
• Patents
• Anti-competitive tactics

5
Monopoly Demand

• Monopolists demand curve slopes downward to the
  right because it is the market demand curve of
  all consumers
• If the monopolist wants to increase output, it
  must lower price or the additional output will
  not be bought
• it must move down along the demand curve

6
Revenue

• The additional revenue (i.e., MR) when a monopoly
  sells more will be less than price
• the additional unit adds revenue equal to the
  price but there is a loss of revenue because of
  the lower price on all the other units

7
At a price of 20.00, the firm sells 1,000
units. If it wants to sell 1,001, it must lower
its price to 19.99. It gains 19.99 when it
sells this extra unit but it loses (0.01 x
1,000), or 10.00, because it is now selling
the 1,000 units at a lower price. MR is
therefore 9.99.

Loss in revenue of 10 because the 1000 units are
sold at 0.01 less.
20.00
19.99
Gain in revenue of 19.99 from the sale of the
1001th unit.
D
0
Q
1000
1001
8

The monopolist will always produce in the elastic
portion of its demand where MR is positive.
Elastic demand
Unit elastic demand
Inelastic demand
The demand curve is also the average revenue
curve. Why?
D, AR
0
Q
MR
9
Monopoly Equilibrium

• The monopoly will maximize profit by producing
  that output at which marginal cost equals
  marginal revenue
• if output is less, then MRgtMC so extra profit can
  be earned by producing more
• if output is more, then MCgtMR making it
  profitable to reduce output
• note that this rule is the same as for perfectly
  competitive firms
• The price charged is whatever the market will
  bear at that quantity

10

Qe is the firms equilibrium output. If Q1 is
being produced, then an extra unit of output
will generate MR1 revenue but only cost MC1, so
it will be profitable to produce the extra
unit. This will always be true as long as Q1ltQe
(and MRgtMC). It is profitable at Q2 to produce
less because MCgtMR so producing less reduces
costs by more than it reduces revenue.
MC
Pe
MR1
MC1
D, AR
0
Qe
Q
Q1
Q2
MR
11
Monopoly Profit

• The monopoly will enjoy positive economic profits
  if average total cost is less than average
  revenue at the equilibrium output
• If economic profit is positive, there will be no
  mechanism to eliminate profit in the long run
• barriers to entry keep new firms out
• monopolies therefore tend to have higher than
  normal returns

12
Monopoly Profit

MC
ATC
Pe
Ce
Profit
D, AR
Qe
0
Q
MR
13
Monopoly Welfare Loss

• Unlike a perfectly competitive firm, a monopoly
  charges a price higher than marginal cost
• undesirable from consumers perspective
• very desirable from owners perspective
• undesirable from full social perspective

14
At the monopoly output, PgtMC. That is,
MSBgtMSC. Monopoly under-produces relative to
efficient amount where PMC. Society suffers a
welfare or deadweight loss in terms of lost
potential net social benefits.

Deadweight loss
MC
Pm
PMC
D, MSB
0
Q
Monopoly output
Efficient output
MR
15
Public Policy

• Prevent monopolies from forming or breaking them
  up if they do
• anti-trust
• Regulate natural monopolies
• Public ownership of natural monopolies
• regulation more common in US, ownership in other
  countries

16
Antitrust Laws

• Sherman Antitrust Act - outlaws restraint of
  trade and any attempt to monopolize
• Clayton Act - outlaws certain business activities
  not covered by Sherman Act
• Federal Trade Commission Act - created the FTC to
  police unfair business practices

17
Activities Prohibited by the Clayton Act

• Price Discrimination
• charging different customers different prices for
  the same good
• Tying Contracts
• contracts requiring the buyer of a good to
  purchase another additional good
• Exclusive Dealing
• requiring buyers of goods to agree not to
  purchase from competing sellers
• Interlocking Directorates
• boards of directors of competing firms with one
  or more members in common
• Predatory Pricing
• selling at unreasonably low prices to destroy
  competition

18
Regulation of Natural Monopolies

• Single firm can supply a good or service at a
  lower cost than could two or more firms
• Economies of scale over the full range of output
• may be due to small size of market
• small-town drug store
• may be due to high fixed costs
• electric utilities

19
The more the firm produces, the lower its
costs. Breaking it up into several smaller firms
raises costs, so that cannot be the efficient
solution.
Natural Monopoly

Average cost pricing is a solution. Not efficient
but no subsidy is needed and ATC easier to
measure.
Do nothing if the monopoly problem is small.
PM
One solution is to regulate price, requiring firm
to charge PMC. Note that firm suffers a loss
which would require long-term subsidies. Also
requires measuring MC.
PA
ATC
PC
MC
D, AR
0
Q
QM
QA
QC
MR
20
Price Discrimination

• Charging different prices to different customers
• Suppose Doc sees patients at constant MC of 5
• There are two types of patients
• 20 rich patients willing to pay 30 and 20 poor
  willing to pay 15

21

• If Doc charges 30 he sees 20 patients and nets
  500
• (30-5)20
• At 15 he sees 40 patients and nets 400
• (15-5)40
• What will he do?
• see 20 patients at 30
• creates deadweight loss because there are 20
  patients willing to pay 15 while the cost of
  seeing them is only 5

22

• Now suppose that Doc doesnt charge everyone the
  same price
• he charges the rich 30 and the poor 15
• he nets 500 from the rich PLUS 200 from the
  poor for a total of 700
• eliminates the deadweight loss which goes to Doc
  in form of higher profit

23

• Price discrimination is profitable for
  monopolists
• increases social welfare in form of higher profit
  to monopolist
• Requires ability to separate customers by
  willingness to pay
• Reselling is not possible
• wouldnt work for book sellers
• low-price book buyers could easily resell at
  lower price than monopolist wants to sell to
  high-price buyers