Chapter 7: Monopoly

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Chapter 7 Monopoly
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• 1. Monopoly Structure

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Monopoly Industry

• Because a monopoly industry consists of only one
  firm, the firm is the industry.

• The firms demand curve is identical to the
  market demand curve for the product.
• Market demand is the total quantities of a good
  or service people are willing and able to buy at
  alternative prices in a given time period.

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Marginal Revenue

• In the case of monopoly, what is brought in from
  an additional sale is not the price.

• Marginal revenue (MR) is the change in total
  revenue that results from a one-unit increase in
  quantity sold

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Perfect Competition and Marginal Revenue

• Only for perfectly competitive firms does price
  equal marginal revenue.

• Marginal revenue is always less than price for a
  monopolist.
• The MR curve lies below the demand (price) curve
  at every point but the first.

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Marginal Revenue An Example
1Ton
2Tons
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Marginal Revenue
Price per basket

• Here we look at the market for Baskets.

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• If the monopolist would like, it may adjust
  its price to maximize its profits.

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• As it lowers its price, its marginal revenue
  for each sequential reduction in price will
  lead to falling levels of marginal revenue, as
  is shown in the graph to the right.

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8

• For example If the firm chooses to reduce
  its price from 10 to 9, it is able to sell
  more units but only increase total revenue by
  5 units.

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rate of total
marginal output price revenue
revenue
4
-------
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1 13
2
24
11
2 12
9
33
3 11
6
7
8
2
1
5
4
3
40
4 10
7
Quantitybaskets per hour
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5 9
5
48
3
6 8
1
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7 7
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• 2. Monopoly Behavior

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Profit Maximization

• The monopolist uses the profit-maximization rule
  to determine its rate of output.

• According to that rule, the monopolists will
  produce at rate of output where marginal revenue
  equals marginal cost. (MR MC)

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Profit Maximization

• The profit maximization rule applies to all
  firms.

• Perfectly competitive firms produce the quantity
  where MC p ( MR).
• The monopolist produces the quantity where MC
  MR (ltP).

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Production Decision

• Choosing a rate of output is a firms production
  decision.

• It is the selection of the short-term rate of
  output with existing plant and equipment.

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Profit Maximization
Price per basket

• Once again, the market for Baskets.

• We add the ATC and MC curves.

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• For the monopolist, the most profitable rate
  of output is going to be where MC MR. Here
  that point, as shown, is at the output level
  of 4.

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10

• As this graph shows, the price the monopolist
  charges for this level of output will be equal
  to 10 a unit.

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• Total Profits are calculated, as before, as (
  p - ATC ) q, -or- (10 - 8) 4 8

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• Total Profits are represented by the shaded
  rectangle, the area above the average total
  cost for that level of output and below the
  price level achieved for that level of output
  across the total number of units sold.

4
2
6
7
8
5
4
3
2
1
Quantitybaskets per hour
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Monopoly Price

• The intersection of the marginal revenue and
  marginal cost curves is the profit-maximizing
  output.

• The demand curve shows the highest price
  consumers are willing to pay for a specific
  quantity of output.
• Only one price is compatible with
  profit-maximization rate of output.

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Monopoly Profits

• Total profit equals average profit per unit times
  the number of units produced.

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• 3. Barriers to Entry

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Monopoly vs. Competitive Outcomes

• A monopoly produces at the rate of output where
  MR MC.

• A competitive industry produces where MC p.
• A monopolist produces less and charges a higher
  price than a competitive industry

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Monopoly vs. Competitive Outcomes
Price per basket

• Once again, the market for Baskets.

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• For the monopolist, the most profitable rate
  of output is going to be where MC MR

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while a competitive
industry will produce where MC p
10

• In this market the monopolist produces at an
  output level of 4 (as was shown before)

and the
competitive firm produces at an output level
of 5.
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6

• Note further that the price that the
  competitive firm charges is dictated by the
  competitive market, here 9,

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while, as the model shows, the monopolist
charges 10.
2

• So the monopolist produces fewer units,
  charges a higher price, and is able to
  capture positive profits which are competed
  away with entry in the competitive model.

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7
8
5
4
3
2
1
Quantitybaskets per hour
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Barriers to Entry

• A monopoly attains higher prices and profits by
  restricting output.

• A monopolist can do so because of barriers to
  entry.
• Barriers to entry are obstacles that make it
  difficult or impossible for would-be producers to
  enter a particular market.

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Patent Protection

• A patent is a government grant of exclusive
  ownership of an innovation.

• A patent is a source of monopoly power.
• For example, Polaroids patents forced Kodak out
  of the instant-photography business.

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Other Entry Barriers

• Legal Harassment

• Suing potential new entrants to deter entry into
  an industry.
• Exclusive Licensing
• Offering a product license.
• Lack of a licensing makes it difficult for
  potential competitors to acquire the factors of
  production they need

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Other Entry Barriers

• Bundled Products

• Combining products into one package.
• For example, Microsoft wants to bundle software
  applications with its Windows 95 and 98 operating
  systems.
• This makes it difficult for competitors in the
  applications market to sell their products
  profitably.

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• 4. What, How, and For Whom

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Competition vs. Monopoly

• In competition, high prices and profits signal
  consumers demand for more output.

• In monopoly, the same

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Competition vs. Monopoly

• In competition, the high profits attract new
  suppliers.

• In monopoly, barriers to entry are erected to
  exclude potential competition.

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Competition vs. Monopoly

• In competition, production and supplies expand.

• In monopoly, production and supplies are
  constrained.

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Competition vs. Monopoly

• In competition, prices slide down the market
  demand curve.

• In monopoly, prices do not move down the market
  demand curve.

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Competition vs. Monopoly

• In competition, a new equilibrium is established.

• In monopoly, no new equilibrium is established.

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Competition vs. Monopoly

• In competition, average costs of production
  approach their minimum.

• In monopoly, average costs are not necessarily at
  or near a minimum.

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Competition vs. Monopoly

• In competition, economic profits approach zero.

• In monopoly, economic profits are at a maximum.

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Competition vs. Monopoly

• In competition, price equals marginal cost
  throughout the process.

• In monopoly, price exceeds marginal cost at all
  times.

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Competition vs. Monopoly

• In competition, the profit squeeze pressures
  firms to reduce cost or improve product quality.

• In monopoly, there is no profit squeeze to
  pressure the firm to reduce costs.

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Near Monopolies

• Any industry dominated by relatively few firms is
  likely to behave more like a monopoly than like
  perfect competition.

• In duopoly two firms together produce the
  industry output.
• In oligopoly several firms dominate the market.

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Near Monopolies

• In monopolistic competition many firms each have
  monopolies on their own brand name but must
  compete against other brand names.

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What Gets Produced?

• There is a basic tendency for monopolies to
  inhibit economic growth.

• There is no pressure to produce at minimum
  average cost

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What Gets Produced?

• Monopolies do not deliver the most utility with
  available resources.

• Monopolies do not engage in marginal cost
  pricing.
• Marginal cost pricing means firms offer (supply)
  goods at prices equal to their marginal cost.

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For Whom?

• Higher prices charged by monopolists favor
  purchases by higher-income consumers.

• Monopolists get fat profits and thus access to
  more goods and services.

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How?

• Monopolists have less of an incentive to
  innovate.

• They can continue to make profits with existing
  equipment
• There is a tendency to inhibit technological
  improvement by keeping out competition.

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• 5. Policy Perspectives

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Pros of Monopoly

• Potential competition a threat even to
  monopolies.

• Sheltered from constant pressure of competition.
• Resources available to invest in expensive RD
  functions.

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Cons of Monopoly

• No clear incentive for invention and innovation.

• Higher prices paid to consumers

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Entrepreneurial Incentives

• Promise of even greater profits is a strong
  incentive for monopolies to innovate.

• Innovators in perfect competition also have the
  ability to earn large profits

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Economies of Scale

• A large firm can produce goods at a lower unit
  cost than a small firm because of economies of
  scale.

• Economies of scale are present if average costs
  fall as the size (scale) of plant and equipment
  increases

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Natural Monopoly

• A natural monopoly is an industry in which one
  firm can achieve economies of scale over the
  entire range of market supply.

• Examples include telephone, cable, and other
  utility services
• Economies of scale are a natural barrier to
  entry.

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Natural Monopoly

• There exists a potential for abuse.

• Government regulation may be necessary to ensure
  that benefits of increased efficiency are shared
  with the consumers.

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Contestable Markets

• A monopolist may face potential competition.

• May cause monopolies to behave more
  competitively.

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Contestable Markets

• How contestable a market is depends not on
  structure but on entry barriers.

• A monopoly is more likely to act competitively
  if there exists foreign firms with similar
  products who will enter the market if prices and
  profits are attractive.

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End of Chapter 7 Lecture