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10 Monopoly The price of monopoly is upon every occasion the highest which can be got. ADAM SMITH Contents ● Monopoly Defined ● The Monopolist’s Supply Decision ● Can Anything Good Be Said About Monopoly? ● Price Discrimination Under Monopoly Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Monopoly Defined ● Only one firm in the industry ● No close substitute for the product ● Little chance of successful entry by a competitor Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Sources of Monopoly ● Barriers to entry ♦ Legal restrictions ♦ Patents ♦ Control of a scarce resource or input ♦ Deliberately erected entry barriers ♦ Large sunk costs Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Sources of Monopoly ● Cost advantages ♦ Technical superiority ♦ Economies of scale Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Natural Monopoly ● Declining long-run average costs ● When a large firm can produce and sell more cheaply than a small firm Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Average Cost FIGURE 10-1 Natural Monopoly B $3.00 A 2.50 C 2.00 AC 1 2 2.5 Quantity Supplied Copyright© 2003 South-Western/Thomson Learning. All rights reserved. The Monopolist’s Supply Decision ● Price maker (or price searcher) ● Faces a negatively sloped demand curve ● Standard supply-demand analysis does not apply. Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ● Joint decision about price and output ● Marginal revenue < selling price Copyright© 2003 Southwestern/Thomson Learning All rights reserved. The Monopolist’s Supply Decision ● Monopolist sets output where MC = MR ● Market demand price for this output ● P > MR ● Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost. Copyright© 2003 Southwestern/Thomson Learning All rights reserved. 10-2 Profit-Maximizing Equilibrium for a Monopolist FIGURE MC Price per Unit D P $9 AC M 7 MC 4 AC C D (AR) MR 0 150 Quantity Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 10-1 A Monopolist’s PriceOutput Decision TABLE Copyright© 2003 South-Western/Thomson Learning. All rights reserved. The Monopolist’s Supply Decision ● Compared to perfect competition, a monopoly: ♦ May enjoy a long-run profit ♦ Restricts its output to raise its selling price (both in the long and short runs) ♦ Leads to inefficient resource allocation (MC < MU) Copyright© 2003 Southwestern/Thomson Learning All rights reserved. 10-3 Compare Monopoly to Competitive Industry FIGURE MC Price per Unit D AC P $9 M B 7 MC D (AR) C AC MR 150 300 Quantity Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Can Anything Good Be Said About Monopoly? ● Under some circumstances a monopoly may: ♦ Raise demand for its product (thus negating the inefficient reduction in output noted above) ♦ Reduce marginal and average cost (produce more efficiently) ♦ Stimulate innovation Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Natural Monopoly: Where SingleFirm Production Is Cheapest ● Natural monopoly = average costs fall as output rises ● Costs of production would be higher if a natural monopoly were broken up into many smaller firms. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Natural Monopoly: Where SingleFirm Production Is Cheapest ● Natural monopolies may allow lower average cost than a market with numerous competing firms. (Natural monopoly must be regulated in order for consumers to receive lower prices, however.) ● Monopolist may have incentive to produce more innovation than firms in more competitive markets. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Price Discrimination Under Monopoly ● Price discrimination = charge different prices to different groups of customers (or charge the same price in markets where costs vary) ● Allows a monopolist to maximize profits Copyright© 2003 Southwestern/Thomson Learning All rights reserved. Price Discrimination Under Monopoly ● Monopolist sets marginal revenue (not price) equal in each market ● Assumes equal cost conditions in each markets Copyright© 2003 Southwestern/Thomson Learning All rights reserved. 10-4 Prices/Quantities under Price Discrimination FIGURE Customer Group A Customer Group B Da Db Pa Price Pb H 0 J Qa W MRa Da 0 Qb H MRb Quantity Quantity (a) (b) Db Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Is Price Discrimination Always Undesirable? ● No, although sometimes justice appears to demand different prices in different markets. ● In some cases, price discrimination may be necessary for a firm to survive. ● In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.