Transcript EconomicsToday-Chapter25

Chapter 25
Monopoly
Learning Objectives
 Identify situations that can give rise to monopoly
 Describe the demand and marginal revenue conditions a
monopolist faces
 Discuss how a monopolist determines how much output to
produce and what price to charge
 Evaluate the profits earned by a monopolist
 Understand price discrimination
 Explain the social cost of monopolies
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Did You Know That...
A monopoly can arise whenever sellers are
given exclusive rights to distribute
a good?
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Definition of a Monopolist
Monopolist
– A single supplier of a good or service for which
there is no close substitute
– The monopolist therefore constitutes the entire
industry.
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Barriers to Entry
Question
– How does a firm obtain monopoly power?
Answers
– Barriers to entry that allow the firm to make
long-run economic profits
– Barriers to entry are restrictions on who can
start as well as stay in business.
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Barriers to Entry
Barriers to entry include
– Ownership of resources without
close substitutes
– Economies of scale
– Legal or governmental restrictions
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Barriers to Entry
Ownership of resources without
close substitutes
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Barriers to Entry
Economies of scale
– Low unit costs and prices drive out rivals.
– The largest firm can produce at the lowest
average total cost.
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The Cost Curves That Might
Lead to a Natural Monopoly
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Barriers to Entry
Legal or governmental restrictions
– Licenses, franchises, and certificates
of convenience
– Examples include
• Electrical utilities
• Radio and television broadcasting
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International Policy Example:
Malaysia’s Drug-Labeling Monopoly
 Sellers of drugs and medical products are required
to affix holographic labels providing information
on usage.
 To obtain these labels, sellers have only one
choice. They must buy the labels from a company
called Mediharta.
 This company is the only label manufacturer that
Malaysia’s Registrar of Companies has approved
to produce holographic labels.
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Barriers to Entry
Legal or governmental restrictions
– Patents
• Intellectual property
– Tariffs
• Taxes on imported goods
– Regulation
• Safety and quality
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Barriers to Entry
Cartels
– An association of producers in an industry that
agree to set common prices and output quotas
to prevent competition
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The Demand Curve
a Monopolist Faces
The monopolist faces the industry
demand curve because the monopolist is
the entire industry.
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The Demand Curve
a Monopolist Faces
Recall that under perfect competition
– Firm faces perfectly elastic demand curve, it is
a price taker
– The forces of supply and demand establish the
price per unit
– Marginal revenue, average revenue, and price
are all the same
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The Demand Curve
a Monopolist Faces
Perfect competition versus monopoly
– The perfect competitor doesn’t have to worry
about lowering price to sell more.
– In a purely competitive situation, the firm
accounts for a small part of the market.
• It can sell its entire output, whatever that may be, at
the same price.
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The Demand Curve
a Monopolist Faces
Perfect competition versus monopoly
– The more the monopolist wants to sell, the
lower the price it has to charge on the last unit
sold.
– To sell the last unit, the monopolist has to lower
the price because it is facing a downward
sloping demand curve.
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Demand Curves for the Perfect
Competitor and the Monopolist
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The Demand Curve
a Monopolist Faces
Monopoly
Perfect Competition
Single seller
Many sellers
Faces entire
industry demand
Faces perfectly
elastic demand
Must lower price
to sell more
Must produce more
to sell more
Not all units sold for
same price (MR < P)
All units sold for same
price (P = MR)
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Marginal Revenue: Always
Less Than Price
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Elasticity and Monopoly
The monopolist faces a downward-sloping
demand curve, and cannot charge any price.
– A common misconception
Thus, depending on the price charged a
different quantity will be demanded.
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Elasticity and Monopoly
Recall
– Monopolist is a single seller of a
well-defined good or service with
no close substitute.
• Think of some imperfect substitutes.
– The demand curve slopes downward because
individuals compare marginal satisfaction to
cost.
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Elasticity and Monopoly
After all, consumers have limited incomes
and unlimited wants.
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Cost and Monopoly
Profit Maximization
We presume profit maximization is the goal
of the pure monopolist, just as it is for the
prefect competitor.
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Cost and Monopoly
Profit Maximization
 Perfect competitor has only to decide on the
profit-maximizing output rate because price is
given.
– The perfect competitor is a price taker.
 For the pure monopolist, we must
seek a profit-maximizing price
output combination.
– The monopolist is a price searcher.
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Cost and Monopoly
Profit Maximization
Price Searcher
– A firm that must determine the price-output
combination that maximizes profit because it
faces a downward-sloping demand curve
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Cost and Monopoly
Profit Maximization
We can determine the profit-maximizing
price-output combination with either of two
equivalent approaches.
– By looking at total revenues and total costs or
by looking at marginal revenues and marginal
costs
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Cost and Monopoly
Profit Maximization
Total revenues-total costs approach
– Maximize the positive difference between total
revenues and total costs
Marginal revenue-marginal
cost approach
– Profit maximization will also occur where
marginal revenue equals marginal cost.
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Cost and Monopoly
Profit Maximization
Question
– Why produce where marginal revenue equals
marginal cost?
Answer
– This is where the greatest positive difference
between total revenue and total cost occurs.
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Monopoly Costs, Revenues,
and Profits
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Monopoly Costs,
Revenues, and Profits
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Cost and Monopoly
Profit Maximization
Producing past where MR = MC
– Incremental cost exceeds incremental revenue
Producing less than where MR = MC
– Monopolist not maximizing profits
here either
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Maximizing Profits
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Calculating Monopoly Profit
Monopoly profit is given by the shaded
area, which is equal to total revenues (P 
Q) minus total costs (ATC  Q).
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Monopoly Profit
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Calculating Monopoly Profit
No guarantee of profit
– The term monopoly conjures up the notion of a
greedy firm ripping off the public.
• If ATC is everywhere above AR, or demand
 No price-output combination allows the monopolist to
cover costs
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Monopolies: Not Always
Profitable
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On Making Higher Profits:
Price Discrimination
Price Discrimination
– Selling a given product at more than one price,
with the difference being unrelated to
differences in cost
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On Making Higher Profits:
Price Discrimination
Price Differentiation
– Establishing different prices for similar
products to reflect differences in marginal cost
in providing those commodities to different
groups of buyers
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On Making Higher Profits:
Price Discrimination
 Necessary conditions for price discrimination
1. The firm must face a downward-sloping
demand curve.
2. The firm must be able to readily (and cheaply) identify
buyers or groups of buyers with predictably different
elasticities of demand.
3. The firm must be able to prevent resale of the product
or service.
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Example: Why Students Pay
Different Prices to Attend College
 Out-of-pocket tuition rates for any two college
students can differ by considerable amounts.
 The reason is that colleges offer students diverse
financial aid packages depending on their
“financial need.”
 The college determines prices that families are
most likely to pay, so that it can engage in price
discrimination.
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Toward Perfect Price Discrimination in
College Tuition Rates
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The Social Cost of Monopolies
Comparing monopoly with
perfect competition
– Let’s assume a monopolist comes in and buys
up every single perfect competitor.
– Notice the monopolist produces a smaller
quantity and sells at a higher price.
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The Social Cost of Monopolies
Comparing monopoly with
perfect competition
– Monopolists raise the price and restrict
production compared to a perfectly competitive
situation.
– Consumers pay a price that exceeds the
marginal cost of production and resources are
misallocated in such a situation.
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The Effects of Monopolizing an
Industry
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Issues and Applications: For This
Monopoly Location is the Key
 A resource with literally few close substitutes is
the Ambassador Bridge.
 Price searching for the profit-maximizing toll rates
have boosted profits.
 Total revenues in excess of $60 million have been
generated per year.
 Estimates of the market value of the bridge value
it in excess of half a billion dollars.
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Summary Discussion
of Learning Objectives
Why a monopoly can occur
– Barriers to entry
Demand and marginal revenue conditions
faced by a monopolist
– Because the monopolist constitutes the entire
industry, it faces the entire market demand
curve.
– Marginal revenue is less than price.
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Summary Discussion
of Learning Objectives
 How a monopolist determines how much
output to produce and what price to charge
– Seeks to maximize its economic profits
– Produces where marginal revenue equals
marginal cost
– Charges maximum price for the amount of
output where MR = MC
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Summary Discussion
of Learning Objectives
A monopolist’s profits
– Profit earned by monopolist is equal to the
difference between the price it charges and its
average production cost times the amount of
output it produces and sells.
– Monopolist typically earns positive economic
profits.
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Summary Discussion
of Learning Objectives
Price discrimination
– Selling at more than one price with the price
differences being unrelated to differences in
production costs.
– Monopolist sells some of its output at higher
prices to consumers with less elastic demand.
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Summary Discussion
of Learning Objectives
Social cost of monopolies
– Price exceeds marginal cost.
– The price is higher and output is lower for a
monopolist as compared to a perfectly
competitive industry.
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