Transcript Chapter 24: Pure Monopoly

Chapter 24:
Pure Monopoly
Pure Monopoly
 Single Seller: only one firm is the sole producer of the
product in the market (the firm and the industry are the
same).
 No Close Substitutes: the monopolist sells a unique
product that has no close substitutes.
 Price Making: the monopolist controls total quantity
supplied to the market and thus has control over the price.
 Blocked Entry: the monopolist has no immediate
competitors because certain barriers prevent potential
competitors from entering the market.
 Non-price Competition: monopolists that sell
standardized products engage mainly in public relations
advertising, whereas those with differentiated products
sometimes advertise their products’ attributes.
MONOPOLY EXAMPLES
 Pure Monopoly: the existence of one producer.
 Near Monopolies: the existence of more than one
producer, but one of them has a very large market share.
 Dual Objectives of the Study:
• Monopoly as a Market Structure
• To Better Understand Other Market Structures
BARRIERS TO ENTRY
 Economies of Scale (Natural Monopoly): some industries
require producing large output to achieve lower average
total cost. Thus, economies of scale serve as entry barrier.
 Legal Barriers to Entry:
 Patents: a patent is the exclusive right of an inventor
to use, or allowing others, to use its invention. Patents
provide the inventor with a monopoly position for the
life of the patent (i.e. 20 years).
 Licenses: the government blocks entry to an industry
through the control of issuance of licenses.
 Ownership or Control of Essential Resources
 Pricing and Other Strategic Barriers to Entry
Average Total Cost
THE NATURAL MONOPOLY CASE
$20
15
ATC
10
If ATC declines over extended
output, least-cost production is
realized only if there is one
producer - a natural monopoly
0
50
100
Quantity
200
MONOPOLY DEMAND
Basic Assumptions:
1) Monopoly Status is Secured
2) No Governmental Regulation
3) Firm Charges the Same Price for all Units Sold
 Market Demand Curve is the Firm’s Demand
Curve
 The monopolist sets the price in the elastic
region of demand.
 In the elastic region of demand, lower price leads
to higher total revenue.
 The monopolist avoids the inelastic region in the
demand curve.
 Profit maximization and loss minimization rule
of monopolist:
MR = MC
 Note that price > MR
MONOPOLY REVENUES & COSTS
Elastic
Dollars
$200
150
200
50
MR
D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MONOPOLY REVENUES & COSTS
Elastic
Inelastic
Dollars
$200
150
200
50
MR
D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
 The monopolist has no supply curve.
 The monopolist equates MR and MC to
determine output.
 The monopolist does not set the highest possible
price.
 Monopolist’s goal is maximum profit not
maximum price.
 Higher price may lead to less profit.
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
0 x $172 = $ 0
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
- $100
= - $100
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
0 $172 $ 0
$100 90 - $100
] $162
]
x
1
162 = 162
- 28
$190.00 190 =
MR = $162 – 0 = $162
MC = $190 – 100 = $90
MR > MC
Loss Improvement
from -$100 to -$28
Check next unit of
output!
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
0
1
2
3
4
5
6
7
8
9
10
$172 $ 0
]
162 162
]
152 304
]
142 426
]
132 528
]
122 610
]
112 672
]
102 714 ]
92 736 ]
82 738 ]
72 720
Cost Data
Average
Total
Cost
$162
$190.00
142
135.00
122
113.33
102
100.00
82
94.00
62
91.67
42
91.43
22
93.73
2
97.78
- 18
103.00
Profit +
Total Marginal or
loss Cost
Cost
$100
]
190
]
270
]
340
]
400
]
470
]
550
]
640 ]
750 ]
880 ]
1030
90
80
70
60
70
80
90
110
130
150
- $100
- 28
+ 34
+ 86
+ 128
+ 140
+ 122
+ 74
- 14
- 142
- 310
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
Can0 you
$172see
$ profit
0
] $162
1
162 162
maximization?
] 142
2
3
4
5
6
7
8
9
10
152
142
132
122
112
102
92
82
72
304
] 122
426
] 102
528
] 82
610
] 62
672
] 42
714 ]
22
736 ]
2
738 ]
- 18
720
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
$100 90 - $100
]= MC
MR
>
- 28
$190.00 190 80
]
135.00 270 70 + 34
]
113.33 340 60 + 86
]
100.00 400 70 + 128
]
94.00 470 80 + 140
]
91.67 550 90 + 122
]
91.43 640 ] 110 + 74
- 14
93.73 750 ] 130
97.78 880 ] 150 - 142
- 310
103.00 1030
MONOPOLY DEMAND
P
As price decreases from
$142 to $132...
but revenue will
$142 Loss = $30
increase with the
132
additional
unit sold
D
Gain = $132
1
2
3
4
5
6
Q
MONOPOLY DEMAND
P
As price decreases from
$142 to $132...
but revenue will
$142 Loss = $30
increase with the
132
additional
unit sold
Marginal Revenue
Gain = $132
$142 - $30 = $102
will necessarily be
less than price $132
1
2
3
4
5
6
Q
D
OUTPUT AND PRICE DETERMINATION




Cost Data
MR = MC Rule
No Monopoly Supply Curve
Monopoly Pricing Misconceptions:
• Not Highest Price
• Total, Not Unit, Profit
• Possibility of Losses
Graphically…
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
Remember
the
MR=MC
Rule?
200
Profit
Per Unit
Price, costs, and revenue
175
150
$122
125
$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
OUTPUT AND PRICE DETERMINATION
Loss Minimization Under Monopoly
200
Since Pm exceedsLoss
AVC,
Per Unit
the firm will produce
Price, costs, and revenue
175
MC
ATC
AVC
150
A
125 Loss
Pm
100
V
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
Qm
6
7
8
9
10
Q
What are the Economic Effects of Monopoly?


•
•
Monopoly pricing effectively creates an income
transfer from buyers to the seller!
X-Inefficiency: When the cost of producing is more
than the lowest possible cost Monopolists are likely
to experience X inefficiency than pure competition
producers (who are under pressures)
Rent-Seeking Behavior: using the monopolistic
position to make more profits.
Technological Advance: monopolists are less likely to
care about Research & Development.
INEFFICIENCY OF PURE MONOPOLY
P An industry in pure competition S = MC
sells where supply and
demand are equal
At MR=MC
A monopolist
will sell less
units at a
higher price
than in
competition
Pm
Pc
D
MR
Qm
Qc
Q
Average total costs
ATCx
X
Inefficient internal
operation leads to
higher-thannecessary costs
X’
ATC1
ATCx’
ATC2
Q1 Quantity
Q2
Average
Total Costs
COST COMPLICATIONS
Cost for monopoly may be different from pure
competition: why?
 Economies of Scale: can easily be reached by a
monopolist.
 Simultaneous Consumption: produce for a large
number of consumers than a small company.
 Network Effects: more benefits as the number of
consumer increases (e.g. internet users, i.e. more value
to consumers)
PRICE DISCRIMINATION
Definition: the sale of a specific product at more than one
price, and price differences are not justified by cost
differences.
Conditions:
 Monopoly Power: the seller must be a monopolist or at
least have some monopoly power (ability to control P&Q).
 Market Segregation: the seller is able to segregate buyers
into distinct classes based on different demand elasticities.
 No Resale: the buyer cannot resell the good or service.
Consequences:
 More Profit: monopolist can gain more profits.
 More Production: monopolist is willing to produce more
PRICE DISCRIMINATION
Price and Costs
P
Economic profits with
a single MR=MC
price
MC
ATC
MR
Q1
D
Q
PRICE DISCRIMINATION
Price and Costs
P
A perfectly discriminating
monopolist has MR=D,
producing more product
and more profit!
MC
ATC
MR=D
D
Q1
Q2
Q
REGULATED MONOPOLY
 Natural Monopolies: they are subject to rate
(price) regulation.
 Socially Optimum Price: if the objective is
achieving allocative efficiency, the regulator
should set a legal (ceiling) price equals the MC:
P = MC
 Fair-Return Price: because optimum price may
lead to losses, price must be set where no losses
occur, that’s at ATC:
P = ATC
REGULATED MONOPOLY
MR = MC
Fair-Return Price
Price and Costs
P
Dilemma of Regulation: Which Price?
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q