Transcript Chapter Fifteen

Monopoly vs. Competition
• While a competitive firm is a price taker, a
monopoly firm is a price maker.
• A firm is considered a monopoly if . . .
• it is the sole seller of its product.
• its product does not have close substitutes.
• No competition (lollipop game).
• Monopoly power arises from barriers to entry.
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WHY MONOPOLIES ARISE
• Barriers to entry have three sources:
• Ownership of a key resource.
• The government gives a single firm the exclusive right
to produce some good.
• Costs of production make a single producer more
efficient than a large number of producers.
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WHY MONOPOLIES ARISE
• Although exclusive ownership of a key resource is
a potential source of monopoly, in practice
monopolies rarely arise for this reason.
• Diamonds, Oil
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WHY MONOPOLIES ARISE
• Governments may restrict entry by giving a single
firm the exclusive right to sell a particular good in
certain markets.
• Patent and copyright laws are two important
examples of how government creates a monopoly
to serve the public interest.
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WHY MONOPOLIES ARISE
• A natural monopoly arises when a single firm can
supply a good or service to an entire market at a
smaller cost than many competing firms.
• A natural monopoly arises when there are
economies of scale over a large range of output.
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Economies of Scale as a Cause of Monopoly
Cost
Average
total
cost
0
Quantity of Output
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HOW MONOPOLIES MAKE PRODUCTION
AND PRICING DECISIONS
• Monopoly versus Competition
• Monopoly
• Sole producer
• Unique product
• Price maker
• Positive Economic Profit (entry/exit)
• Competitive Firm
• Many producers
• Identical product
• Price taker
• Zero economic profit (entry/exit)
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Profit Maximization
• A monopoly maximizes profit by producing the
quantity at which MR = MC.
• Restrict Q below where Demand intersects MC.
• It then uses the demand curve to find the P that
will induce consumers to just buy that Q.
• Market power, price maker, mark-up (P > MC).
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Profit Maximization
• Profit equals total revenue minus total costs.
• Profit = TR - TC
• The monopolist will receive economic profits as
long as the P the market is willing to pay results in
TR > TC.
• This can be a long run equilibrium (entry barrier).
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THE WELFARE COST OF
MONOPOLY
• A monopolist restricts Q and marks-up P.
• For consumers, this combination of low Q and
high P makes monopoly undesirable.
• However, for the firm, this monopoly power is
very desirable (positive economic profit).
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Inefficiency of Monopoly
• Because a monopoly restricts the quantity and
marks the price up above marginal cost, it places a
wedge between the consumer’s willingness to pay
(D) and the producer’s cost of production (MC) .
• This outcome is inefficient compared to perfect
competition.
• Units not produced and consumed that could benefit
society.
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The Efficient Level of Output
Price
Marginal cost
Value
to
buyers
Cost
to
monopolist
Value
to
buyers
Cost
to
monopolist
Demand
(value to buyers)
Quantity
0
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.
Efficient
quantity
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Figure 10 Welfare with Single Price Monopolist
(a) Monopolist with Single Price
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Marginal cost
Marginal
revenue
0
Quantity sold
Demand
Quantity
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Monopoly: Good or Bad?
• Good – new innovative products
• Prescription drugs, technology (R&D)
• Bad
• Restricted output, higher prices
• Government subsidy…..higher taxes
• Patents…..higher prices
• You Choose!
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PRICE DISCRIMINATION
• Price discrimination is the business practice of
selling the same good at different prices to
different customers, even though the costs for
producing for the two customers are the same.
• Perfect price discrimination occurs when the monopolist
knows exactly the willingness to pay of each customer
and can charge each customer a different price.
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Figure 10 Welfare with Monopoly Price Discrimination
(b) Monopolist with Perfect Price Discrimination
Price
Profit
Marginal cost
Demand
0
Quantity sold
Quantity
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PRICE DISCRIMINATION
• More likely lower degree of price discrimination.
• Segment markets
• Prevent re-sale from low WTP to high WTP markets
• Two important effects of price discrimination:
• Increase the monopolist’s profits
• Lessen inefficiency (more output)
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PRICE DISCRIMINATION
• Examples of Price Discrimination
•
•
•
•
•
•
•
Movie tickets
Airline tickets
Discount coupons
Quantity (volume) discounts
Financial aid
Prescription drugs
If airlines sold paint
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CONCLUSION: THE PREVALENCE
OF MONOPOLY
• How prevalent are monopolies?
• Monopoly power is relatively common.
• Most firms have some control over their prices because
of differentiated products.
• Firms with substantial monopoly power are rare.
• Few goods are truly unique.
• The story of Cooperatives.
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Summary
• A monopoly firm is the only seller in its market.
• Like a competitive firm, a monopoly maximizes
profit by producing the quantity at which marginal
cost and marginal revenue are equal (MR = MC).
• Unlike a competitive firm, market power allows a
mark-up of price above marginal cost (P > MC).
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Summary
• A monopolist’s profit-maximizing output is below
the level that maximizes the sum of consumer and
producer surplus (where D intersects MC).
• In this respect, monopoly power is bad for
consumers, but good for the monopolist.
• Welfare economics suggests monopoly power is
undesirable for society.
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Summary
• Monopoly power can also be considered good for
society in the following ways.
• Natural monopoly results in lower price than
competition, but must be regulated.
• Patents give incentive to produce goods that may
otherwise never be produced, but at high prices.
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Summary
• Monopoly profits can be increased by charging
different prices to different buyers based on their
willingness to pay.
• Price discrimination lessens inefficiency, but
gives most of the gains to monopolist.
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