Transcript MicroChap11

Chapter 11:
Monopoly
Prepared by:
Kevin Richter, Douglas College
Charlene Richter,
British Columbia Institute of Technology
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rights reserved.
1
Introduction

Monopoly is a market structure in which a
single firm makes up the entire market.

Monopolies exist because of barriers to entry
into a market that prevent competition.
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2
Introduction

Legal barriers, such as patents, prevent
others from entering the market.

Sociological barriers – entry is prevented
by custom or tradition.
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3
Introduction

Natural barriers – the firm has a unique
ability to produce what other firms can’t
duplicate.

Technological barriers – the size of the
market can support only one firm.
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4
Differences Between a Monopolist
and a Perfect Competitor

A competitive firm is too small to affect the
price.

The monopolist takes into account the fact
that its production decision can affect price.
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5
Differences Between a Monopolist
and a Perfect Competitor

A competitive firm's marginal revenue is the
market price.

A monopolistic firm’s marginal revenue is not
its price – it takes into account that in order to
sell more it has to decrease the price of its
product.
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6
Differences Between a Monopolist
and a Perfect Competitor

Monopolist as the only supplier faces the
entire market demand curve.

Therefore, monopoly demand is downward
sloping, and to increase output the firm
must decrease its price.
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7
Model of Monopoly

How much should the monopolistic firm
choose to produce if it wants to maximize
profit?

The monopolist employs a two-step profit
maximizing process; it chooses quantity and
price.
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8
Monopolist’s Price and Output
Numerically

The first thing to remember is that marginal
revenue is the change in total revenue that
occurs as a firm changes its output.
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9
Monopolist’s Price and Output
Numerically

When a monopolist increases output, it
lowers the price on all previous units.

As a result, a monopolist’s marginal revenue
is always below its price.
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10
Monopolist’s Price and Output
Numerically

In order to maximize profit, a monopolist
produces the output level at which
marginal cost equals marginal revenue.

Producing at an output level where MR >
MC or where MR < MC will yield lower
profits.
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11
Profit Maximization for a Monopolist
Output Price
0
1
2
3
4
5
6
7
8
9
36
33
30
27
24
21
18
15
12
9
TR
MR
TC
MC
0
33
60
81
96
105
108
105
96
81
—
33
27
21
15
9
3
–3
–9
–15
47
48
50
54
62
78
102
142
196
278
—
1
2
4
8
16
24
40
56
80
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ATC
Profit
48.00
25.00
18.00
15.50
15.60
17.00
20.29
24.75
30.89
–47
–15
10
27
34
27
6
–37
–102
–197
12
Monopolist’s Price and Output
Graphically

The marginal revenue curve is a graphical
measure of the change in revenue that
occurs in response to a change in price.

It tells us the additional revenue the firm will
get from an additional unit of output.
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13
MR = MC Determines the ProfitMaximizing Output

If MR > MC, the monopolist gains profit by
increasing output.

If MR < MC, the monopolist gains profit by
decreasing output.

If MC = MR, the monopolist is maximizing
profit.
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14
Price a Monopolist Charges

The MR = MC condition determines the
quantity a monopolist produces.

The monopolist will charge the maximum
price consumers are willing to pay for that
quantity.

That price is found on the demand curve.
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15
Price a Monopolist Charges

To determine the profit-maximizing price
(where MC = MR), first find the profit
maximizing output.

That quantity determines the price the
monopolist will charge.
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16
Determine Monopoly Price and Output
MC
Price
$36
30
24
18
12
6
0
6
12
Monopolist
price
D
1
2
3
4
5
6
7
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8 9 10
MR
17
Comparing Monopoly and Perfect
Competition

Equilibrium output for both the monopolist
and the competitor is determined by the MC
= MR condition.
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18
Comparing Monopoly and Perfect
Competition

Because the monopolist’s marginal revenue
is below its price, price and quantity will not
be the same as it is under perfect
competition.

The monopolist’s equilibrium output is less
than, and its price is higher than, for a firm in
a competitive market.
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19
Comparing Monopoly and Perfect
Competition
MC
Price
$36
30
24
18
12
6
0
6
12
Monopolist
price
Competitive price
D
1
2
3
4
5
6
7
8 9 10
MR
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20
Profits and Monopoly

Draw the firm's marginal revenue curve.

Determine the output the monopolist will
produce by the intersection of the MC and
MR curves.
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21
Find Monopoly Price and Output
Price
MC
D
MR
Quantity
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22
Profits and Monopoly

Determine the price the monopolist will
charge for that output.

Determine the average cost at that level of
output.
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23
Find Monopoly Price and Output
Price
MC
PM
D
MR
QM
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Quantity
24
Profits and Monopoly

Determine the monopolist's profit (loss) by
subtracting average total cost from average
revenue (P) at that level of output and
multiply by the chosen output.
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25
Profits and Monopoly

The monopolist will make a profit if price
exceeds average total cost.

The monopolist will make a normal return if
price equal average total cost.

The monopolist will incur a loss if price is less
than average total cost.
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26
Monopolist Making a Profit

A monopolist can make a profit.
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27
Monopolist Making a Profit
MC
Price
A
PM
Profit
CM
ATC
B
MR
0
QM
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D
Quantity
28
Monopolist Breaking Even

A monopolist can break even.
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29
Monopolist Breaking Even
MC
Price
ATC
PM
MR
0
QM
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D
Quantity
30
Monopolist Making a Loss

A monopolist can make a loss.
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31
Monopolist Making a Loss
MC
Price
CM
PM
B
Loss
A
MR
0
ATC
QM
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D
Quantity
32
Welfare Loss from Monopoly

People’s purchase decisions don’t reflect the
true cost to society because monopolies
charge a price higher than marginal cost.
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33
Welfare Loss from Monopoly

The marginal cost of increasing output is
lower than the marginal benefit of increasing
output.
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34
Welfare Loss from Monopoly

A single price monopoly creates welfare
losses.

Welfare losses can be illustrated by the
area of consumer and producer surplus
that is lost due to smaller output produced,
compared to output produced in perfect
competition.
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35
Welfare Loss from Monopoly

Compare the normal monopolist's equilibrium
to the equilibrium of a perfect competitor.

Equilibrium in both market structures is
determined by the MC = MR condition.
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36
Welfare Loss from Monopoly

But the monopolist's MR is below its price,
thus its equilibrium output is different from a
competitive market.
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37
Welfare Loss from Monopoly

The welfare loss of a monopolist is
represented by the triangles B and D.

The welfare loss is often called the
deadweight loss or welfare loss triangle.
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38
Welfare Loss from Monopoly
Price
MC
PM
C
PC
D
B
A
0
QM
MR
QC
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D
Quantity
39
Price-Discriminating Monopolist

Price discrimination is the ability to charge
different prices to different individuals or
groups of individuals.
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40
Price-Discriminating Monopolist

In order to price discriminate, a monopolist
must be able to:



Identify groups of customers who have different
elasticities of demand;
Separate them in some way; and
Limit their ability to resell its product between
groups.
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41
Price-Discriminating Monopolist



A price-discriminating monopolist can
increase both output and profit.
It can charge customers with more inelastic
demands a higher price.
It can charge customers with more elastic
demands a lower price.
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42
Price Discrimination Occurs in the
Real World

Movie theaters give senior citizens and child
discounts.

Airline seat sales usually require Saturday
night stopovers.

Automobiles are seldom sold at their sticker
price.

Theaters have midweek special rates.
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43
Price-Discriminating Monopolist

A perfect price discriminating monopoly will
stop expanding its output when MR = MC,
which corresponds to the perfectly
competitive output.

The deadweight loss is therefore eliminated
under perfect price discrimination.
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44
Perfect Price Discrimination
Price
10
9
8
7
6
5
4
3
2
1
MC
D=MR
1 2 3 4 5 6 7 8 9 10 11
MR
Quantity (number of
consumers)
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45
Barriers to Entry and Monopoly

What prevents other firms from entering the
monopolist’s market in response to profits the
monopolist earns?

Monopolies exist because of barriers to
entry.
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46
Barriers to Entry and Monopoly

Barrier to entry – a social, political, or
economic impediment that prevents firms
from entering the market.
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47
Barriers to Entry and Monopoly

In the absence of barriers to entry, the
monopoly would face competition from other
firms, which would erode its monopoly
position .
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48
Barriers to Entry and Monopoly

Economies of scale:

When production is characterized by increasing
returns to scale, the larger the firm becomes, the
lower its per unit costs become.
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49
Economies of Scale

If significant economies of scale are possible,
it is inefficient to have two producers.

If each produced half of the output, neither
could take advantage of economies of scale.
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50
Economies of Scale

A natural monopoly is an industry in which
one firm can produce at a lower cost than can
two or more firms.
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51
Barriers to Entry and Monopoly

Economies of scale:

In cases of natural monopoly, technology is such
that minimum efficient scale is so large that
average total costs decrease over the range of
potential output.
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52
Average Cost
Natural Monopoly
C3
C2
C1
0
ATC
Q⅓
Q½
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Q1
Quantity
53
Economies of Scale

There is no welfare loss in the natural
monopoly situation.

There can actually be a welfare gain because
a single firm is so much more efficient than
several firms producing the good.
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54
Average Cost
Natural Monopoly
PM
Profit
CM
CC
PC
Loss
MR
0
QM
QC
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ATC
MC
D
Quantity
55
Barriers to Entry and Monopoly

Set-up costs:

In many industries high set-up costs characterize
production.

The industry may be highly capital-intensive,
requiring a large investment in expensive but
highly specialized capital.

Examples are an oil refinery or a diamond mine.
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56
Barriers to Entry and Monopoly

Set-up costs:


In some industries a lot of money may be spent
on advertising.
Heavy advertising creates a barrier to entry in
those cases, such as in the perfume industry or
the automobile industry.
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57
Barriers to Entry and Monopoly

Legislation:


Monopolies can also exist as a result of
government charter.
Patents are another way in which government can
grant a company a monopoly.
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58
Barriers to Entry and Monopoly

Legislation:


A patent is a legal protection of technical
innovation that gives the inventor a monopoly on
using the invention.
To encourage research and development of new
products, government gives out patents for a wide
variety of innovations.
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59
Barriers to Entry and Monopoly

Other barriers to entry:

Sometimes one company can gain ownership of
some essential aspect of the production process,
a unique input, or control over a resource.

An example is DeBeers. By controlling the worldwide distribution network for diamonds, the
company enjoys a monopoly in the diamond
industry.
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60
Normative Views of Monopoly

The public generally views monopolies the
way the Classical economists did – they
consider them unfair and wrong.
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61
Normative Views of Monopoly

Some normative arguments against
monopoly include:

Income distributional effects associated with
monopoly.

Rent-seeking activities in which people spend
resources to lobby government for the monopoly
power.
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62
Normative Views of Monopoly

The public does not like the distributional
effects of monopoly.

They believe that it transfers income from
“deserving” consumers to “undeserving”
monopolists.
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63
Normative Views of Monopoly

It is possible for the well-financed and the
well-connected to garner government
favours.

The public prefers that firms do productive
things rather than lobby for government
favours.
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64
Government Policy and Monopoly:
AIDS Drugs

The patents for AIDS drugs are owned by a
small group of pharmaceutical companies.

They can charge a very high price for a drug
whose marginal cost is very low.
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65
Government Policy and Monopoly:
AIDS Drugs

What, if anything, should the government do?

Government could force the producer to charge a
price equal to its marginal cost.

Society would be better off but this would create a
significant disincentive for drug companies to do
further research on other life-threatening
diseases.
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66
Government Policy and Monopoly:
AIDS Drugs

Another alternative is for the government to
buy the patents and allow anyone to produce
the drugs.

Payment would come from increased taxes and
would be quite expensive.

The cost of regulation would decrease, but it
would raise the question as to which patents the
government should buy.
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67
Monopoly
End of Chapter 11
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68