Transcript Monopoly - Cobb Learning

Monopoly
Pure Monopoly
 exists when a single firm is the sole
producer of a product for which there
are no close substitutes
Characteristics
 Single Seller - a one producer of a specific product
 No Close Substitutes - no reasonable alternative
products
 "Price Maker" - the firm exercises considerable control
over price because it is responsible for the quantity
supplied.
 Totally Blocked Entry - no competitors because of
economic, technological, legal obstacles
 Advertising - monopolies may or may not advertise
 monopolist selling luxury good can advertise to
increase demand
 monopolist selling utilities/necessities will not
advertise (but may promote good will).
Examples
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gas/electric companies
water company
cable TV
telephone company
professional sports leagues
monopoly caused by geographic
isolation
Barriers to Entry
Economies of Scale
 natural monopoly - economies of scale that are so great
that a good or service can be produced by one firm at an
average total cost lower than if produced by more than one
firm.
 New firms attempting to enter the industry as small-scale
producers will have little or no chance to survive and
expand
 New small-scale entrants cannot realize the cost of
economies of scale of the monopolist and therefore cannot
realize profits necessary for survival and growth
 New large-scale producers find it extremely difficult to
secure enough startup money and capital
more
Barriers to Entry
 Legal Barriers: Patent and Licenses
 Patents
 Patents allow inventor from having the product
usurped by rivals who have not shared in the
time, effort, and money put into the products
development
 Patents give the inventor a monopoly position
for the life of the patent
 Profits gained from a patent can further
finance research required to develop new
patentable products. Therefore, tremendous
monopoly power can be obtained
more
Barriers to Entry
 Licenses
 Entry into an industry or occupation may
require a government license
 Allows the government to create a public
monopoly
 Examples: radio/TV stations, taxi cabs
 Ownership of Essential Resources
 Example: De Beers owns most of the world's
known diamond mines
Implications:
 Monopolies are relatively rare
 Barriers to entry are rarely complete - meaning
pure monopoly is relatively rare
 Technology may undermine existing monopoly
power (e.g. email and postal service)
 Existing patent advantages can be
circumvented by new and distinct, yet
substitutable products
 New resources can be found
Desirability
 Comments on resource ownership,
patents, and licensing imply undesirable
connotations
Monopoly Demand Curve
 The demand curve in a monopoly is downsloping - This implies that the monopolist
cannot sell more without lowering the price.
Price Exceeds Marginal
Revenues
 Marginal revenue is less than
price for every level of output
except for the first
 Why?
P > MR : Why?
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Why?
Price cuts apply to both extra output
sold as well as all other units of output,
which could have been sold at a higher
price
The monopolist must lower price to
boost sales
• When marginal revenue is positive - total revenue is
increasing
•When marginal revenue is negative - total revenue is
decreasing
Price Elasticity
(This part’s really important!)
 When demand is elastic, a decline in price will
increase total revenue
 When demand is inelastic, a decline in price
will reduce total revenue
 The profit-maximizing monopolist will always
want to avoid the inelastic segment of its
demand curve
 By lowering price into inelastic range, total
revenue will decline
Monopoly Output and
Price Determination
MR = MC Rule - this tells us that
maximum profit/minimum loss will
occur if we produce where MR = MC
How to determine
economic profit
 find quantity where MC = MR
 find the corresponding quantity on the
demand curve
 draw a line down to the ATC curve
 draw a rectangle to the y-axis
 the area of this rectangle is economic
profit
Losses occur when ATC
exceeds demand
There is no supply curve
in a monopoly.
 Why?
 There is no unique relationship
between price and quantity supplied
 There is only one producer
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Misconceptions Concerning
Monopoly Pricing
 The monopolist will not charge the
highest price possible
 The monopoly will charge the price
where total profit is greatest
 Monopolists want to maximize total
profit, not unit profit
Economic Effects of
Monopoly
 Price, Output, and Efficiency
 The monopolist will find it profitable to
sell a smaller output and to charge a
higher price than would a competitive
producer
 Competitive markets seek to optimize
allocative and productive efficiency.
Monopolistic markets seek to optimize
profits.
 Therefore, monopolies never achieve
allocative or productive efficiency
Income Distribution
 Monopolists generally charge a higher
price than a competitive firm with the
same costs.
 Thus, monopolies earn much more
economic profit
 Thus, the owners of the monopolistic
enterprise are enriched at the expense of
society
X-inefficiency
 Occurs when a firm's actual costs of
producing any output are greater than the
minimum possible costs. For example, at
quantity Q1, a firm produces at ATCx
when it could produce at ATCm
X-inefficiency
 Monopolists are sheltered from
competitive forces by entry barriers.
Thus, this allows X-inefficiency to occur
 In competitive markets, firms are
continually under pressure from rivals.
Thus, X-inefficiency does not occur
Rent-seeking Expenditures
 Rent seeking behavior refers to activities
designed to transfer income or wealth to a
particular firm or resource supplier at someone
else's expense.
 Example: Monopolies spend lots of money
lobbying for legislation that allows monopolies
to hold their privileged position. This increases
costs, but not output. This is a rent-seeking
expenditure.
Dynamic Efficiency
 Dynamic efficiency considers
whether monopolists are more likely to
develop more efficient techniques over
time than competitive firms.
The Competitive Model
 There is little or no technological
progress in a purely competitive market
because there are no economic profits,
which are a large incentive to produce
new technology
The Monopoly Model
 "Does not promote advancement" view
 Because monopolies make a large economic profit,
there is no incentive to change the status quo. As a
result, firms do not develop new technology.
 "Does promote advancement" view
 Monopolies are more willing to develop new
technology because doing so lowers costs and
expands profits. Monopolies can develop new
technology without the fear of competitors.
Price Discrimination
 Price discrimination occurs when a given
product is sold at more than one price,
and these price differences are not
justified by cost differences
 Price discrimination is workable under
three conditions:
Price Discrimination
 1. The seller possesses some degree of
monopoly power
2. The seller must be able to segregate
buyers into separate classes
3. The original purchaser cannot resell
product or service
Price Discrimination
Consequences
of price discrimination
 Monopolists that practice price
discrimination get more profit
 Price-discriminating Monopolists produce
more output
 When a monopolist lowers the price, the
reduced price applies only to additional
units sold and not to prior units. Hence,
price and marginal revenue are equal.
Therefore, the demand curve and marginal
revenue curves will coincide. This allows
the monopolist to produce more output to
receive maximum profit.
 More allocative efficiency is attained.
Regulated Monopoly
 When the government regulates monopolies, there
are two prices the government can choose from
Socially Optimal Price: P =
MC
 Socially Optimal
Price: P = MC
 if government
sets the price,
the monopolist
will choose its
profit
maximizing
output
 there is
allocative
efficiency
"Fair-Return" Price:
P = ATC
 "FairReturn"
Price: P =
ATC
 firm will
only realize
a normal
profit