Transcript Chapter 6: The Theory and Estimation of Production

ECON 201: Principles of Microeconomics
Chapter 9 of McEachern:
Monopoly
What is Monopoly?
A Single Seller is the Sole Supplier
in a Market where the Product has no Substitutes
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Chapter 9: Monopoly
Major Themes for this Chapter:
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What are Barriers to Entry, and what are their
relationships to monopolies?
What are examples of Monopolies in real world
markets?
What is the Theory of Pure Monopoly? What does
it predict?
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Chapter 9: Monopoly
What are Barriers to Entry, and what are their
relationships to monopolies?
Barriers to Entry prevent new firms from
becoming viable competitors within a profitable
market.
Contrast this situation to the “Free Entry-Free
Exit” Conditions in Perfect Competition.
“Entry and Exit” Conditions are a key factor in
determining the competitiveness and the level of
long-run profit of a firm within a market.
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Chapter 9: Monopoly
What are typical examples of Barriers to Entry?
• Legal Restrictions
• Patents – 20-year incentive for inventors
• Licenses – e.g., broadcast radio and TV signals
• Economies of Scale – reduce average total cost by increasing
# of units produced. e.g., electric power utility firms
• Control of Essential Resources – e.g., China as a monopoly
supplier of Pandas to zoos
• Customer Loyalty – consumers who will only purchase
specific brands. e.g., Harley Davidson motorcycle riders
• High Cost of Start-up – e.g., in the aircraft industry, the very
high cost of designing and producing airliners.
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Chapter 9: Monopoly
What are examples of Monopolies in
real world markets?
• The US Post Office has the exclusive right to deliver first-class
mail to your mailbox.
• Many local public utilities are the exclusive providers of water
supply and electric power to individual households within their
service areas.
• DeBeers Consolidated Mines, for many years, was practically the
sole source of the world’s supply of rough diamonds.
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Chapter 9: Monopoly
Economist’s vocabulary:
How does a “Natural Monopoly” differ from an “Artificial Monopoly”?
What are Natural Monopolies?
• Technological or Production-Related Factors create a Downward-Sloping
long-run Average Total Cost Curve known as “Economies of Scale”
• Public Utilities (such as electric power and water supply) are typical
examples of natural monopolies.
• Many Natural Monopolies are regulated by Public Utility Commissions
• See below for an illustration of "Economies of Scale”
$TC/Q
Average Total Cost Curve
Quantity of Output
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Chapter 9: Monopoly
Economist’s vocabulary:
How does a “Natural Monopoly” differ from
an “Artificial Monopoly”?
(Continued)
What are Artificial Monopolies?
• Collusion or cooperation among sellers in the same industry
create a “Cartel”
• Instead of competition , the industry's firms unite their
production and pricing strategies into a unified cartel
policy – effectively becoming a single seller.
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Chapter 9: Monopoly
Economist’s vocabulary:
How does a “Natural Monopoly”
differ from an “Artificial Monopoly”?
What are Artificial Monopolies? (Continued)
• OPEC (Organization of the Petroleum Exporting Countries)
is an example of a cartel.
• In the US, if firms in the same industry secretly conspire to
create a cartel to fix prices or otherwise control the market,
they can be investigated by the Federal Trade Commission
and prosecuted by the US Justice Department under the US
Antitrust Laws.
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Chapter 9: Monopoly
What is the Theory of Pure Monopoly?
What does it predict?
• Important Observation about Pure Monopoly:
• A Monopolist is a “Price Maker” who faces a downward-sloping
demand curve.
• Contrast the Monopolist with a Perfectly Competitive Firm
$Price
Monopolist’s Demand
$Price
Perfectly Competitive Firm’s Demand
Quantity
Quantity
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Chapter 9: Monopoly
The importance of calculating “Marginal Revenue”
for a monopolist (or any imperfect competitor):
Marginal
Revenue (MR) = Change in $Total Revenue  Change in
Total
Output Sold
MR =  $TR/Q
Marginal Revenue – Answers the entrepreneur’s question,
“What is the extra gain in revenue by producing and selling
another product unit?”
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Chapter 9: Monopoly
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Chapter 9: Monopoly
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Chapter 9: Monopoly
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Chapter 9: Monopoly
Next Question: In microeconomic theory, what is the
primary goal of managing any firm?
Answer: Maximize Total Profit
Result: Assume that a pure monopoly is managed to
earn maximum total profit.
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Chapter 9: Monopoly
Follow-up Question: How will the manager of the
monopoly assure that maximum total profit is
achieved?
Answer: To maximize total profit, a monopolist will
monitor the extra revenue (Marginal Revenue = MR) and
extra cost (Marginal Cost = MC) of each production unit.
As long as a positive (+) profit margin is generated by
producing another unit, then expand production by
another unit.
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Chapter 9: Monopoly
Production will increase, as long as:
Marginal Revenue (MR) > Marginal Cost (MC)
The monopolist’s production will only stop when no
additional (+) profit margin exists.
When “marginal profit” = $0, then Total Profit has hit a
maximum. Logically, the goal of Maximum Total Profit
means that production is taken to the output level where:
$Marginal Revenue (MR) = $Marginal Cost(MC)
The above result (MR=MC) can be graphically
illustrated. See the next slide.
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Chapter 9: Monopoly
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Chapter 9: Monopoly
Question: What are the long run impacts
on the entire economy when a monopoly sets MR=MC
to maximize total profit?
Multi-faceted Answer:
• Monopolists earn an above-normal profit in the
long run, if entry barriers remain high.
• Monopolists produce Q where $P > $MC, because
they maximize total profit where $MR=$MC.
• Monopolists restrict market output Q compared to
the results of Perfect Competition.
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Chapter 9: Monopoly
Question: What are the long run impacts
on the entire economy when a monopoly sets MR=MC to
maximize total profit?
Answer: Continued, in more detail.
Production and Price Results in Monopoly:
Produce the level of Q such that:
$MR = $MC
However, we also know that*:
$MR < $Product Price
*Note: ($P > $MR) by definition, because of negatively-sloped demand.
Therefore, by logical deduction, we conclude:
$MC < $Product Price
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Chapter 9: Monopoly
Question: What are the long run impacts
on the entire economy when a monopoly sets MR=MC to
maximize total profit?
Answer: Continued, in more detail.
In Pure Monopoly, produce the Q level where:
$Price > $Marginal Cost
What does $P > $MC mean?
It means that consumers value the last unit of the product more
than it costs to produce that last unit.
The $P > $MC outcome of monopoly
is not economically efficient.
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Chapter 9: Monopoly
Question: What are the long run impacts
on the entire economy when a monopoly sets MR=MC to
maximize total profit?
Answer: Continued, in more detail.
The $P > $MC outcome of monopoly is not economically
efficient:
• Product Price does NOT measure the product’s true
scarcity.
• The economy no longer has any guarantee that it will
be allocatively efficient.
• Monopolists restrict the output level (Q) compared to
the output volume produced in perfect competition.
• If entry of new firms into the industry never occurs,
then a monopoly can permanently earn above-normal
(economic) profit.
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