Chapter Ten Monopolies. Copyright © by Houghton Mifflin Company, Inc. All rights reserved10 - 2 A Model of Monopoly Monopoly: One firm in an industry

Chapter TenMonopolies

Copyright © by Houghton Mifflin Company, Inc. All rights reserved 10 - 2

A Model of Monopoly

• Monopoly: One firm in an industry selling a product for which there are no close substitutes

• Barriers to Entry: Anything that prevents firms from entering a market.

• Monopoly will choose level of output that maximizes profit• Difference between monopoly and competitive firm is how

actions affect market price.– Monopoly has MARKET POWER: Firm’s power to set its price

without losing its entire share of the market

– Monopoly is a PRICE-MAKER: A firm that has the power to set its price, rather than taking the price set by the market


Monopoly

• Market Power– There is no one to undercut the monopolist’s

price

– The impact of quantity decisions on the price• Competitive firm cutting production has very

little impact on market price. Monopoly cutting production has large impact on market price.


Figure 10.1: How the Market Power of a Monopoly and a Competitive Firm Differ


Revenue, Costs, and Profits for a Monopoly

Q P TR MR TC MC PROF

0 160 0 ---- 70 --- -70

1 150 150 150 79 9 71

2 140 280 130 84 5 196

3 130 390 110 94 10 296

4 120 480 90 114 20 366

5 110 550 70 148 34 402

6 100 600 50 196 48 404

7 90 630 30 261 65 369

8 80 640 10 351 90 289

9 70 630 -10 481 130 149

10 60 600 -30 656 175 -56


Figure 10.2: Total Revenue, Marginal Revenue, and Demand


Maximizing Profits

• As long as marginal revenue is greater than marginal cost, a monopoly should keep producing to maximize profits.

• The monopolist should produce up to the level of production where marginal cost = marginal revenue (MC=MR)


Figure 10.3: Finding a Quantity of Output to Maximize Profits


Figure 10.4: Marginal Revenue and Marginal Cost


MC = MR vs. MC = P

• For a competitive firm, TR = Q x P where the firm cannot affect the price– MC = MR is virtually the same as MC = P


Figure 10.5: Profit Maximization for a Monopoly and a Competitive Firm


Figure 10.6: The Generic Diagram for a Monopoly


Figure 10.7: A Monopoly with Negative Profits


Figure 10.8: Deadweight Loss from Monopoly


The Monopoly Price is Greater than Marginal Cost• The price with a monopoly is higher than with

competition (since a monopoly can withhold production and drive the price up)

• The loss to society can be measured as the difference between price and marginal cost

• The size of the difference (or of the loss) can be measured by the elasticity of the monopoly’s demand curve. – If the demand curve is highly elastic then the difference

between price and marginal cost is small


Monopoly price is greater than marginal cost

• Price-cost margin: The difference between price and marginal cost divided by the price. – Indicates market power: 0 is no market power

• Price – Marginal Cost

Price

• Price-cost margin of a competitive firm is 0

• 1 / Price Elasticity of Demand


Why Monopolies Exist

• If big firms are needed in order to produce at a low cost, it may be natural for a few firms or only one firm to exist.– Economies of scale – decreasing long run ATC – can

lead to a monopoly.• Minimum efficient scale of a firm is the minimum size of the

firm for which ATC is lowest. If minimum efficient scale is a small fraction of the market then there will be many firms.

• Water Company: Large fixed costs to lay pipes, but connecting each house has low cost. As connect more houses, ATC declines. (Electricity and Local Telephone Service)


Monopolies, con’t.

• Natural monopoly: A single firm in an industry in which ATC is declining over the entire range of production and the minimum efficient scale is larger than the size of the market.– Usually regulated by the government to keep the price

below the monopoly price and closer to the competitive price, reducing the deadweight loss

– Nationwide telephone service no longer a natural monopoly due to advances in technology


Patents and Copyrights

• Another way monopolies arise is through the granting of patents and copyrights by the government. – Intel had a patent on computer chips– If granted a patent, can have a monopoly for 20 years– Pharmaceutical drugs are another example– Provides good incentive for innovation– Government could lower prices on drugs, but would not

be an incentive to create new and improved products


Licenses

• The government can create a monopoly by giving or selling to one firm a license to produce the product. – U.S. Postal Service

• Attempts to create barriers– Adam Smith encouraged free trade between countries to

try to eliminate monopolies• De Beers, Standard Oil

– Contestable Market: A market in which the threat of competition is enough to encourage firms to act like competitors.


Price Discrimination

• Price Discrimination: A situation in which different groups of consumers are charged different prices for the same good.– Senior citizen discounts, Foreign Markets, Quantity

Discounts

• Price Discrimination is partly determined by the elasticity of demand


Figure 10.9: Price Discrimination Targeted at Different Groups


Quantity Discounts

• By charging higher fees for lower quantities, monopolies increase their profits and also increase consumer surplus, thereby reducing deadweight loss.


Figure 10.10: Price Discrimination Through Quantity Discounts or Premiums

Documents

Chapter Ten Monopolies. Copyright © by Houghton Mifflin Company, Inc. All rights reserved10 - 2 A Model of Monopoly Monopoly: One firm in an industry