MONOPOLY---IN MICROECONOMICS

MARKET STRUCTURES

In economics, monopoly is a pivotal area to the study of market structures, which directly concerns normative aspects of economic competition, and sets the foundations for fields such as industrial organization and economics of regulation. There are four basic types of market structures under traditional economic analysis: perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a market structure in which a single supplier produces and sells the product. If there is a single seller in a certain industry and there are no close substitutes for the goods being produced, then the market structure is that of a "pure monopoly". Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being produced, but nevertheless firms retain some market power. This is called monopolistic competition, whereas in oligopoly the main theoretical framework revolves around firm's strategic interactions.

MONOPOLY

In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν (to sell)) exists when a specific individual or an enterprise is the only supplier of a particular kind of product or service

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.

Why Monopolies Arise

• The fundamental cause of monopoly is barriers to entry

The fundamental cause of monopoly is barriers to entry.

Barriers to entry have three sources:Ownership of a key resource.

This tends to be rare. De Beers is an example

The government gives a single firm the exclusive right to produce some good.

Patents, Copyrights and Government Licensing.

Costs of production make a single producer more efficient than a large number of producers.

Natural Monopolies

Monopoly versus Competition

Monopoly

Is the sole producer

Has a downward-sloping demand curve

Is a price maker

Reduces price to increase sales

Competitive Firm

Is one of many producers

Has a horizontal demand curve

Is a price taker

Sells as much or as little at same

price

A Monopoly’s Marginal Revenue

• A monopolist’s marginal revenue is always less than the price of its good.

The demand curve is downward sloping.

When a monopoly drops the price to sell one more unit, the revenue received from

previously sold units also decreases.

A MONOPOLY’S REVENUE

• Total Revenue

P x Q = TR

• Average Revenue

TR/Q = AR = P

• Marginal Revenue

DTR/DQ = MR

A Monopoly’s Total, Average, and Marginal Revenue

Quantity(Q) Price(P) Total Revenue(TR=P×Q)

Average Revenue(AR=TR/Q)

Marginal Revenue(MR)

0 $11.00 $0.00 - -

1 $10.00 $10.00 $10.00 $10.00

2 $9.00 $18.00 $9.00 $8.00

3 $8.00 $24.00 $8.00 $6.00

4 $7.00 $28.00 $7.00 $4.00

5 $6.00 $30.00 $6.00 $2.00

6 $5.00 $30.00 $5.00 $0

7 $4.00 $28.00 $4.00 -$2.00

8 $3.00 $24.00 $3.00 -$4.00

• Profit equals total revenue minus total costs.

• Profit = TR - TC

• Profit = (TR/Q - TC/Q) x Q

• Profit = (P - ATC) x Q

MONOPOLIST’S PROFIT• The monopolist will receive economic profits as long as price is greater than average total

cost

A Monopoly’s Profit

Potential Benefits from Monopoly

• A high market concentration (fewness of sellers) does not

always signal the absence of competition

• Important in essays and data questions

• Increasingly markets where a monopoly appears to exist are

actually becoming more contestable

• So what are the main advantages of a market dominated by a

few sellers?

• Economies of Scale

• A monopolist might be better positioned to exploit economies

of scale leasing to an equilibrium which gives a higher output

and a lower price than under competitive conditions.

EXAMPLE OF THE BEFITS OF MONOPOLY

In 2007, there were orders for only 16 aircraft. Clearly an industry like this is going to have huge economies of scale. To develop a Boeing 747 is very expensive. The unit cost of over $200 million dollars means that it would not make sense to have more competition in this market. If there was competition, then the unit costs would probably increase substantially making it potentially unprofitable. The Boeing will have various economies of scale such as:SpecialisationTechnical economiesBulk buyingfinancial economiesmarketing economiesThis is an example of a market where firms with monopoly power are likely to lead to better deals for consumers. In developing the next generation of jumbo jets, the firms will require huge amounts of investment. This investment is only viable for a firm with a high market share and large profit.

For example the unit cost ofA Boeing 747-400 is $228-260 million (2007)Boeing 747-8 $285.5-300 million (2007)

CHARACTERISTICS OF MONOPOLY

• Profit Maximiser: Maximizes profit.• Price Maker: Decides the price of the good or product to be sold.• High Barriers to Entry: Other sellers are unable to enter the

market of the monopoly.• Single seller: In a monopoly there is one seller of the good who

produces all the output. Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry.

• Market power: Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition). Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers.

• Firm and industry: In a monopoly, market, a firm is itself an industry. Therefore, there is no distinction between a firm and an industry in such a market.

• Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging less price against the product in a highly elastic market and sells less quantities charging high price in a less elastic market.

SUMMARY OF MONOPOLY