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Previous Conclusion
If markets are perfectly completive: All firms would be efficient. P would just be the Average Cost of
production and firms will not be able to make profit for a long time.
It is very hard to find Perfectly Competitive markets. Firms would want to make profit, and it is
practically difficult to do so in perfectly competitive markets.
Previous Conclusion
In the real world, however, many firms make Economic Profit
Markets are NOT Perfectly Competitive!
Imperfect Competition
What is Left?
How and why such markets (real world) arise?
How do firms in imperfect market maximize profit
How imperfect is imperfect competition?
Monopoly Markets (Chap-9) Oligopoly Markets (Chap-10) Monopolistically Competitive
Markets (11)
Some Questions
1. Which of the following two products are more IMPORTANT?
A) Water B) Diamond2. Which of the above two products have
inelastic price elasticity of demand?
3. What does Price Inelasticity of the demand for water imply about Profit making and the Price of water?
Producers can increase the Price of water to maximize Profit!
Some Questions4. Which of the two products are made from
a relatively more SCARCE Resources?
5. Which of the two products ( Water or Diamond) are more Expensive (Command Higher Price)?
6. Why?
Some Questions
7. What does Price of a product reflect (tell us)? A) The importance of the product
B) The scarcity of the resource from which the product is made?C) The structure of the market?
Monopoly
Chapter 9
In This Chapter….
9.1. Monopoly, Sources and Its Market Power9.2. Profit Max Under Monopoly9.3. Is Monopoly bad for the Society?
9.1. Monopoly, Sources and Its Market Power
Definition… Monopoly is a sole producer/supplier of a
good with no substitute.
Monopoly is a firm that produces the entire market supply of a particular good or service.
A monopolist has a market Power Market power is the ability to alter the
market price of a good or service. That is monopoly is a Price Maker, not
a Price Taker…Why?
9.1. Monopoly, Sources and Its Market Power
because unlike competitive firms that face a horizontal demand curve,…
Monopoly (a firm with market power) confront downward-sloping demand curves.
The industry
Quantity(thousands of bushels per day)
0
The competitive firm
Quantity (bushels per day)
Pric
e (p
er b
ushe
l)
0
9.1. Monopoly, Sources and Its Market Power
Demand facing competitive firm
$13
Marketdemand
$13
How Monopolies Arise
The fundamental cause of monopoly is:
•Barriers to Entry:
How Monopolies Arise
Barriers to entry could arise from three sources:
1. Ownership of a key resource (s).2. Exclusive right to produce some good
(s), given by the government.3. Efficiency resulting from Economies of
Scale.
•Barriers to Entry
How Monopolies Arise
Exclusive ownership of a key resource provides a firm a monopoly power.
E.g. DeBeers: (Controls about 80% Diamond Production)
In practice, however, monopolies rarely arise from this reason.
•Barriers to Entry
A Government may create monopoly: by giving a single firm the
exclusive right to sell a particular good in certain market (s).
Through:(1) Franchise Agreement(2) Patent and Copyright Laws
•Barriers to Entry
How Monopolies Arise
Government may create Monopolies for several reasons: To Generate More Income To Serve Public Interest
Promote research, innovation, and investment.
Avoid wastage of public resources (One may be better than many)
Efficiency argument
•Barriers to Entry
How Monopolies Arise
Could arise for natural reasons When a single firm can supply a good
or service to an entire market at a smaller cost than could two or more firms.
Natural Monopoly. it arises because of economies of scale
•Barriers to Entry
How Monopolies Arise
Merger and Acquisition of firms: When all else fails, purchase of or
merger with a potential competitor.
Economies of scale: The ability to produce at an extremely
low average cost than any other firm wanting to enter the market.
How Monopolies Arise
Copyright © 2004 South-Western
Quantity of Output0
Cost
Average Total Cost(ATC)
When market demand is met before a firm achieves its minimum ATC, it becomes a natural monopoly
9.1. Monopoly, Sources and Its Market Power
In general the preservation of monopoly power depends on… keeping potential competitors out of
the market.
Maintain strong barriers to entry
9.2. Profit Maximization Under Monopoly
15.3.1. A Monopoly’s Revenue Just as in perfectly competitive
markets, in a monopoly market:
Total RevenueP Q = TR
Average RevenueTR/Q = AR = P
Marginal RevenueTR/Q = MR
A Monopoly’s Total (TR), Average (AR), and Marginal Revenue (MR)
Quantity of Water
Price Total Revenue
Average Revenue
MarginalRevenue
Q P TR AR MR0 11
1 10
2 9
3 8
4 7
5 6
6 5
7 4
8 3
A Monopoly’s Total (TR), Average (AR), and Marginal Revenue (MR)
Quantity of Water
Price Total Revenue
Average Revenue
MarginalRevenue
Q P TR AR MR0 11 0
1 10 10
2 9 18
3 8 24
4 7 28
5 6 30
6 5 30
7 4 28
8 3 24
A Monopoly’s Total (TR), Average (AR), and Marginal Revenue (MR)Quantity of Water
Price Total Revenue
Average Revenue
MarginalRevenue
Q P TR AR MR0 11 0
1 10 10 10
2 9 18 9
3 8 24 8
4 7 28 7
5 6 30 6
6 5 30 5
7 4 28 4
8 3 24 3
15.3.1. A Monopoly’s Revenue
Monopoly’s AR:Is just equal to its price
Is the same as market demand curve
A Monopoly’s Total (TR), Average (AR), and Marginal Revenue (MR)
Quantity of Water
Price Total Revenue
Average Revenue
MarginalRevenue
Q P TR AR MR0 11 0
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4
15.3.1. A Monopoly’s Revenue
A monopolist’s marginal revenue is always less than the price of its good. Why?
The demand curve is downward sloping.
To sell one more unit the monopoly should drop the price, and thus declining MR.
15.3.1. A Monopoly’s Revenue
When a monopoly increases the amount it produces, it has two effects
The output effect—more output is sold, so Q is higher.
The price effect—price falls, so P is lower.
Demand and Marginal-Revenue Curves for a Monopoly
Copyright © 2004 South-Western
Quantity
Price
$1110
9876543210
–1–2–3–4
Demand(averagerevenue)
Marginalrevenue
1 2 3 4 5 6 7 8
Profit Maximization Under Monopoly
Recall that: The demand curve facing the monopoly
firm is identical to the market demand curve for the product.
…because monopoly is a firm that produces the entire market supply of a particular good or service.
Profit Maximization Under Monopoly
Thus a monopoly faces a different profit maximizing situation than competitive firms. Recall Profit-maximization rule for
Competitive firms is to Produce at that rate of output where P= MR = MC.
Unlike competitive firms, marginal revenue (MR) for a monopolist is not equal to price (P)
Profit Maximization Under Monopoly
Recall: Marginal revenue is the change in
total revenue that results from a one-unit increase in the quantity sold.
Profit Maximization Under Monopoly
So long as the demand curve is downward-sloping, MR will always be less than price.
Implication… In order to sell larger quantities the
monopolist has to reduce prices By producing and selling smaller
quantities, the monopolist can raise the price of its product.
Profit Maximization Under Monopoly
0 1 2 3 4 5 6 7 8 9 10
2
4
6
8
10
12
$14
Demand (= price)
Marginal revenue
Pric
e (p
er b
eshe
l)
Quantity (bushels per hour)
BC
DE
FG
A
b
c
d
e
f
g
Profit Maximization
The profit Maximization Rule for any firm in any Market is MR=MC
Thus the monopolist needs to find the intersection of its marginal cost and marginal revenue.
This will give the monopolist its profit-maximizing rate of output.
Only one price is compatible with the profit-maximizing rate of output.
The Monopoly Price
The intersection of the marginal revenue and marginal cost curves establishes the profit-maximization rate of output.
The monopoly price is set automatically.
The demand curve tells the monopolist how much consumers are willing to pay for that output.
0 Quantity
Pric
e
Market demand
ATC
Marginal Revenue
MC
Monopoly profit
Profit Maximization Under Monopoly
Monopolist's equilibrium
AR
T U V
qM qC
$1000$1100
Monopoly Profits
Total profit equals average profit per unit times the number of units produced.
Profit per unit = price – average total cost
Profit per unit = p – ATC
Total profits = profit per unit X quantity
Total profits = (p – ATC) X q
The Production Decision
A monopolist with several plants…
A monopolist can foresee the impact of increased production/supply on market price.
• Thus it prevents production increase by coordinating the production decisions of its plants.
Comparing Outcomes of Monopoly
and Competitive Markets
Substantial difference under Competitive Markets and Monopoly conditions exist
Comparing Outcomes of Monopoly and Competitive Markets
Both in the short and long run, Total Quantity of Output Produced Under Monopoly is less than Total Quantity Produced Under Perfect competition
Price is higher under monopoly than perfect competition
A monopoly receives larger profits than a comparable competitive industry.
0 Quantity (computers per month)
Pric
e (p
er c
ompu
ter)
Market demand
ATC
MR
MC
Monopoly profit
Monopoly Profits: The Entire Company
Competitive short-runequilibrium
Competitivelong-run equilibrium
Monopolist's equilibrium
AXR
T U V
qM qC
$1000$1100
Comparing Outcomes of Monopoly and Competitive Markets
Because monopoly markets do not tend towards marginal cost pricing, consumers do not get the mix of output that delivers the most utility from available resources.
– Marginal cost pricing – the offer (supply) of goods at prices equal to their marginal cost.
Competitive Industry
High prices and profits signal consumers’ demand for more output.
The high profits attract new suppliers. Production and supplies expand.
Prices slide down the market demand curve.
Competitive Industry
A new equilibrium is established.
Price equals marginal cost at all times.
Throughout the process, there is great pressure to reduce costs or improve product quality.
Monopoly Industry
High prices and profits signal consumers’ demand for more output.
Barriers to entry are erected to exclude potential competition.
Production and supplies are constrained.
Prices don’t move down the market demand curve.
Monopoly Industry
No new equilibrium is established.
Price exceeds marginal cost at all times.
There is no squeeze on profits and thus no pressure to reduce costs or improve product quality.
Political Power
A firm with considerable market power likely to have significant political power as well.
The Limits to Market Power
Monopolists only have absolute control of the quantity of output supplied to the market.
Monopolists must still contend with the market demand curve.
The Limits to Market Power
The greater the price elasticity of demand, the more a monopolist will be frustrated in its attempts to establish both high prices and high volume.
– Price elasticity of demand – The percentage change in quantity demanded divided by the percentage change in price.
Price Discrimination
A monopolist may be able to extract greater profits by practicing price discrimination.
Price discrimination is the sale of an identical good at different prices to different consumers by a single seller.
9.3. Is Monopoly bad for the Society?
Pros and Cons of Market Power
It is conceivable that monopolies could benefit the society.
Research and Development
Because of their greater profits, monopolists have a greater advantage in pursuing research and development.
They do not have a clear incentive to do so.
Entrepreneurial Incentives
Market power can be an incentive for entrepreneurial activity.
An innovator can make substantial profits in a competitive market before the competition catches up.
Economies of Scale
If economies of scale exist, the monopolist may attain much greater efficiency than a large number of competitive firms.
However, there is no guarantee that such economies of scale will exist in a given industry.
Natural Monopolies
A natural monopoly is an industry in which one firm can achieve economies of scale over the entire range of market supply.
Economies of scale act as a “natural” barrier to entry.
Contestable Markets
As a results Monopoly markets in the long run become contestable.
A contestable market is an imperfectly competitive market subject to potential entry if prices or profits increase.
• When potential profits reach a certain level competitors are enticed to enter the market.
Structure vs. Behavior
The structure of monopoly is, in itself, not a problem.
If potential rivals force a monopolist to behave like a competitive firm, then a monopoly imposes no cost on consumers or on society at large.
Real World Examples:The Case of Microsoft
Microsoft: Bully or Genius?
Concerning Microsoft, critics argue that Microsoft: Charges too much for its systems
software. Suppresses substitute technologies. Bullies potential competitors.
Antitrust Laws
The legal foundations for antitrust intervention are contained in three landmark antitrust laws.
Sherman Act (1890) – prohibits “conspiracies in restraint of trade.
Antitrust Laws
Clayton Act (1914) – principally aimed at preventing the development of monopolies by prohibiting price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms.
Antitrust Laws
The Federal Trade Commission Act (1914) – created the FTC to study industry structures and behavior so as to identify anti-competitive practices.
The AT&T Case
The federal government dismantled AT&T in 1984.
Prior to the break-up, AT&T supplied 96 percent of all long-distance service and over 80 percent of local telephone service.
The Microsoft Case
Microsoft was accused of: Thwarting competitors in operating
systems by erecting entry barriers. Using its monopoly position in
operating systems to gain an unfair advantage in the applications market.
It bought out its competitors.
Microsoft’s Defense
In its defense, Microsoft asserted that: It dominates the computer industry
because it produces the best products at attractive prices.
The computer industry is highly contestable if not perfectly competitive.
The Verdict
A federal court concluded that Microsoft abused its monopoly position in operating systems.
By limiting consumer choices and stifling competition, Microsoft had denied consumers better and cheaper information technology.
The Remedy
The trial judge suggested a structural remedy, that Microsoft might have to be broken into two companies to ensure competition.
The U.S. Department of Justice decided to seek a behavioral remedy instead.
