Monopoly - Principles of Macroeconomics

Monopoly •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. •The fundamental cause of monopoly is barriers to entry. WHY MONOPOLIES ARISE •Barriers to entry have three sources: •Ownership of a key resource. •The government gives a single firm the exclusive right to produce some good. •Costs of production make a single producer more efficient than a large number of producers. Monopoly Resources •Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. 1. Government-Created Monopolies •Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. •Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest. 2. Natural Monopolies •An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. •A natural monopoly arises when there are economies of scale over the relevant range of output. Cost Average total cost 0 Quantit y of Output 1 HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS •Monopoly versus Competition •Monopoly Is the sole producer •Faces a downward-sloping demand curve •Is a price maker •Reduces price to increase sales•Competitive Firm •Is one of many producers •Faces a horizontal demand curve •Is a price taker •Sells as much or as little at same price (a) A Competitive Firm (b) A Mono polist s ’Demand Curve ’s Demand Curve Price Price Demand Demand 0 Quantity of Output 0 Quantity of Output A Monopoly’s Revenue •Total Revenue P x Q = TR •Average Revenue TR/Q = AR = P •Marginal Revenue DTR/DQ = MR 2 •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. When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). •The output effect—more output is sold, so Q is higher. •The price effect—price falls, so P is lower. Price $11 10 9 8 7 6 5 4 3 2 Marginal 1 revenue Demand (average revenue) 0 –1 1 2 3 4 5 a 6 –2 7 8 Quantity of Water –3 –4 Profit Maximization •A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. •It then uses the demand curve to find the price that will induce consumers to buy that quantity. Costs and Revenue 2. . . . and then the demand curve shows the price consistent with this quantity. B Monopoly price 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity . . . Average total cost A Demand Marginal cost Marginal revenue 0 Q QMAX Q Quantity 3 •Comparing Monopoly and Competition •For a competitive firm, price equals marginal cost. P = MR = MC •For a monopoly firm, price exceeds marginal cost. P > MR = MC •Profit equals total revenue minus total costs. •Profit = TR – TC •Profit = (TR/Q - TC/Q) x Q •Profit = (P - ATC) x Q Costs and Revenue Marginal cost Monopoly price E B Monopoly profit Average total cost D Average total cost C Demand Marginal revenue 0 QMAX Quantity •The monopolist will receive economic profits as long as price is greater than average total cost. PUBLIC POLICY TOWARD MONOPOLIES •Government responds to the problem of monopoly in one of four ways. •Making monopolized industries more competitive. •Regulating the behavior of monopolies. •Turning some private monopolies into public enterprises. •Doing nothing at all. PRICE DISCRIMINATION •Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. •Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power. 4 •Perfect Price Discrimination•Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price. •Two important effects of price discrimination: •It can increase the monopolist’s profits. •It can reduce deadweight loss. •Examples of Price Discrimination•Movie tickets •Airline prices •Discount coupons •Financial aid •Quantity discounts Summary •A monopoly is a firm that is the sole seller in its market. •It faces a downward-sloping demand curve for its product. •A monopoly’s marginal revenue is always below the price of its good. •Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. •Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost. •A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. •A monopoly causes deadweight losses similar to the deadweight losses caused by taxes. •Policymakers can respond to the inefficiencies of monopoly behavior with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. •If the market failure is deemed small, policymakers may decide to do nothing at all. •Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. •Price discrimination can raise economic welfare and lessen deadweight losses. 5