monopoly © 2003 south-western/thomson learning. what is a monopoly? a monopoly firm is the only...

MonopolyMonopoly

© 2003 South-Western/Thomson © 2003 South-Western/Thomson LearningLearning

What Is a Monopoly?What Is a Monopoly?A A monopoly firmmonopoly firm is the is the only seller of a good or only seller of a good or service with service with no close no close

substitutessubstitutes. . The market in which the The market in which the

monopoly firm operates is monopoly firm operates is called a called a monopoly monopoly

marketmarket. .

Sources of Sources of MonopolyMonopoly

•Economies of ScaleEconomies of Scale•Control of Scarce InputsControl of Scarce Inputs•Government-Enforced Government-Enforced

Barriers Barriers

Economies of ScaleEconomies of ScaleNatural MonopolyNatural Monopoly

A market in which, due to A market in which, due to economies of scale, one economies of scale, one

firm can operate at lower firm can operate at lower average cost than can two average cost than can two

or more firmsor more firms

Government-Enforced Government-Enforced BarriersBarriers

Protection of intellectual property(IP):Protection of intellectual property(IP):•Government allows creators of IP to enjoy Government allows creators of IP to enjoy a monopoly and earn economic profit, a monopoly and earn economic profit, but but onlyonly for a limited timefor a limited time•Once the time is up, other sellers are Once the time is up, other sellers are allowed to enter the market, and allowed to enter the market, and competition is expected to bring down competition is expected to bring down pricesprices

Government-Enforced Government-Enforced BarriersBarriersPatentPatent

A temporary grant of A temporary grant of monopoly rights over a monopoly rights over a

new product or new product or scientific discovery.scientific discovery.

Government-Enforced Government-Enforced BarriersBarriers

CopyrightCopyright A grant of exclusive A grant of exclusive

rights to sell a rights to sell a literary, musical, or literary, musical, or

artistic workartistic work

Government-Enforced Government-Enforced BarriersBarriers

Government Government FranchiseFranchise

A government-granted A government-granted right to be the sole right to be the sole seller of a product or seller of a product or serviceservice–U. S. Postal ServiceU. S. Postal Service–Local utilities, etc.Local utilities, etc.

Monopoly Goals and Monopoly Goals and ConstraintsConstraints

•Monopoly Price or Monopoly Price or Output Decision Output Decision •Profit and LossProfit and Loss

Monopoly Goals and Monopoly Goals and ConstraintsConstraints

For any level of output a firm For any level of output a firm might produce, total cost is might produce, total cost is determined by determined by

(1) its technology of production, and (1) its technology of production, and (2) the prices it must pay for its (2) the prices it must pay for its

inputs. inputs. For any level of output it might For any level of output it might

produce, the maximum price it produce, the maximum price it can charge is determined by can charge is determined by the market demand curve for the market demand curve for its productits product

Monopoly Goals and Monopoly Goals and ConstraintsConstraints

5,000

Numberof Subscribers

Monthly Price per

SubscriberB

A

18

MR6,00015,000 20,000

21,00030,000

20

30

38

4850

$60

Demand

FG

C

Monopoly Price or Monopoly Price or Output Decision Output Decision

When When anyany firm - including a firm - including a monopoly - faces a downward-monopoly - faces a downward-

sloping demand curve, sloping demand curve, marginal revenue is less than marginal revenue is less than

the price of output. the price of output. Therefore, the marginal Therefore, the marginal

revenue curve will lie below revenue curve will lie below the demand curve.the demand curve.

Monopoly Price or Monopoly Price or Output DecisionOutput Decision

A monopoly will never A monopoly will never produce a level of output produce a level of output

at which its marginal at which its marginal revenue is negative.revenue is negative.

Monopoly Price or Output Monopoly Price or Output DecisionDecision

Number of Subscribers

Monthly Price per

Subscriber

E

MR10,000

40

MC

D

$60

30,000

Profit and LossProfit and Loss

A monopoly earns a profit A monopoly earns a profit whenever P>ATCwhenever P>ATCand suffers a loss and suffers a loss whenever P<ATCwhenever P<ATC

Monopoly Profit and Monopoly Profit and LossLoss

Number of Subscribers

Dollars

E

MR10,000

$40

MC

32

Total Profit

ATC

D

(a)

E

Total Loss AVC

ATC

Number of Subscribers

Dollars

MR10,000

40

MC

D

(b)

$50

Equilibrium in Equilibrium in Monopoly MarketsMonopoly Markets•Short-Run EquilibriumShort-Run Equilibrium•Long-Run EquilibriumLong-Run Equilibrium•Comparing Monopoly to Comparing Monopoly to

Perfect CompetitionPerfect Competition•Why Monopolies Often Earn Why Monopolies Often Earn

Zero Economic ProfitZero Economic Profit

Short-Run EquilibriumShort-Run Equilibrium

Any firm - including a Any firm - including a monopoly - should shut monopoly - should shut down if P<AVC at the down if P<AVC at the

output level where MR = output level where MR = MC.MC.

Long-Run EquilibriumLong-Run Equilibrium•A privately owned monopoly A privately owned monopoly suffering an economic loss in suffering an economic loss in the long run will exit the the long run will exit the industry, just as would any industry, just as would any other business firm. other business firm. •In the long run, therefore, In the long run, therefore, we should not find privately we should not find privately owned monopolies suffering owned monopolies suffering economic losses.economic losses.

Comparing Monopoly Comparing Monopoly to Perfect to Perfect

CompetitionCompetitionA monopoly market can be A monopoly market can be

expected to have a higher price expected to have a higher price and lower output than an and lower output than an

otherwise similar perfectly otherwise similar perfectly competitive market.competitive market.

Comparing Monopoly to Comparing Monopoly to Perfect CompetitionPerfect Competition

100,000 Quantityof Output

PriceperUnit

E$10

D

(a) Competitive Market

S

1,000 Quantityof Output

DollarsperUnit

ATC

MC

d

(b) Competitive Firm

$10

DollarsperUnit

E

F

D

(c) Monopoly

Quantityof Output

MR

S = MC

10

$15

100,00060,000

Two Opposing EffectsTwo Opposing Effects1) For any given technology of 1) For any given technology of production, production, monopolization leads to monopolization leads to higher prices and lower outputhigher prices and lower output..2) 2) ChangesChanges in the technology of in the technology of production made possible under production made possible under monopoly monopoly may lead to lower prices and may lead to lower prices and higher output.higher output.

Monopolies Often Monopolies Often Earn Zero Economic Earn Zero Economic

ProfitProfit

1.1. Government regulationGovernment regulation2.2. Rent-seeking activityRent-seeking activity

Monopolies Often Monopolies Often Earn Zero Economic Earn Zero Economic

ProfitProfitRent-Seeking ActivityRent-Seeking Activity

Any costly action a firm Any costly action a firm undertakes to establish undertakes to establish

or maintain its monopoly or maintain its monopoly statusstatus

What Happens When What Happens When Things Change?Things Change?

•A monopolist will react to A monopolist will react to an an increaseincrease in demand by in demand by producing more output, producing more output, charging a higher price, and charging a higher price, and earning a larger profit. earning a larger profit. •It will react to a It will react to a decreasedecrease in in demand by reducing output, demand by reducing output, lowering price, and suffering lowering price, and suffering a reduction in profit.a reduction in profit.

What Happens When What Happens When Things Change?Things Change?

Numberof Subscribers

MonthlyPrice per

Subscriber

(a) (b)

A

MR1

10,000

$40

MC

D1

30,000Number

of Subscribers

MonthlyPrice per

Subscriber

MR1

MR210,000

11,000

40

MC

D1 D2

$47A

B

Price Price DiscriminationDiscrimination

•Requirements for Price Requirements for Price DiscriminationDiscrimination•Effects of Price Effects of Price Discrimination Discrimination

Price DiscriminationPrice Discrimination

Single-Price MonopolySingle-Price Monopoly A monopoly firm that is A monopoly firm that is limited to charging the limited to charging the same price for each unit same price for each unit

of output sold.of output sold.

Price DiscriminationPrice Discrimination

Price DiscriminationPrice Discrimination Charging different prices Charging different prices to different customers for to different customers for

reasons other than reasons other than differences in cost.differences in cost.

Price DiscriminationPrice DiscriminationRequirements for Price Requirements for Price DiscriminationDiscrimination•There must be a downward-There must be a downward-sloping demand curve for the sloping demand curve for the firm’s outputfirm’s output•The firm must be able to The firm must be able to identify consumers willing to identify consumers willing to pay morepay more•The firm must be able to The firm must be able to prevent low-price customers prevent low-price customers from reselling to high-price from reselling to high-price customerscustomers

Effects of Price Effects of Price DiscriminationDiscrimination

Price discrimination Price discrimination that that harms harms consumers:consumers:

when prices are above the when prices are above the price consumers would pay price consumers would pay under a single price policy. under a single price policy. The additional profit for the The additional profit for the firm is equal to the monetary firm is equal to the monetary

loss of consumersloss of consumers

Effects of Price Effects of Price DiscriminationDiscrimination

Price discrimination Price discrimination that that benefitsbenefits consumers:consumers:

when the price for some when the price for some consumers is below what they consumers is below what they would pay under a single-price would pay under a single-price policy. This benefits both the policy. This benefits both the

consumer and the firm.consumer and the firm.

Effects of Price Effects of Price DiscriminationDiscrimination

30 Number of Round-tripTickets

Dollarsper

Ticket

80

$120 ATC

MR

MC

(a)

Number of Round-tripTickets

30

Dollarsper

Ticket

120

MR

MC

(b)

10

$160

Additional profitfrom pricediscrimination

Number of Round-tripTickets

(c)

30

Dollarsper

Ticket

$120

MR

MC

40

100

D

Additional profitfrom pricediscrimination

G

H

F

D

E

D

Perfect Price Perfect Price DiscriminationDiscrimination

Perfect Price Perfect Price DiscriminationDiscrimination

Charging each customer Charging each customer the most he or she would the most he or she would be willing to pay for each be willing to pay for each

unit purchasedunit purchased

Perfect Price Perfect Price DiscriminationDiscrimination

Number of Dolls per Day

Dollars per Doll

E

20

$30

25

10

30 60

JBMC = ATC

H

DMR

MR curve before price discrimination