Chapter 24 Pure Monopoly Pure Monopoly I INTRODUCTION

Chapter 24: Pure Monopoly

Pure Monopoly I. INTRODUCTION A. Main Characteristics § Single Seller: only one firm is the sole producer of the product in the market (the firm and the industry are the same). § No Close Substitutes: the monopolist sells a unique product that has no close substitutes. § Price Making: the monopolist controls total quantity supplied to the market and thus has control over the price.

§ Blocked Entry: the monopolist has no immediate competitors because certain barriers prevent potential competitors from entering the market. § Non-price Competition: monopolists that sell standardized products engage mainly in public relations advertising, whereas those with differentiated products sometimes advertise their products’ attributes.

B. Monopoly Examples § Pure Monopoly: the existence of one producer. § Near Monopolies: the existence of more than one producer, but one of them has a very large market share.

II. BARRIERS TO ENTRY § Economies of Scale (Natural Monopoly): some industries require producing large output to achieve lower average total cost. Thus, economies of scale serve as entry barrier.

Average Total Cost THE NATURAL MONOPOLY CASE $20 15 10 0 ATC If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly 50 100 Quantity 200

§ Legal Barriers to Entry: § Patents: a patent is the exclusive right of an inventor to use, or allowing others, to use its invention. Patents provide the inventor with a monopoly position for the life of the patent (i. e. 20 years). § Licenses: the government blocks entry to an industry through the control of issuance of licenses. § Ownership or Control of Essential Resources § Pricing and Other Strategic Barriers to Entry

III. MONOPOLY DEMAND Basic Assumptions: 1) Monopoly Status is Secured 2) No Governmental Regulation 3) Firm Charges the Same Price for all Units Sold

NOTES: § Market Demand Curve is the Firm’s Demand Curve § The monopolist sets the price in the elastic region of demand. § In the elastic region of demand, lower price leads to higher total revenue. § The monopolist avoids the inelastic region in the demand curve. § Profit maximization and loss minimization rule of monopolist: MR = MC § Note that price > MR

MONOPOLY REVENUES & COSTS Dollars $200 Elastic 150 200 50 MR D 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q Dollars $750 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS Dollars $200 Elastic Inelastic 150 200 50 MR D 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q Dollars $750 500 TR 250 Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

§ The monopolist has no supply curve. § The monopolist equates MR and MC to determine output. § The monopolist does not set the highest possible price. § Monopolist’s goal is maximum profit not maximum price. § Higher price may lead to less profit.

MONOPOLY REVENUES & COSTS Revenue Data Quantity Price of (Average Total Marginal Output Revenue) Revenue 0 x $172 = $ 0 Cost Data Average Total Cost Profit + Total Marginal or loss Cost - $100 = - $100

MONOPOLY REVENUES & COSTS Revenue Data Quantity Price of (Average Total Marginal Output Revenue) Revenue Cost Data Average Total Cost Profit + Total Marginal or loss Cost 0 $172 $ 0 $100 90 - $100 ] $162 ] x 1 162 = 162 - 28 $190. 00 190 = MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

MONOPOLY REVENUES & COSTS Revenue Data Quantity Price of (Average Total Marginal Output Revenue) Revenue 0 1 2 3 4 5 6 7 8 9 10 $172 $ 0 ] 162 ] 152 304 ] 142 426 ] 132 528 ] 122 610 ] 112 672 ] 102 714 ] 92 736 ] 82 738 ] 72 720 Cost Data Average Total Cost $162 $190. 00 142 135. 00 122 113. 33 102 100. 00 82 94. 00 62 91. 67 42 91. 43 22 93. 73 2 97. 78 - 18 103. 00 Profit + Total Marginal or loss Cost $100 ] 190 ] 270 ] 340 ] 400 ] 470 ] 550 ] 640 ] 750 ] 880 ] 1030 90 80 70 60 70 80 90 110 130 150 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 142 - 310

MONOPOLY REVENUES & COSTS Revenue Data Quantity Price of (Average Total Marginal Output Revenue) Revenue Can 0 you $172 see $ profit 0 ] $162 1 162 maximization? ] 142 2 3 4 5 6 7 8 9 10 152 142 132 122 112 102 92 82 72 304 ] 122 426 ] 102 528 ] 82 610 ] 62 672 ] 42 714 ] 22 736 ] 2 738 ] - 18 720 Cost Data Average Total Cost Profit + Total Marginal or loss Cost $100 90 - $100 ]= MC MR > - 28 $190. 00 190 80 ] 135. 00 270 70 + 34 ] 113. 33 340 60 + 86 ] 100. 00 400 70 + 128 ] 94. 00 470 80 + 140 ] 91. 67 550 90 + 122 ] 91. 43 640 110 + 74 ] - 14 93. 73 750 ] 130 97. 78 880 ] 150 - 142 - 310 103. 00 1030

IV. OUTPUT AND PRICE DETERMINATION § § Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions: • Not Highest Price • Total, Not Unit, Profit • Possibility of Losses Graphically…

OUTPUT AND PRICE DETERMINATION Case 1: Profit Maximization Under Monopoly Remember the MR=MC Rule? 200 Profit Per Unit Price, costs, and revenue 175 150 $122 125 $94 100 MC Profit ATC D 75 50 MR = MC 25 0 1 2 3 4 MR 5 6 7 8 9 10 Q

OUTPUT AND PRICE DETERMINATION Case 2 : Loss Minimization Under Monopoly 200 Since Pm exceeds. Loss AVC, Per Unit the firm will produce Price, costs, and revenue 175 MC ATC AVC 150 A 125 Loss Pm V 100 D 75 50 MR = MC 25 0 1 2 3 4 MR 5 Qm 6 7 8 9 10 Q

V. Economic Effects of Monopoly What are the Economic Effects of Monopoly? § § • • Monopoly pricing effectively creates an income transfer from buyers to the seller! X-Inefficiency: When the cost of producing is more than the lowest possible cost Monopolists are likely to experience X inefficiency than pure competition producers (who are under pressures) Rent-Seeking Behavior: using the monopolistic position to make more profits. Technological Advance: monopolists are less likely to care about Research & Development.

INEFFICIENCY OF PURE MONOPOLY P An industry in pure competition S = MC sells where supply and demand are equal At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Qm Qc Q

Average total costs ATCx X Inefficient internal operation leads to higher-thannecessary costs X’ ATC 1 ATCx’ ATC 2 Q 1 Quantity Q 2 Average Total Costs

VI. PRICE DISCRIMINATION Definition: the sale of a specific product at more than one price, and price differences are not justified by cost differences. Conditions: § Monopoly Power: the seller must be a monopolist or at least have some monopoly power (ability to control P&Q). § Market Segregation: the seller is able to segregate buyers into distinct classes based on different demand elasticities. § No Resale: the buyer cannot resell the good or service. Consequences: § More Profit: monopolist can gain more profits. § More Production: monopolist is willing to produce more

Price and Costs P Economic profits with a single MR=MC price MC ATC MR Q 1 D Q

Price and Costs P A perfectly discriminating monopolist has MR=D, producing more product and more profit! MC ATC MR=D D Q 1 Q 2 Q

VII. REGULATED MONOPOLY § Natural Monopolies: they are subject to rate (price) regulation. § Socially Optimum Price: if the objective is achieving allocative efficiency, the regulator should set a legal (ceiling) price equals the MC: P = MC § Fair-Return Price: because optimum price may lead to losses, price must be set where no losses occur, that’s at ATC: P = ATC

MR = MC Fair-Return Price and Costs P Dilemma of Regulation: Which Price? Pm Socially-Optimum Price ATC MC Pf Pr D MR Qm Qf Qr Q