MICROECONOMICS Theory Applications Chapter 11 Monopoly l By

MICROECONOMICS: Theory & Applications Chapter 11: Monopoly l. By Edgar K. Browning & Mark A. Zupan l. John Wiley & Sons, Inc. l 11 th Edition, Copyright 2012 l. Power. Point prepared by Della L. Sue, Marist College

Terminology Monopoly – a market with a single seller l Monopoly power – some ability to set price above marginal cost l Price maker – a monopoly that supplies the total market and can choose any price along the market demand curve that it wants l Copyright 2012 John Wiley & Sons, Inc. 2

The Monopolist’s Demand Marginal Revenue Curves l Demand curve market demand l average revenue l l Marginal revenue: effect on total revenue due to change in output l decreases as output increases l less than price when demand curve slopes downward l Copyright 2012 John Wiley & Sons, Inc. 3

Figure 11. 1 - The Monopolist’s (Desperate Housewives co-stars) Demand Curve Copyright 2012 John

Table 11. 1 Copyright 2012 John Wiley & Sons, Inc. 5

Profit-Maximizing Output of a Monopoly l Marginal revenue is always less than price when the demand curve slopes downward. l Profit is maximized where MR=MC: l l Copyright 2012 If MR>MC, then profits will increase if output is increased. If MR<MC, then profits will increase if output is decreased. John Wiley & Sons, Inc. 6

Table 11. 2 Copyright 2012 John Wiley & Sons, Inc. 7

Figure 11. 2 - Profit-Maximization: Total and per-Unit Curves Copyright 2012 John Wiley &

Figure 11. 3 - Profit Maximization Copyright 2012 John Wiley & Sons, Inc. 9

The Monopoly Price and Its Relationship to Elasticity of Demand The smaller the demand elasticity, the greater the profit-maximizing price, relative to marginal cost. Copyright 2012 John Wiley & Sons, Inc. 10

Figure 11. 4 - The Inverse Elasticity Pricing Rule Copyright 2012 John Wiley &

Further Implications of Monopoly Analysis A monopoly has no supply curve. l A monopoly does not necessarily make positive economic profit. l A monopoly’s demand curve is elastic where marginal revenue is positive. l A profit-maximizing monopolist will always sell at a price where demand is elastic. l Copyright 2012 John Wiley & Sons, Inc. 12

Figure 11. 5 - Monopoly and the Shutdown Condition Copyright 2012 John Wiley &

Figure 11. 6 - Monopoly Demand, Marginal Revenue, and Total Revenue Copyright 2012 John

Figure 11. 7 - Monopoly Power When There are Several Suppliers Copyright 2012 John

Measuring Monopoly Power Lerner Index – a means of measuring a firm’s monopoly power that takes the markup of price over marginal cost expressed as a percentage of a product’s price: Lerner Index = (P – MC)/P (3) l The Lerner index varies between zero and one. l The larger the Lerner index value, the greater a firm’s monopoly power. l Copyright 2012 John Wiley & Sons, Inc. 16

Sources of Monopoly Power l What factors determine the extent to which a firm has monopoly power? l The elasticity of the market demand curve l l If the market demand curve is perfectly elastic, any individual supplier has no monopoly power. The elasticity of supply by other firms l Copyright 2012 The monopoly power of any one firm is more limited when there is a greater number of rival firms. John Wiley & Sons, Inc. 17

Barriers to Entry l Barrier to entry – any factor that limits the number of firms operating in a market and thereby serves to promote monopoly power l Categories: l l Absolute cost advantage l A situation in which an incumbent firm’s production cost (long-run average total cost) is lower than potential rivals’ production costs at all relevant output levels Economies of scale l A situation in which the long-run average total cost curve for all firms slopes downward over the entire range of market output l Natural monopoly – an industry in which production cost is minimized if one firm supplies the entire output. (continued) Copyright 2012 John Wiley & Sons, Inc. 18

Barriers to Entry l (continued) Categories (continued): l Product differentiation l l Regulatory barriers l l l Copyright 2012 A means by which consumers may perceive the product sold by an incumbent firm to be superior to that offered by prospective rivals. Barriers to entry created by the government through vehicles such as patents, copyrights, franchises, and licenses Government purchases from particular firms Limits on nonprice competition, e. g. , advertising John Wiley & Sons, Inc. 19

Strategic Behavior by Firms: Incumbents and Potential Entrants l Factors affecting market power: Elasticity of demand l Number of other firms in industry l Elasticity of market demand l Elasticity of supply of other firms l Product homogeneity l Nature of the competition between firms l Possibility of entry by new firms l Copyright 2012 John Wiley & Sons, Inc. 20

Figure 11. 8 - Potential Entry and Monopoly Copyright 2012 John Wiley & Sons,

The Efficiency Effects of Monopoly l Comparison between perfectly competitive industry and monopoly: l l Perfectly competitive firm - horizontal MR Monopoly – downward-sloping MR Marginal cost curve is horizontal for both industry structures For the same demand cost conditions, price will be higher and output lower under monopoly than under competition. Copyright 2012 John Wiley & Sons, Inc. 22

Figure 11. 9 - The Deadweight Loss of Monopoly Copyright 2012 John Wiley &

A Dynamic View of Monopoly and Its Efficiency Implications l Static analysis – a form of economic analysis that looks at the efficiency of a market at any one point in time l l Dynamic analysis – a form of economic analysis that looks, over time, at the efficiency of a market l l Monopoly: less efficient than a perfectly competitive industry Monopoly: enhances social welfare in the creation of better products Which approach is more appropriate? It depends: l l l Pricing power provides incentive to innovate Competition increases total surplus Pricing power forestalls benefits of competition Copyright 2012 John Wiley & Sons, Inc. 24

Figure 11. 10 - A Dynamic View of Monopoly Copyright 2012 John Wiley &

Public Policy Toward Monopoly l Antitrust laws – a series of codes and amendments intended to promote a competitive market environment l 3 major statutes: Sherman Act (1890) l Clayton Act (1914) l Federal Trade Commission Act (1914) l Copyright 2012 John Wiley & Sons, Inc. 26

Regulation of Price l Price ceiling: l l l government-imposed maximum limit on price => restriction on output cannot result n higher price eliminates the monopolist’s reason for restraining output reduces monopoly profit benefits consumers by lowering price increases output to the efficient level, eliminating the deadweight loss from monopoly Limitations: l l l Copyright 2012 outcome depend upon where price ceiling is set Price should be high enough for profit>=0 Monopoly firm may decrease quality as a result John Wiley & Sons, Inc. 27

Figure 11. 11 - Regulation of Price Copyright 2012 John Wiley & Sons, Inc.

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