Monopoly 2003 SouthWesternThomson Learning What Is a Monopoly

Monopoly © 2003 South-Western/Thomson Learning

What Is a Monopoly? A monopoly firm is the only seller of a good or service with no close substitutes. The market in which the monopoly firm operates is called a monopoly market.

Sources of Monopoly • Economies of Scale • Control of Scarce Inputs • Government-Enforced Barriers

Economies of Scale Natural Monopoly A market in which, due to economies of scale, one firm can operate at lower average cost than can two or more firms

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

Government-Enforced Barriers Patent A temporary grant of monopoly rights over a new product or scientific discovery.

Government-Enforced Barriers Copyright A grant of exclusive rights to sell a literary, musical, or artistic work

Government-Enforced Barriers Government Franchise A government-granted right to be the sole seller of a product or service –U. S. Postal Service –Local utilities, etc.

Monopoly Goals and Constraints • Monopoly Price or Output Decision • Profit and Loss

Monopoly Goals and Constraints For any level of output a firm might produce, total cost is determined by (1) its technology of production, and (2) the prices it must pay for its inputs. For any level of output it might produce, the maximum price it can charge is determined by the market demand curve for its product

Monopoly Goals and Constraints Monthly $60 Price per Subscriber 50 48 38 A B C 30 F 20 18 G Demand 5, 000 6, 000 15, 000 20, 000 21, 000 MR 30, 000 Number of Subscribers

Monopoly Price or Output Decision When any firm - including a monopoly faces a downward-sloping demand curve, marginal revenue is less than the price of output. Therefore, the marginal revenue curve will lie below the demand curve.

Monopoly Price or Output Decision A monopoly will never produce a level of output at which its marginal revenue is negative.

Monopoly Price or Output Decision Monthly $60 Price per Subscriber 40 MC E D 10, 000 MR 30, 000 Number of Subscribers

Profit and Loss A monopoly earns a profit whenever P>ATC and suffers a loss whenever P<ATC

Monopoly Profit and Loss (a) (b) Dollars MC ATC Total Profit $40 ATC Total Loss MC AVC $50 E 40 E 32 D D 10, 000 MR Number of Subscribers

Equilibrium in Monopoly Markets • Short-Run Equilibrium • Long-Run Equilibrium • Comparing Monopoly to Perfect Competition • Why Monopolies Often Earn Zero Economic Profit

Short-Run Equilibrium Any firm - including a monopoly should shut down if P<AVC at the output level where MR = MC.

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

Comparing Monopoly to Perfect Competition A monopoly market can be expected to have a higher price and lower output than an otherwise similar perfectly competitive market.

Comparing Monopoly to Perfect Competition (a) Competitive Market Price per Unit (b) Competitive Firm Dollars per Unit S MC ATC $10 d $10 E D 100, 000 1, 000 Quantity of Output (c) Monopoly Dollars per Unit $15 10 F S = MC E MR 60, 000 100, 000 D Quantity of Output

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

Monopolies Often Earn Zero Economic Profit 1. 2. Government regulation Rent-seeking activity

Monopolies Often Earn Zero Economic Profit Rent-Seeking Activity Any costly action a firm undertakes to establish or maintain its monopoly status

What Happens When Things Change? • A monopolist will react to an increase in demand by producing more output, charging a higher price, and earning a larger profit. • It will react to a decrease in demand by reducing output, lowering price, and suffering a reduction in profit.

What Happens When Things Change? (a) (b) Monthly Price per Subscriber MC MC B $47 $40 A D 1 10, 000 30, 000 Number MR 1 of Subscribers 10, 000 D 2 MR 1 11, 000 MR 2 Number of Subscribers

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

Price Discrimination Single-Price Monopoly A monopoly firm that is limited to charging the same price for each unit of output sold.

Price Discrimination Charging different prices to different customers for reasons other than differences in cost.

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

Effects of Price Discrimination Price discrimination that harms consumers: when prices are above the price consumers would pay under a single price policy. The additional profit for the firm is equal to the monetary loss of consumers

Effects of Price Discrimination Price discrimination that benefits consumers: when the price for some consumers is below what they would pay under a single-price policy. This benefits both the consumer and the firm.

Effects of Price Discrimination (a) (b) Dollars per Ticket Additional profit from price discrimination MC MC $160 $120 E ATC 120 80 D MR 30 MR 10 Number of Round-trip Tickets 30 (c) Dollars per Ticket MC Additional profit from price discrimination $120 100 G F H MR 30 40 D Number of Round-trip Tickets

Perfect Price Discrimination Charging each customer the most he or she would be willing to pay for each unit purchased

Perfect Price Discrimination Dollars per Doll H MR curve before price discrimination $30 E 25 10 B J D MR 20 30 MC = ATC 60 Number of Dolls per Day