Monopoly Characteristics of a Monopoly Pure Monopoly exists

Monopoly

Characteristics of a Monopoly �Pure Monopoly: exists when a single firm is the sole producer of a product for which there are no close substitutes �There are several key characteristics of a monopoly, � 1) Single seller: a monopolist is the sole producer of a specific good � 2) No close substitutes: a pure monopoly’s product is unique in that there are no close substitutes � 3) Price maker: a pure monopolist controls the total quantity supplied and thus has considerable control over price � 4) Blocked entry: a pure monopolist has no immediate competitors because certain barriers keep potential

Barriers to Entry �Barriers to entry: are the factors that prohibit firms from entering an industry. �There are three types of barrier to entry: legal, natural and strategic �Legal barriers to entry: create a legal monopoly, a market in which competition and entry are restricted by, o Granting of a public franchise (e. g. Canada Post) o Government licensing (e. g. a license to practice law or medicine) o Patents and copyrights

�Natural barriers to entry: create a natural monopoly, which is an industry in which one firm can supply the entire market at a lower price than two or more firms can. o A firm is a natural monopoly if it exhibits increasing returns to scale (i. e. has a downward sloping long-run average cost (LRAC) curve) �Pricing and strategic barriers to entry: monopolists may slash prices, step up advertising, or take other strategic action to make it difficult for the entrant to succeed.

Examples of Monopoly �Examples of pure monopolies are relatively rare, but there are many examples of less pure forms o Cable TV companies (Rogers, Cogeco) o Government-regulated public utilities o Intel, provide 80 percent of microprocessors o Pfizer, patents for many pharmaceutical drugs o Professional sports teams, sole suppliers of specific services in large geographic areas

Demand curve for a Monopolist �Unlike a perfect competitor, a monopolist is a price maker �Since it is the sole producer of a product, it faces the market demand curve �That is, a monopolist’s demand curve is downward sloping �Under conditions of monopoly the marginal revenue curve is below the demand curve

Revenues for a Monopolist �A monopolist’s average revenue (AR) curve is the same as the downward-sloping market demand curve �A monopolist’s marginal revenue (MR) curve is also downward sloping but below the market demand curve �Example; Revenue schedules for IBM Price (P) Quantit y (Q) Total Marginal Averag Revenue e e (TR) (MR) Revenu e (AR) Total Cost (TC) Averag e Cost (AC) Marginal Cost (MC) 160 160 140 140 120 2 240 80 120 180 90 40 80 3 240 0 80 249 83 34. 5 40 4 160 -80 40 400 100 75. 5

�We can use the table to graph the marginal revenue and demand curves,

Monopolist- Profit Maximization �Profit-maximizing output rule: says that profit is maximized when the firm produces an output at which MR equals MC. o The MR = MC rule applies to all profit-maximizing firms regardless the market structures

�A monopolist produces an output level at which MR = MC �Hence, the monopolist’s optimal price is PM and optimal output is QM �Since a perfectly competitive firm faces a horizontal demand curve, where P = MR = AR �A perfectly competitive firm produces an output level at which P = MC �Hence, it’s optimal price is PC and optimal output is QC �A monopoly raises revenue by reducing output, relative to the competitive equilibrium, and increasing price �Monopolies do not allocate resources in a way that maximizes welfare and consequently they achieve a level of output that is allocative inefficient o P > MC

Profit Maximization for a Monopolist �A monopolist maximizes profit at the quantity where MR = MC �At this level of output, they charge the highest price possible, as found using the demand curve

�There are there possible cases when determining the profit maximizing output for a monopolist �If P < AC then Profit < 0 (i. e. the firm’s profit is negative) �If P = AC then Profit = 0 (i. e. the firm breaks even) �If P > AC then Profit > 0 (i. e. the firm’s profit is positive) o Supernormal profits can be achieved, and are common, in the long-run Supernormal Profit Negative Profit

Revenue Maximization �In some circumstances a monopoly make seek to maximize revenues, o Total revenue (TR) is maximized when MR = 0 o Monopolists who seek to maximize revenues will sell at lower prices and produce more output. o They will also earn less profit (B + C) than monopoly firms seeking to maximize profits (A + B)

Competition versus Monopoly �As a result of monopoly power, a monopolist charges a higher price and a lower quantity is produced than would occur if the market were perfectly competitive Demand Perfect Competition Monopoly Demand is perfectly elastic, P = MR = AR Demand is downward sloping, P = AR Profit. Produces at an output where P = MR Produces at an output Maximizing = MC level where MR = MC Output Rule �There are two possible scenarios when a monopolist take over the industry �Case 1: No economies of scale are available o The monopolist runs a multi-plant firm with a higher price and lower output than under perfect competition

�Case 2: Substantial economies of scale are present o The price under monopoly may well be lower than under perfect competition (i. e. PM < PPC) o The quantity under monopoly may be greater than under perfect competition (i. e. QM > QPC) o However, P > MC and resource allocation is nonoptimal

Regulation of Natural Monopolies �Natural monopoly is a market in which only one firm is economically viable because of increasing returns to scale �When an industry is a natural monopoly, the government usually intervenes in the industry to ensure that the cost savings of the monopolist are passed on to the consumers �A common way to regulate a natural monopolist is using average-cost pricing �Average-cost pricing is the practice of setting price where it equals average cost (P = AC) �Unregulated, the monopolist would produce QM and charge PM

�If the price were regulated to the competitive market price PC, the firm would lose money and go out of business o It wouldn’t be able to cover average cost (AC) �Setting the price at PR forces the firm to produce more, QR, and achieve a normal profit

Monopoly- Government Intervention �A monopolist will be less efficient than a purely competitive firm because the monopolist produces less output and charges a higher price o Allocative efficiency requires that P = MC o Productive efficiency requires that P = minimum ATC �Government’s often have legislation in place to limit monopoly power and use the following methods, o Taxation: taxes on profits can be imposed on monopolists to remove supernormal profits

o Subsidies: the government can subsidize the good to promote allocative efficiency. The subsidy shifts the MC curve to the right o Nationalizing the Industry: by making the monopoly government regulated or controlled the industry can be given price and output objectives to promote efficiency

o Price controls: a maximum price can be imposed on the industry where MC curve cuts the demand curve o Monopoly Break-up: if the monopoly can be costefficient at a smaller size, it can be broken up into competing units. This is suitable for a multi-plant monopoly

o Restriction on Mergers: the government may refuse permission for a merger to take place if it would lead the firms to have a controlling share of the market o Reduction of Entry Barriers: the barriers to other firms entering the industry may be reduced or removed by government action, allowing market forces to break up the monopoly o Changing Demand Technology: market forces may end a monopoly naturally without government intervention when are substantial changes in consumer demand technology

Example; Monopolist �Question: With the aid of at least one diagram, explain one way a consumer might gain from the behaviour of a monopolist and one way a consumer might lose from the behaviour of a monopolist. Solution- (10 Marks/20 Minutes) �Monopoly is a market structure in which there is a single firm that is the sole producer of a product for which there are no close substitutes �Since a monopolist is the sole producer of a product, it faces the market demand curve �That is, a monopolist’s demand curve is downward sloping and consequently relatively inelastic �Under conditions of monopoly the marginal revenue curve is below the demand curve

�This can be represented in the diagram below, �The monopolist chooses the profit maximizing level of output by setting marginal revenue equal to marginal cost (i. e. MR = MC) �Depending on the position of the average cost (AC) curve the monopolist may make supernormal, normal or negative profits �However, it is common for monopolists to earn supernormal

�Monopolists may benefit consumers through innovation or by achieving economies of scale �If substantial economies of scale are present, o The price under monopoly may be lower than under perfect competition (i. e. PM < PC) o The quantity under monopoly may be greater than under perfect competition (i. e. QM > QC)

�However, there are several ways in which a consumer might lose from the behaviour of a monopolist �Compared to a competitive industry, a monopolist will o Charge consumers a higher price (i. e. PM > PC) o Have a lower level of output (i. e. QM < QC) o Result in lower consumer surplus o Give rise to productive and allocative inefficiency �Deadweight loss: is a loss of economic efficiency that occurs when the equilibrium for a good or service is not Pareto optimal or allocatively efficient

�The deadweight loss is illustrated in the diagram below, �The loss in consumer surplus is represented by the upper half of the triangular region and the loss in producer surplus is represent by the lower half �This stems from the monopolist charging a higher price and producing less than under perfect competition

Study Questions � 1) The Clean Waters Company has a monopoly on selling bottled water in the local community. The firm is facing a downward demand curve. �A) Suppose that the Clean Waters is making a positive profit. Sketch the demand curve, marginal revenue curve, marginal cost curve, and average cost curve �B) profit (PM) �C) In your graph above, label and indicate the firm’s maximizing output (QM) and price If this were a perfectly competitive market, rather than a monopoly, what would be the equilibrium output level (QC) and (PC)?