Transcript Econ 101: Microeconomics Chapter 9: Monopoly

Econ 101:
Microeconomics
Chapter 9:
Monopoly
What Is A Monopoly?

A monopoly firm is the only seller of a good or service
with no close substitutes
• Market in which the monopoly firm operates is called a
monopoly market

Existence of a monopoly means that something is
causing other firms to stay out of the market
•

Rather than enter and compete with firm already there
What barrier prevents additional firms from entering
the market?
•
Several possible answers
•
•
•
Economies of scale
Network externalities
Legal barriers
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Economies of Scale

If economies of scale persist to the point where
a single firm is producing for entire market, the
market is a natural monopoly
•


Market in which, due to economies of scale, one firm
can operate at lower average cost than can two or
more firms
Unless government intervenes, only one seller
would survive—market would naturally become
a monopoly
Small local monopolies are often natural
monopolies
•
Because they continue to enjoy economies of scale up
to point at which they are serving entire market
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Figure 1: A Natural Monopoly
Dollars
A
15
B
12
LRATC
C
5
DMarket
300
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350
Pieces of Clothing
per Week
4
Network Externalities


Exist when an increase in network’s
membership increases its value to current and
potential members
When network externalities are present, joining
a large network is more beneficial than joining
a small network
•

Even if product in larger network is somewhat inferior
to product in smaller one
In addition to advantages of joining a larger
network
•
Advantage in not leaving it once you’ve joined
• Avoiding switching costs
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Network Externalities

All of this clearly applies to the market for computer
operating systems
•
When you buy a computer already loaded with Microsoft
Windows, you benefit
•
•
•
•
By having a large number of people with whom you can easily
share documents
Huge number of computers everywhere you can easily operate
You gain access to many more software programs, like
Microsoft Word, Excel, or Outlook, since many more
programs are designed for Windows than for the few
alternatives
You can save time by just calling knowledgeable friends or
coworkers
•
Rather than attempting to contact technical support
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Legal Barriers


Sometimes public interest is best served by
having a single seller in a market
Many monopolies arise because of legal
barriers including
•
•
Protection of intellectual property
Government franchise
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Protection of Intellectual Property


The words you are reading right now are an example of intellectual
property, which includes literary, artistic and musical works, and
scientific inventions
In dealing with intellectual property government strikes a
compromise
•
•

Most important kinds of legal protection for intellectual property are
•
•

Allows creators of intellectual property to enjoy a monopoly and earn
economic profit, but only for a limited period of time
Once time is up, other sellers are allowed to enter the market, and it is
hoped that competition among them will bring down prices
Patents
•
Temporary grant of monopoly rights over a new product or scientific discovery
Copyrights
•
Grant of exclusive rights to sell a literary, musical, or artistic work
Copyrights and patents are often sold to another person or firm, but
this does not change monopoly status of the market.
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Government Franchise

Large firms we usually think of as monopolies
have their monopoly status guaranteed
through government franchise
•


Grant of exclusive rights over a product
Barrier to entry is
•
Any other firm that enters the market will be
prosecuted
Governments usually grant franchises when
they think market is a natural monopoly
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Monopoly Goals And Constraints


Goal of a monopoly—like that of any firm—is to
earn highest profit possible
However, a monopolist faces constraints
•
Constraint on monopoly’s cost
• For any level of output it might produce, total cost is
determined by
•
•
•
Technology of production
Price it must pay for its inputs
Demand constraint
• Monopolist’s demand curve tells us maximum price
•
monopolist can charge to sell any given quantity of
output
And for any level of output it might produce, maximum
price it can charge is determined by market demand
curve for its product
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Monopoly Price or Output Decision

Noncompetitive firms—such as monopolies—do not
make two separate decisions about price and quantity,
but rather one decision
•

When any firm—including a monopoly—faces a
downward sloping demand curve, marginal revenue is
less than price of output
•

Once firm determines its output level, it has also determined
its price
Therefore, marginal revenue curve will lie below demand
curve
Monopoly will always produce at an output level where
marginal revenue is positive
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Figure 2: Demand and Marginal
Revenue
Monthly $60
Price per
Subscriber 50
48
38
30
A
B
C
F
20
18
G
Demand
5,000
6,000
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15,000 20,000
30,000
MR 21,000
Number of Subscribers
12
The Profit-Maximizing Output Level

To maximize profit, the firm should
produce level of output where MC = MR
and
• MC curve crosses MR curve from below

For a monopoly, price and output are not
independent decisions
• But different ways of expressing the same
decision
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Figure 3: Monopoly Price and Output
Determination
Monthly $60
Price per
Subscriber
40
MC
E
D
10,000
30,000
MR
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Profit And Loss

A monopoly earns a profit whenever P > ATC
•
Its total profit at best output level equals area of a
rectangle
• Height equal to distance between P and ATC
• Width equal to level of output

A monopoly suffers a loss whenever P < ATC
•
Its total loss at best output level equals area of a
rectangle
• Height equal to distance between ATC and P
• Width equal to level of output
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Figure 4: Monopoly Profit and Loss
(a)
Dollars
MC
(b)
ATC
MC AVC
Dollars
ATC
$50
E
$40
40
32
E
Total Loss
Total
Profit
D
D
10,000
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Number of
MR Subscribers
10,000
Number of
MR Subscribers
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Equilibrium in Monopoly Markets

A monopoly market is in equilibrium
when the only firm in market
• The monopoly firm is maximizing profit

For monopoly—as for perfect
competition—we have different
expectations about equilibrium in shortrun and equilibrium in long-run
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Short-Run Equilibrium



Monopoly may earn an economic profit or
suffer an economic loss
What if a monopoly suffers a loss in short-run?
•
Any firm should shut down if P < AVC at output level
where MR = MC
If monopoly suddenly finds that P < AVC,
government will usually not allow it to shut
down,
•
Instead use tax revenue to make up for firm’s losses
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Long-Run Equilibrium



Important insights of previous chapter—
perfectly competitive firms cannot earn a
profit in long-run equilibrium
However, monopolies may earn
economic profit in long-run
A privately owned monopoly suffering an
economic loss in long-run will exit the
industry
• Should not find privately owned monopolies
suffering economic losses in long-run
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Comparing Monopoly to Perfect
Competition

In perfect competition, economic profit is relentlessly
reduced to zero by entry of other firms
•

But monopoly differs from perfect competition in another
way
•


In monopoly, economic profit can continue indefinitely
Can expect a monopoly market to have a higher price and
lower output than an otherwise similar perfectly competitive
market
By raising price and restricting output, new monopoly
earns economic profit
Consumers lose in two ways
•
•
Pay more for output they buy
Due to higher prices they buy less output
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Figure 5a/b: Comparing Monopoly
and Perfect Competition
(a) Competitive Market
Price
per
Unit
Dollars
per
Unit
S
(b) Competitive Firm
2. and each firm produces
1,000 units, where P = MC.
MC
ATC
E
$10
3. When monopoly $10
takes over, the old
market supply
curve . . .
d
D
Quantity of
100,000
Output
1. In this competitive
market of 100 firms,
equilibrium price is $10
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1,000
Quantity of
Output
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Figure 5c: Comparing Monopoly and
Perfect Competition
(c) Monopoly
Price
per
Unit
$15
S = MC
4. becomes the monopoly's MC curve.
F
E
5. The monopoly produces where MR = MC,
10
6. with a higher price and lower market
output than under perfect competition.
MR
100,000
D
Quantity of
Output
60,000
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Comparing Monopoly to Perfect
Competition

Changeover from perfect competition to monopoly benefits
owners of monopoly and harms consumers of the product
•

In comparing monopoly and perfect competition, price is
higher and output is lower under monopoly if all else is equal
General conclusion
•
Monopolization of a competitive industry leads to two
opposing effects
•
•
•
For any given technology of production, monopolization leads to
higher prices and lower output
Changes in technology of production made possible under
monopoly may lead to lower prices and higher output
Ultimate effect on price and quantity depends on relative
strengths of two effects
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Why Monopolies Often Earn Zero
Economic Profit



Forces tending to cut monopoly profits
•
•
Any costly action a firm undertakes to establish or maintain its
monopoly status is called rent-seeking activity
In countries with corrupt bureaucracies, rent-seeking activity
includes bribes to government officials
•

Government regulation
Rent-seeking activity
In less corrupt governments, it includes time and money spent lobbying
legislators and public for favorable polices
Rent-seeking activity that helps establish or maintain a firm’s
monopoly position is part of firm’s costs
•
As a result, rent-seeking activity can reduce economic profit of a monopoly
•
May even reduce it to zero
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What Happens When Things Change?

Once a monopoly is maximizing profit, it has no
incentive to change its price or its level of output
•


Unless something that affects these decisions changes
Possible events
•
•
Change in demand for monopolist’s product
Change in its costs
What might cause a monopolist to experience a
shift in demand?
•
Possible causes are the same as for perfect competition
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An Increase in Demand and a CostSaving Technological Advance



Monopolist will react to an increase in demand by
•
•
•
It will react to a decrease of demand by
•
•
•
Reducing output
Lowering price
Suffering a reduction in profit
In general, monopoly will pass to consumers only part of
benefits from a cost-saving technological change
•

Producing more output
Charging a higher price
Earning a larger profit
After change in technology, monopoly’s profits will be higher
In general, a monopoly will pass only part of a cost increase
onto consumers in form of a higher price
•
After its cost increase, monopoly’s profits will be lower
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Figure 6: A Change in Demand
(a)
Monthly
Price per
Subscriber
MC
(b)
Monthly
Price per
Subscriber
$47
40
A
$40
MC
B
A
D1
10,000 MR1 30,000
Number of Subscribers
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D1 D2
10,000 MR1
11,000
MR2 Number of
Subscribers
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Figure 7: Monopoly Profit and Loss
Dollars
MC1
$40
38
E
D
MC2
D
10,000
MR
Number of Subscribers
12,000
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Price Discrimination
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
Single-price monopoly
•
Firm that is limited to charging same price for each
unit of output sold
Price discrimination occurs when a firm
charges different prices to different customers
for reasons other than differences in costs
Price-discriminating monopoly does not
discriminate based on prejudice, stereotypes,
or ill-will toward any person or group
•
Rather, it divides its customers into different
categories based on their willingness to pay for good
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Requirements for Price
Discrimination


Although every firm would like to practice price
discrimination, not all of them can
To successfully price discriminate, three
conditions must be satisfied
•
•
•
Must be a downward-sloping demand curve for the
firm’s output
Firm must be able to identify consumers willing to pay
more
Firm must be able to prevent low-price customers from
reselling to high-price customers
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Price Discrimination That Harms
Consumers

Price discrimination always benefits
owners of a firm
• Can use this ability to increase its profit

When price discrimination raises price
for some consumer above price they
would pay under a single-price policy it
harms consumers
• Additional profit for the firm is equal to
monetary loss of consumers
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Figure 8a: Price Discrimination
(a)
Dollars per
Ticket
MC
$120
E
ATC
80
MR
30
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Number of Round-trip Tickets
32
Figure 8b: Price Discrimination
(b)
Dollars per
Ticket
Additional profit from
price discrimination
MC
$160
120
MR
10
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D
Number of Round-trip Tickets
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Figure 8c: Price Discrimination
(c)
Dollars per
Ticket
MC
$120
100
G
Additional profit from
price discrimination
F
H
MR
30
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D
Number of Round-trip Tickets
34
Price Discrimination That Benefits
Consumers


Price discrimination benefits monopoly at
the same time it benefits a group of
consumers
Since no one’s price is raised, no one is
harmed by this policy
• When price discrimination lowers price for
some consumers below what they would pay
under a single-price policy, it benefits
consumers as well as firm
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Perfect Price Discrimination


Suppose a firm could somehow find out maximum price
customers would be willing to pay for each unit of output it sells
It could increase profits even further by practicing perfect price
discrimination
•
•

Perfect price discrimination is very difficult to practice in the real
world
•

Firm charges each customer the most the customer would be willing
to pay for each unit he or she buys
Increases profit at expense of consumers
Would require firm to read its customers’ minds
Marginal revenue is equal to price of additional unit sold
•
Firm’s MR curve is same as its demand curve
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Figure 9: Perfect Price Discrimination
Dollars per
Doll
H
MR curve before
price discrimination
$30
E
25
10
B
J
MR
20
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60
MC = ATC
D
Number of Dolls
per Day
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Using the Theory



Movie tickets
•
•
•
Have local monopoly power
Lower price for children, students and senior citizens than for other patrons.
Raise profit by price discrimination
Airline prices
•
•
Seats sold at many different prices
Lower prices for round-trip if the traveler stays over a Saturday night. Why?
• Helps to separate business traveler from personal traveler
• Business traveler has higher willingness to pay and most likely does not
want to stay over a Saturday night
Financial aid
•
•
•
•
•
Many colleges and universities give financial aid to students.
Wealthy students have higher willingness to pay than needy students.
By charging higher tuition and selectively offering financial aid schools charge
prices to customers based on the value they place on going to school.
Financial aid has been used as an effective method of price discrimination
Designed to increase revenue of the college
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