hall and lieberman, 3 rd edition, thomson south-western, chapter 9 monopoly
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Hall and Lieberman, 3rd edition, Thomson South-Western, Chapter 9
Monopoly
2
Overview
What you will learn in this lecture What is a monopoly? Why does a monopoly exist? How is monopolized optimal output / price
level determined? How is a monopoly different from a perfect
competitive firm? What happens when things change?
3
Part I. Monopoly Negative reputation of monopoly is in
many ways deserved Unfairly prices, extraordinary power, etc This negative characterization goes too far
Monopolies should be avoided in many markets, but in some it may be best to organize the production
We do better by managing monopoly problem, rather than eliminating it
4
What Is A Monopoly? A monopoly firm is the only seller of a good or
service with no close substitutes Monopoly market is the one where the monopoly firm
operates Key concept is notion of substitutability Example
How “close” are the substitutes in the real world? Depends on how broadly or how narrowly we define a
market when trying to decide if it is a monopoly Example
the only doctor, attorney or food market in a small town
5
Figure 1 What A Monopolist Does?
P2
D
M
P1C
Q2 Q1
S
Quantity
Price
6
What A Monopolist Does? Compared with a firm in perfectly
competitive market, a monopolist moves along the demand curve to produce less but charge a higher price To earn higher profit rather than zero profit The ability of a monopolist to raise its price
above the competitive level by reducing output is known as market power
Example Why don’t profit get competed away?
7
The Sources of Monopoly
Existence of a monopoly means that something is causing other firms to stay out of the market
What barrier prevents additional firms from entering the market? Several possible answers
Economies of scale Legal barriers Network externalities
8
I. Economies of Scale
Economies of scale: the higher output, the lower LRATC or the lower unit cost Example
If economies of scale persist to the point where the monopoly is producing for entire market, the market is a natural monopoly one firm can operate at lower average
cost than can two or more firms
9
Figure 2: A Natural Monopoly from Economy of Scale
M
Q
P
Quantity
Dollars
LRATC
DMarket
Natural monopolist’s break-even price
Relevant output range
10
I. Economies of Scale Why natural monopoly may exist?
Incumbent advantages Example: dry cleaning in a small town,
Figure 2 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
11
II. Legal Barriers
Sometimes public interest is best served by having a single seller in a market Purposely creating barriers leading to monopoly
Many monopolies arise because of legal barriers including Protection of intellectual property Government franchise
12
II. Legal Barrier -- Protection of Intellectual Property
Most important kinds of legal protection for intellectual property are Patents
Temporary grant of monopoly rights over a new product or scientific discovery
CopyrightsGrant of exclusive rights to sell a literary,
musical, or artistic work
13
II. Legal Barrier -- Protection of Intellectual Property
Government strikes a compromise 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
Free usage if not having purpose of making profit
14
II. Legal Barrier -- 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
Governments usually grant franchises when they think market is a natural monopoly
Example?
15
III. Network Externalities Exist when an increase in network’s
membership increases its value to current and potential members
Advantages of joining a large network more beneficial than joining a small network
The value to consumers of a good rises as the number of people who also use the good rises Example: computer operating systems
Microsoft Windows
16
Monopoly Goals & Constraints
Goal of a monopoly—Maximize profit like that of any firm
Noncompetitive firms make ONE decision Once firm determines its output level, it has also
determined its price Constraints
Cost constraint for any level of possible Q Technology of production Price it must pay for its inputs
Demand constraint maximum price monopolist can charge, given Q
17
Demand Constraints and MR
Monopoly firm faces a downward sloping demand curve, marginal revenue is less than price of output Graphically, marginal revenue curve will lie below
demand curve (figure 3a) Why?
By Intuition By Mathematics
Monopoly will always produce at an output level where marginal revenue is positive
18
Figure 3a: Demand and Marginal Revenue
5,000
BA
18
MR6,00020,000
21,00030,000
20
3038
4850
$60
Demand
F G
C
Number of Subscribers
Monthly Price per
Subscriber
15,000
19
Figure 3b:Profit Maximization by Monopoly-- MC curve crosses MR curve from below
E
MR10,000
MC
D
30,000
Number of Subscribers
Monthly Price per
Subscriber
40
$60
20
Profit And Loss
A monopoly earns a profit whenever P > ATC Profit is the shadow area in the Figure 4(a)
Height equal to P - ATC Width equal to level of output
A monopoly suffers a loss whenever P < ATC Loss is the shadow area in the Figure 4(b)
Height equal to ATC - P Width equal to level of output
21
Figure 4: Monopoly Profit and Loss
E
MR10,000
$40
MC
32
Total Profit
ATC
D
E
Total Loss
AVCATC
MR10,000
40
MC
D
$50
Dollars(a)
Number of Subscribers
Dollars(b)
Number of Subscribers
22
Part II. Equilibrium in Monopoly Markets
A monopoly market is in equilibrium when this only firm in market is maximizing profit
For monopoly—as for perfect competition—we have different expectations about equilibrium in short-run and equilibrium in long-run
23
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
24
Long-Run Equilibrium Remember that perfectly competitive
firms earn zero profit in the long-run equilibrium
However, monopolies may earn economic profit in the long-run May still benefit from economies of scale
A privately owned monopoly suffering an economic loss in long-run will exit the industry
25
Part III. Comparing Monopoly to Perfect Competition In perfect competition, economic profit is relentlessly
reduced to zero by entry of other firms In monopoly,
economic profit can continue indefinitely have a higher price and lower output than an
otherwise similar perfectly competitive market earns economic profit due to this reason
Consumers lose in two ways Pay more for output they buy Due to higher prices they buy less output
26
Figure 5a/b: Comparing Monopoly and Perfect Competition
100,000
E$10
D
S
1,000
ATCMC
d$10
Quantity of Output
Price per
Unit
(a) Competitive Market (b) Competitive FirmDollars
per Unit
Quantity of Output
2. and each firm produces 1,000 units, where P = MC.
1. In this competitive market of 100 firms, equilibrium price is $10
3. When monopoly takes over, the old market supply curve . . .
27
Figure 5c: Comparing Monopoly and Perfect Competition
100,000 Quantity of Output
Price per
Unit
E10
D
(c) Monopoly
S = MC
60,000
MR
$15F
6. with a higher price and lower market output than under perfect competition.
4. becomes the monopoly's MC curve.
5. The monopoly produces where MR = MC,
28
MC
MR
Demand
Figure 5d Comparison of the social loss between Monopoly and Perfect Competition
Competitive Competitive equilibriumequilibrium
Monopolistic Monopolistic equilibriumequilibriumPM
PC
29
Comparing Monopoly to Perfect Competition
Perfect Competition Monopoly
Firm’s choice Q P or Q
Profit maximization
P = MC MR=MC
Maximized Profit
Zero in the long runProfit / loss in the short run
Profit / loss in short run / long run with lower Q and
higher P than those in perfect competitive market
Characteristics Many firms; free entry & exit; undifferentiated goods
Entry barrier; only one firm; differentiated goods;
Technology’s effect
Still zero profit; usually P goes down and Q goes up
Generate higher profits; P and Q change is not
determined
30
Why Monopolies Often Earn Zero Economic Profit ?
Government regulation Rent-seeking activity
Any costly action a firm undertakes to establish or maintain its monopoly status
Example: Bribes to government officials in corrupt bureaucracies
Or time and money spent lobbying legislators and public for favorable polices in less corrupt governments
Rent-seeking activity is part of firm’s costs. It can reduce economic profit of a monopoly, even reduce it to zero.
31
Part IV. 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
32
I. An Increase in Demand
Monopolist’s reactions Producing more output Charging a higher price Earning a larger profit Figure 6
It will react to a decrease of demand by Reducing output Lowering price Suffering a reduction in profit
33
Figure 6: A Change in Demand
A
MR110,000
$40
MC
D1
30,000
(a)
Number of Subscribers
Monthly Price per
Subscriber
MR211,000
D2
$47B
A
D1
MR1
(b)
10,000
40
MC
Monthly Price per
Subscriber
Number of Subscribers
34
II. Cost-Saving Technological Advance
Benefits perspective: Monopoly’s profits will be higher after adoption
Only part of benefits are passed to consumers In perfect competitive market, all of the benefits are
passed to consumers Costs perspective:
After its cost increase, monopoly’s profits will be lower Only part of a cost increase onto consumers in form of a
higher price In perfect competitive market, all of the costs are passed
to consumers – have to pay higher prices
35
Figure 7: Monopoly Profit and Loss-- Increased Cost
Number of Subscribers
Dollars
ED
MR10,00012,000
$40MC2
MC1
D
38
36
Summary Monopoly has market power Possible reasons for existence of monopoly:
Economies of scale – natural monopolyLegal barriersNetwork externalities
Standard profit maximization approach (MR =MC) Profit or loss both in short run and long run
Rent seeking activity and zero profit Increase in demand / technology adoption
effects on monopolist’s decision
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