monopoly

MonopolyMonopoly

OutlineOutline

I. Introduction

A. Definition

B. Barriers to Entry

II. Monopoly in the Short-Run

A. Demand

B. Profit Maximization in the Short-Run

Outline (Cont.)Outline (Cont.)

III. Monopoly in the Long-Run

A. Losses in the Short-Run

B. Break-Even or Profits in the Short-Run

IV. Advantages and Disadvantages of Monopoly

A. Benefits

B. Disadvantages

IntroductionIntroduction

• Perfect Competition was one type of market structure. It had to satisfy many assumptions - some of which are not all that realistic. Now we will look at another market structure which is nearly he opposite of perfect competition

• Monopoly - a single firm that produces all the output in a particular market with no close substitutes and high barriers to entry.

Barriers to EntryBarriers to Entry

• Barriers to Entry are what keeps monopoly from becoming like a perfectly competitive market

• Barriers to entry are things that prevent firms from entering the market. Such as...

• Control of Raw Materials• Example: The DeBeer’s family owns most of the

diamond mines in the world

• Economies of Scale

Barriers to Entry (Cont.)Barriers to Entry (Cont.)

• Patents and Copyrights– Patents - an exclusive right, granted by the

government, to market a product or process for 17 years.

– Copyrights - an exclusive right, granted by the government, to publish, copy or sell a piece of music, art or literature.

• Other Legal Restrictions– Example: U.S. Mail, Cable Monopolies, etc.

Monopoly in the Short-RunMonopoly in the Short-Run

• What makes monopoly different from perfect competition is the firm’s demand curve.

• Since the firm is the market, the firm’s demand curve is the market demand curve

• Hence, it’s downward sloping

Monopoly in the Short RunMonopoly in the Short Run

• A profit-maximizing monopolist, then not only chooses how much to produce, but also chooses what price to charge.

• What prevents a monopolist from charging an amazingly high price?– there may not be much demand at that price

• So a monopolist wants to get the highest price that maximizes their profit

Monopoly and Total RevenueMonopoly and Total Revenue

• Profits = Total Revenue - Total Cost

• But Total Revenue is different for a monopolist than in perf. comp.

• In perf. comp. the moreyou sell, the more the total revenue, but now if you sell more you have to lower your price.

• Remember when we discussed elasticity, we looked at how total revenue changes as you move down a demand curve

Monopoly and Total RevenueMonopoly and Total Revenue

Total Revenue

Demand

$

$

Q

Q

Elasticity = 1Elastic

Inelastic

Monopoly ProfitMonopoly Profit

• So does a monopolist want to produce at the quantity where elasticity equals 1 and total revenue is at a maximum?– Not necessarily. Remember we need to

consider total cost, as well

• The monopolist wants to maximize the difference between total revenue and total cost

Total Revenue and Total CostTotal Revenue and Total Cost

$

Q

TC

TR

Q*

Monopoly Profit MaximizationMonopoly Profit Maximization

• Like perfect competition, this is the quantity where the slopes of the TC and TR curves are the same

• And also like perfect competition, this is the quantity where MR=MC.

• But the MR curve looks different, since the demand curve is downward sloping

D and MRD and MR

Qd P ($)0 101 82 63 44 25 0

D and MRD and MR

Qd P ($) TR ($)0 10 01 8 82 6 123 4 124 2 85 0 0

D and MRD and MR

Qd P ($) TR ($) MR ($)0 10 0 ---1 8 8 82 6 12 43 4 12 04 2 8 -45 0 0 -8

D and MRD and MR

P

Q5

$10

D

0 1 2 3 4

24

6

8

D and MRD and MR

P

Q5

$10

D

0 1 2 3 4

24

6

8

MR

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

Profit MaximizingProfit Maximizing

• So the monopolist chooses the quantity where MC=MR (a quantity of 2, in this example)

• If they chose less, MR>MC so they could get more money from selling one more than it would cost to make one more.

• But they also get to choose the price• They choose the highest price they can charge

in order to sell Q*

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

Profit MaximizingProfit Maximizing

• The price is found by looking to the demand curve and finding the price people are will to pay in order to buy the quantity the firm wants to produce

• In the case of this example, this is a price of about $6.50

• How do we show the profit in this case?

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVC

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVCatc*

p*

Profit MaximizingProfit Maximizing

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVCatc*

p*

Profit

Shut Down RulesShut Down Rules

• A monopolist faces the same short run shut down rules as a perfectly competitive firm for all of the same reasons

• As long as P>AVC, the firm is paying off some fixed cost and should stay open in the short run

• If P<AVC, the firm should shut down. Just because the firm is a monopolist, does not guarantee a profit.

A Monopolist Who Should Shut A Monopolist Who Should Shut DownDown

MCP

Q5

$10

D

0 1 2 3 4

24

6

8

MR

ATC

AVCatc*

p*

Profit MaximizingProfit Maximizing

• Q* - where MR = MC (profit maximization)• P* - highest P consumers are willing and able

to pay for Q*• Demand curve at Q*

• In the Short-Run a Monopolist may• Make Profits• Break Even• Operate at a Loss

Profit MaximizingProfit Maximizing

• Note that a Monopolist always Operates on Elastic Portion of Demand Curve• Profit Maximizing - MR = MC• MC > 0 always• MR > 0 when demand is elastic

Monopoly in the Long-RunMonopoly in the Long-Run

• If Losses in Short-Run• Firm exits the Industry• Industry Disappears

• If Profits or Break-Even in the Short-Run• Profit may or may not persist in the long run

Benefits of MonopolyBenefits of Monopoly

• Natural Monopoly - a monopolist whose ATC decreases over the relevant range of output.

• Economies of Scale - monopolist can produce at lower costs.

Why Monopoly Profits May Why Monopoly Profits May PersistPersist

• Since there are barriers to entry, firms don’t enter the industry and drive down prices

Why Monopoly Profits May Not Why Monopoly Profits May Not PersistPersist

• When Selling The Firm– If the firm is sold for the value of future profits,

the new owner of the monopoly will make zero profits or certainly less profit

• Auctioning of the Monopoly Rights (Rent Seeking)– Ex. - If the govt. auctioned off the right to be the

monopolist, they price for this right would eventually equal the expected profit

Benefits of MonopolyBenefits of Monopoly

• While Costs are lower, price can still be relatively "high" since P > MC in monopoly.

• Sometimes, Gov. regulates natural monopolies to lower price.• Ex: Utilities

• A Natural Monopoly is an industry where is can be cheaper to let one firm provide the good (because of econ. of scale, etc)

Natural MonopolyNatural Monopoly

P

QDMR

ATC

Natural MonopolyNatural Monopoly

P

QDMR

MC

ATC

Benefits of MonopolyBenefits of Monopoly

• Technological Innovations• Incentive for monopoly profits gives firm an

incentive to innovate.

Costs of MonopolyCosts of Monopoly

• To begin to understand the costs of monopoly, we need to introduce another concept– Producer Surplus

• Producer Surplus - the revenue received by the firm above the marginal cost

Producer SurplusProducer SurplusP

Q

MCp

Q

Producer SurplusProducer Surplus

P

Q

MCp

Q

The Shaded Area is the Producer Surplus

Comparison of Monopoly and Comparison of Monopoly and Perfect CompetitionPerfect Competition

• We can compare Monopoly and Perfect Competition by looking at the total amount of social surplus (consumer surplus plus producer surplus) generated by both and then comparing them.

Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.

P

Q

D

0

MR

MC

QMonop

PMonop

Qperf comp

Pperf comp

Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.

P

Q

D

0

MR

MC

QMonop

PMonop

Qperf comp

Pperf comp

Total Surplusfor PerfectCompetition

Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.

P

Q

D

0

MR

MC

QMonop

PMonop

Qperf comp

Pperf comp

Total Surplusfor Monopoly

Dead Weight LossDead Weight Loss

• If we take the difference between the total social surplus under perfect competition and subtract the total surplus under monopoly we find the dead weight loss

• This is the loss in surplus to consumers and producers from having a monopoly

Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.

P

Q

D

0

MR

MC

QMonop

PMonop

Qperf comp

Pperf comp

The area of this triangleis the dead weight loss

Disadvantages of MonopolyDisadvantages of Monopoly

• Inefficient Allocation of Resources• Allocatively Inefficient (P > MC)• Productively Inefficient (P not = min ATC)

Price Discriminating MonopolistPrice Discriminating Monopolist

• A price discriminating monopolist is a monopolist who can charge different prices to different customers for the same good or service.

• In order to be a price discriminator you need– at least 2 types of consumers with different

elasticities of demand– to be able to distinguish between the types– to be able to prevent one type from re-selling the

good to the other

Examples of Price Examples of Price Discriminating BehaviorDiscriminating Behavior

• Coupons

• Airline Tickets

• Dry Cleaning and Haircuts (?) (…think gender)

The idea is that the monopolist charges a higher price to the consumer with more inelastic demand

Perfect Price DiscriminationPerfect Price Discrimination

• A Perfectly Price Discriminating Monopolist is a monopolist who charges everyone exactly what they are willing to pay

• In other words, they work their way down the demand curve, lowering the price only to those who aren’t willing to pay the high price, until P=MC

• Example - Auctions

Perfect Price DiscriminationPerfect Price Discrimination

Note that in this case there is no dead weight loss AND the firm is allocatively efficient