copyright © 2002 by thomson learning, inc. to accompany exploring economics 3rd edition by robert...

Copyright © 2002 by Thomson Learning, Inc.

to accompanyto accompany

Exploring EconomicsExploring Economics3rd Edition3rd Edition

by Robert L. Sextonby Robert L. SextonCopyright © 200Copyright © 20055 Thomson Learning, Inc. Thomson Learning, Inc.

Thomson Learning™ is a trademark used herein under license.Thomson Learning™ is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICSEXPLORING ECONOMICS, 3, 3rdrd EditionEdition by by Robert L. Sexton as an assigned textbook may reproduce material from this publication for Robert L. Sexton as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or classroom use or in a secure electronic network environment that prevents downloading or

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A Lecture PresentationA Lecture Presentation


MonopolyMonopoly

Chapter 12Chapter 12


12.1 Monopoly: The Price 12.1 Monopoly: The Price Maker Maker

A true or pure A true or pure monopolymonopoly exists exists where there is only one seller of a where there is only one seller of a product for which no close substitute product for which no close substitute is available.is available.

The firm and “the industry” are one The firm and “the industry” are one and the same. and the same.


Because a monopoly firm faces the Because a monopoly firm faces the industry demand curve, it can pick industry demand curve, it can pick the most profitable point on that the most profitable point on that demand curve. demand curve.

Monopolists are price makers (rather Monopolists are price makers (rather than takers) who try to pick the price than takers) who try to pick the price that will maximize their profits. that will maximize their profits.


Pure Monopoly is a RarityPure Monopoly is a Rarity

Pure monopolies are a rarity because Pure monopolies are a rarity because few goods and services truly have few goods and services truly have only one producer.only one producer.


Near-monopoly conditions may exist, Near-monopoly conditions may exist, such as many public utilities, but such as many public utilities, but absolute total monopoly is rather absolute total monopoly is rather unusual. unusual.

However, the number of situations However, the number of situations where monopoly conditions are fairly where monopoly conditions are fairly closely approximated are numerous closely approximated are numerous enough to make the study of enough to make the study of monopoly useful.monopoly useful.


Barriers to EntryBarriers to Entry For a monopoly to persist, it must be virtually For a monopoly to persist, it must be virtually

impossible for other firms to overcome barriers impossible for other firms to overcome barriers to entry. to entry.

Barriers to entryBarriers to entry legal barrierslegal barriers

franchisingfranchising licensinglicensing patentspatents

economies of scaleeconomies of scale control of important inputscontrol of important inputs


The situation in which one large firm The situation in which one large firm can provide the output of the market at can provide the output of the market at a lower cost than two or more smaller a lower cost than two or more smaller firms is called a firms is called a natural monopolynatural monopoly. . With a natural monopoly, it is more With a natural monopoly, it is more efficient to have one firm produce the efficient to have one firm produce the good. The reason for the cost good. The reason for the cost advantage is economies of scale advantage is economies of scale throughout the relevant output range.throughout the relevant output range.


Quantity of Output


Another barrier to entry is control Another barrier to entry is control over an important input.over an important input. Alcoa's control over aluminum in the Alcoa's control over aluminum in the

1940s 1940s DeBeers control over much of the world's DeBeers control over much of the world's

output of diamondsoutput of diamonds


12.2 Demand and Marginal 12.2 Demand and Marginal Revenue in Monopoly Revenue in Monopoly

In monopoly, the market demand In monopoly, the market demand curve may be regarded as the curve may be regarded as the demand curve for the firm's product demand curve for the firm's product because the monopoly firm is the because the monopoly firm is the market for that particular product.market for that particular product.


Unlike perfect competition, the Unlike perfect competition, the demand curve for a monopolist’s demand curve for a monopolist’s product is downward sloping because product is downward sloping because the market demand curve is the market demand curve is downward sloping. downward sloping. If the monopolist reduces output, the If the monopolist reduces output, the

price will rise.price will rise. If the monopolist expands output, the If the monopolist expands output, the

price will fall.price will fall.


Pri

ce


The marginal revenue curve for a The marginal revenue curve for a monopolist lies below the demand monopolist lies below the demand curve.curve. In order to get revenue from marginal In order to get revenue from marginal

customers, the firm has to lower the customers, the firm has to lower the price.price.

So marginal revenue is always less than So marginal revenue is always less than price. price.


In monopoly, if the seller wants to In monopoly, if the seller wants to expand output, it will have to lower its expand output, it will have to lower its price on all units.price on all units.


That means that the monopolist That means that the monopolist receives additional revenue from the receives additional revenue from the new unit sold, but it will receive less new unit sold, but it will receive less revenue on all of the units it was revenue on all of the units it was previously selling. previously selling.

So when the monopolist cuts price to So when the monopolist cuts price to attract new customers, the old attract new customers, the old customers benefit.customers benefit.


In Exhibit 4, we can compare marginal In Exhibit 4, we can compare marginal revenue for the competing firm with revenue for the competing firm with the marginal revenue for the the marginal revenue for the monopolist.monopolist.


The Monopolist’s Price in the Elastic The Monopolist’s Price in the Elastic Portion of the Demand CurvePortion of the Demand Curve

The relationship between the The relationship between the elasticity of demand and marginal elasticity of demand and marginal and total revenue are shown in and total revenue are shown in Exhibit 5.Exhibit 5. In the elastic portion of the curve, when In the elastic portion of the curve, when

the price falls, total revenue rises, so that the price falls, total revenue rises, so that marginal revenue is positive. marginal revenue is positive.

In the inelastic portion of the curve, when In the inelastic portion of the curve, when the price falls, total revenue falls, so that the price falls, total revenue falls, so that marginal revenue is negative. marginal revenue is negative.


A monopolist will never knowingly A monopolist will never knowingly operate in the inelastic portion of its operate in the inelastic portion of its demand curve. demand curve. Increased output will lead to lower total Increased output will lead to lower total

revenue and higher total cost in that revenue and higher total cost in that region.region.


12.3 The Monopolist's 12.3 The Monopolist's Equilibrium Equilibrium

The monopolist, like the perfect The monopolist, like the perfect competitor, will maximize profits at competitor, will maximize profits at that output where that output where MRMR = = MCMC. Profits . Profits continue to grow until that output is continue to grow until that output is reached. reached.

Therefore, the equilibrium output is Therefore, the equilibrium output is where where MRMR = = MCMC..


Three Step Method for Three Step Method for MonopolistsMonopolists

The three-step method for determining The three-step method for determining economic profits, economic losses, or zero economic profits, economic losses, or zero economic profitseconomic profits Find where Find where MRMR equals equals MC,MC, which is the which is the

profit-maximizing output level. profit-maximizing output level. Go straight up to the demand curve, then Go straight up to the demand curve, then

left to find the corresponding market price.left to find the corresponding market price. Find Find TCTC as as ATCATC times the quantity produced. times the quantity produced.

TCTC = = ATCATC QQ


If If TRTR > > TCTC (the price exceeds average (the price exceeds average total cost), the monopolist is total cost), the monopolist is generating economic profits.generating economic profits.

If If TRTR < < TCTC (the price is less than (the price is less than average total cost), the monopolist is average total cost), the monopolist is generating economic losses.generating economic losses.

Profits for a MonopolistProfits for a Monopolist


In perfect competition, profits in an In perfect competition, profits in an economic sense will persist only in the economic sense will persist only in the short run because in the long run,short run because in the long run, new firms will enter the industry, new firms will enter the industry, increasing industry supply increasing industry supply and thus driving down the price of the and thus driving down the price of the

good. good. Thus, profits are eliminated.Thus, profits are eliminated.


In monopoly, profits are not In monopoly, profits are not eliminated because barriers to entry eliminated because barriers to entry exist. exist.

Other firms cannot enter, so Other firms cannot enter, so economic profits can persist in the economic profits can persist in the long run.long run.


Being a sole supplier does not Being a sole supplier does not guarantee that consumers will guarantee that consumers will demand your product.demand your product.

A monopolist will incur a loss if there A monopolist will incur a loss if there is insufficient demand to cover is insufficient demand to cover average total costs at any price and average total costs at any price and output combination along the demand output combination along the demand curve.curve.

Losses for the MonopolistLosses for the Monopolist


PatentsPatents

Patents and copyrights Patents and copyrights examples of monopoly powerexamples of monopoly power designed to provide an incentive to develop designed to provide an incentive to develop

new productsnew products The fall in the price of a patented good The fall in the price of a patented good

when the patent expires illustrates the when the patent expires illustrates the effect of introducing competition.effect of introducing competition.


12.4 Monopoly and12.4 Monopoly and Welfare Loss Welfare Loss

The major objections to monopolyThe major objections to monopoly not “fair” for monopoly owners to not “fair” for monopoly owners to

have persistent economic profits have persistent economic profits monopoly leads to lower output monopoly leads to lower output

and higher prices than would exist and higher prices than would exist under perfect competition under perfect competition


Does Monopoly Promote Does Monopoly Promote Inefficiency?Inefficiency?

Efficiency objection: monopolists charge Efficiency objection: monopolists charge higher prices and produce less output.higher prices and produce less output. Monopolist produces an output where the Monopolist produces an output where the

price is greater than its cost, price is greater than its cost, so that the value to society from the last so that the value to society from the last

unit produced is greater than its cost, unit produced is greater than its cost, so the monopoly is not producing enough so the monopoly is not producing enough

of the good from society's perspective, of the good from society's perspective, creating a welfare loss. creating a welfare loss.


The actual amount of the welfare loss The actual amount of the welfare loss in monopoly is of considerable debate in monopoly is of considerable debate among economists. among economists.

Estimates vary between 0.1 percent Estimates vary between 0.1 percent to 6 percent of national income. to 6 percent of national income.


Does Monopoly Retard Does Monopoly Retard Innovation?Innovation?

Some argue that a lack of competition Some argue that a lack of competition retards technological advance. retards technological advance. Already reaping monopolistic profits, firms Already reaping monopolistic profits, firms

do not work at do not work at product improvement, product improvement, technical advances designed to promote technical advances designed to promote

efficiency, and so forth.efficiency, and so forth. The notion that monopoly retards innovation The notion that monopoly retards innovation

can be disputed. Many near‑monopolists are can be disputed. Many near‑monopolists are important innovators.important innovators.


Indeed, innovation helps firms initially Indeed, innovation helps firms initially obtain a degree of monopoly status.obtain a degree of monopoly status.

Even monopolists want more profits, Even monopolists want more profits, and any innovation that lowers costs and any innovation that lowers costs or expands revenues creates profits or expands revenues creates profits for a monopolist.for a monopolist.

Therefore, the incentive to innovate Therefore, the incentive to innovate may well exist in monopolistic market may well exist in monopolistic market structures.structures.


12.5 Monopoly Policy12.5 Monopoly Policy

Two major approaches to dealing Two major approaches to dealing with the monopoly problem: with the monopoly problem: antitrust policies antitrust policies regulationregulation


Antitrust PoliciesAntitrust Policies

By imposing monetary and By imposing monetary and nonmonetary costs on monopolists nonmonetary costs on monopolists antitrust policies reduce the antitrust policies reduce the profitability of monopoly.profitability of monopoly. the fear of lawsuits the fear of lawsuits even jail sentenceseven jail sentences

Policies include attempts to keep firms Policies include attempts to keep firms from getting “too big” and eliminating from getting “too big” and eliminating restrictions on price competition.restrictions on price competition.


Have Antitrust Policies Been Have Antitrust Policies Been Successful?Successful?

The success of antitrust policies can The success of antitrust policies can be debated. be debated.

It is very likely that at least some It is very likely that at least some anticompetitive practices have been anticompetitive practices have been prevented simply by the very prevented simply by the very existence of laws prohibiting existence of laws prohibiting monopoly‑like practices.monopoly‑like practices.


While the laws have been enforced While the laws have been enforced in an imperfect fashion, on balance, in an imperfect fashion, on balance, they have probably successfully they have probably successfully impeded monopoly influences.impeded monopoly influences.


Government RegulationGovernment Regulation

Government regulation is an alternative Government regulation is an alternative approach to dealing with monopolies. approach to dealing with monopolies.

The goal is to achieve the efficiency The goal is to achieve the efficiency of large-scale production without of large-scale production without permitting the high monopoly prices permitting the high monopoly prices and low output that can promote and low output that can promote allocative allocative inefficiencyinefficiency..


Regulators often face a basic policy Regulators often face a basic policy dilemma. dilemma.

Without regulation, profit‑maximizing Without regulation, profit‑maximizing monopolist will produce where monopolist will produce where MRMR = = MCMC. . At that output, the price exceeds average At that output, the price exceeds average

total cost, so economic profits exist.total cost, so economic profits exist.


The monopolist isThe monopolist is producing relatively little outputproducing relatively little output charging a relatively high pricecharging a relatively high price producing at a point where price is producing at a point where price is

above marginal costabove marginal cost


Quantity


Socially Socially allocative efficiencyallocative efficiency where where PP = = MCMC

With natural monopoly, With natural monopoly, where where PP = = MCMC, the , the ATCATC > > PP

The optimal output, then, is an output The optimal output, then, is an output that produces losses for the producer. that produces losses for the producer.


Any regulated business that produced Any regulated business that produced for long at this “optimal” output would for long at this “optimal” output would go bankrupt; it would be impossible to go bankrupt; it would be impossible to attract new capital to the industry. attract new capital to the industry.

Therefore, the “optimal” output from a Therefore, the “optimal” output from a welfare perspective really is not viable. welfare perspective really is not viable.


A compromise between unregulated A compromise between unregulated monopoly and marginal cost pricing is monopoly and marginal cost pricing is average cost pricingaverage cost pricing, where price , where price equals average total cost. equals average total cost.

The monopolist is permitted to price The monopolist is permitted to price the product where economic profits are the product where economic profits are zero, meaning that a normal return is zero, meaning that a normal return is being permitted, like firms experience being permitted, like firms experience in perfect competition in the long run. in perfect competition in the long run.


Difficulties in Average Cost Difficulties in Average Cost PricingPricing

The actual implementation of a rate The actual implementation of a rate (price) that permits a “fair and (price) that permits a “fair and reasonable” return is more difficult than reasonable” return is more difficult than the graphical analysis suggests.the graphical analysis suggests.

The calculations of costs and values is The calculations of costs and values is very difficult, often forcing regulatory very difficult, often forcing regulatory agencies to use profits as a guide agencies to use profits as a guide instead. instead.


Another problem is that average cost Another problem is that average cost pricing gives the monopolist no pricing gives the monopolist no incentive to reduce costs (which incentive to reduce costs (which regulators have tackled by letting the regulators have tackled by letting the firm keep some of the profits that firm keep some of the profits that come from lower costs).come from lower costs).


Also, consumer groups are constantly Also, consumer groups are constantly battling for lower rates, while the battling for lower rates, while the utilities themselves are lobbying for utilities themselves are lobbying for higher rates so that they can achieve higher rates so that they can achieve some monopoly profits.some monopoly profits.


The temptation is great for the The temptation is great for the commissioners to be generous to the commissioners to be generous to the utilities. utilities.

On the other hand, there may be a On the other hand, there may be a tendency for regulators to bow to tendency for regulators to bow to pressure from consumer groups.pressure from consumer groups.


12.6 Price Discrimination and 12.6 Price Discrimination and Peak Load Pricing Peak Load Pricing

Sometimes sellers will charge different Sometimes sellers will charge different customers different prices for the same customers different prices for the same good or service when the cost does not good or service when the cost does not differ is called differ is called price discriminationprice discrimination. .

Under certain conditions , the monopolist Under certain conditions , the monopolist finds it profitable to discriminate among finds it profitable to discriminate among various buyers, charging higher prices to various buyers, charging higher prices to those that are more willing to pay and those that are more willing to pay and lower prices to those less willing to pay.lower prices to those less willing to pay.


Conditions for Price Conditions for Price DiscriminationDiscrimination

Monopoly PowerMonopoly Power Price discrimination is possible only with Price discrimination is possible only with

monopoly or where members of a small monopoly or where members of a small group of firms follow identical pricing group of firms follow identical pricing policies. policies.

When there are a number of competing When there are a number of competing firms, discrimination is less likely because firms, discrimination is less likely because competitors tend to undercut the higher competitors tend to undercut the higher prices charged by the firms engaging in prices charged by the firms engaging in price discrimination.price discrimination.


Market SegregationMarket Segregation Price discrimination can only occur if the Price discrimination can only occur if the

demand curve for markets, groups or demand curve for markets, groups or individuals are different. If the demand curves individuals are different. If the demand curves are not different, a profit maximizing monopolist are not different, a profit maximizing monopolist would charge the same price in both markets. would charge the same price in both markets.

In short, price discrimination requires the ability In short, price discrimination requires the ability to separate customers according to their to separate customers according to their willingness to pay. willingness to pay.




No ResaleNo Resale For price discrimination to work, the For price discrimination to work, the

purchaser buying the product at a purchaser buying the product at a discount must have difficulty in reselling discount must have difficulty in reselling the product to customers being charged the product to customers being charged more. Otherwise, consumers would buy more. Otherwise, consumers would buy extra product at the discounted price and extra product at the discounted price and sell it at a profit to others, reducing the sell it at a profit to others, reducing the number of customers paying the higher number of customers paying the higher price. price.


Examples of Price DiscriminationExamples of Price Discrimination

AIRLINE TICKETSAIRLINE TICKETS Seats on airlines usually go for different prices. Seats on airlines usually go for different prices. The airlines can discriminate against business The airlines can discriminate against business

travelers who usually have little advance warning travelers who usually have little advance warning and often travel on weekdays—preferring to be and often travel on weekdays—preferring to be home on the weekends. home on the weekends.

Because the business traveler has a high Because the business traveler has a high willingness to pay (a relatively inelastic demand willingness to pay (a relatively inelastic demand curve) the airlines can charge them a higher price.curve) the airlines can charge them a higher price.


College and University TuitionCollege and University Tuition Students who are well off financially Students who are well off financially

tend to pay more for their education tend to pay more for their education than do students who are less well off than do students who are less well off because of different financial aid because of different financial aid packages.packages.


Quantity discountsQuantity discounts The seller charges a higher price for the first The seller charges a higher price for the first

unit than for later units, allowing the producer unit than for later units, allowing the producer to extract some consumer surplus.to extract some consumer surplus.

Six pack of soda might be less than buying each Six pack of soda might be less than buying each separately. Or you might be able to buy a separately. Or you might be able to buy a bakers dozen of donuts—13 for the price of 12.bakers dozen of donuts—13 for the price of 12.

With this type of price discrimination you are With this type of price discrimination you are charging more for the first units than say for the charging more for the first units than say for the 2020thth unit. unit.


The Welfare Effects of Perfect The Welfare Effects of Perfect Price Discrimination Price Discrimination

When the firm able to perfectly price When the firm able to perfectly price discriminate, each unit is sold at its discriminate, each unit is sold at its reservation price—that the firm sells each reservation price—that the firm sells each unit at the maximum amount that the unit at the maximum amount that the customer would be willing to pay. Because customer would be willing to pay. Because each customer pays exactly the amount each customer pays exactly the amount she or he is willing to pay, the marginal she or he is willing to pay, the marginal revenue is the same as the demand curve. revenue is the same as the demand curve.


Peak Load PricingPeak Load Pricing

Sometimes producers will charge different prices Sometimes producers will charge different prices during different periods of time because the during different periods of time because the demand and the cost of producing the product demand and the cost of producing the product vary over time. vary over time.

For a number of goods and services, demand For a number of goods and services, demand peaks at particular times—bridges, roads and peaks at particular times—bridges, roads and tunnels during rush hour traffic, telephone services tunnels during rush hour traffic, telephone services during business hours, electricity during late during business hours, electricity during late summer afternoons, movie theaters on weekend summer afternoons, movie theaters on weekend evenings and amusement parks and ski resorts evenings and amusement parks and ski resorts during holidays.during holidays.


In price discrimination we saw that prices reflected In price discrimination we saw that prices reflected different demands from buyers but with peak load different demands from buyers but with peak load pricing we have different demands and different pricing we have different demands and different costs. Peak load pricing leads to greater efficiency costs. Peak load pricing leads to greater efficiency because consumer prices reflect the higher because consumer prices reflect the higher marginal costs of production during peak periods. marginal costs of production during peak periods. That is, buyers are charged a higher price for That is, buyers are charged a higher price for goods and services during peak periods and a goods and services during peak periods and a lower price during non-peak periods.lower price during non-peak periods.

copyright © 2002 by thomson learning, inc. to accompany exploring economics 3rd edition by robert...

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