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Chapter 11: Monopoly
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Monopoly market single seller for a product with no
close substitutes barriers to entry
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Barriers to entry economies of scale actions by firms actions by government
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Economies of scale – natural monopolies
Natural monopolies are often regulated monopolies
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Actions by firms to create and protect monopoly power patents and copyrights, high advertising expenditures
result in high sunk costs (costs that are not recoverable on exit), and
illegal actions designed to restrict competition
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Monopolies created by government action patents and copyrights, government created franchises,
and licensing.
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Local monopoly Local monopoly – a monopoly that
exists in a local geographical area (e.g., local newspapers)
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Price elasticity and MR As noted earlier, since the demand
curve facing a monopoly firms is downward sloping, MR < P
MR > 0 when demand is elastic MR = 0 when demand is unit
elastic MR < 0 when demand is inelastic
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Average revenue As in all other market structures,
AR=P (note that AR = TR/Q = (PxQ) / Q = P)
The price given by the demand curve is the average revenue that the firm receives at each level of output.
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Monopolist receiving positive profits
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Zero-profit monopolist
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Monopolist receiving economic loss
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Monopolist that shuts down in the short run
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Monopoly price setting There is a unique profit-maximizing
price and output level for a monopoly firm.
It is optimal to produce at the level of output at which MR = MC and to charge the price given by the demand curve at this output level.
Charging a higher (or lower) price results in lower profits.
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Price discrimination In imperfectly competitive markets, firms
may increase their profits by engaging in price discrimination (charging higher prices to those customers with the most inelastic demand for the product).
Necessary conditions for price discrimination: the firm must not be a price-taker firms must be able to sort customers by their
elasticity of demand resale must not be feasible
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Example: air travel
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Dumping If firms practice price discrimination by
charging different prices in different countries, they are often accused of dumping in the low-price country.
Predatory dumping occurs if a country charges a low price initially in an attempt to drive out domestic competitors and then raises prices once the domestic industry is destroyed.
There is little evidence of the existence of predatory dumping.
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Today’s slides, 11/6 Based on Dr. Kane’s, with added
detail Available today at www.oswego.edu/~edunne I will ask Dr. Kane to post them on
his site next week.
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Deadweight loss due to monopoly
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Deadweight loss due to monopoly
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P, MR
Q
D
S=MC
competition
Pc
Qc
consumersurplus
producersurplus
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monopoly
P, MR
Q
DMR
Qm
Pm
consumersurplus
Transfer fromConsumer to producer
deadweight loss
S=MC
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Is monopoly efficient? No output too low
deadweight loss Society loses the benefit of that extra
output Monopoly leads to market failure
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Other costs associated with monopoly X-inefficiency
Without competition, no incentive to produce efficiently or at least cost
Example: Microsoft What is the incentive to fix software
bugs?
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Other costs associated with monopoly Rent-seeking behavior
incur costs to acquire, maintain monopoly power.
Lawyers, lobbyists, etc. This does not benefit society and
diverts resources away from productive activities.
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Why allow monopolies? Two potential benefits:
Encourage innovation Patents encourage the development of
new drugs Copyright encourages the development
of new software Economies of scale
One producer meets the market demand at the lowest average cost
Natural monopoly
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Regulation of natural monopoly
P, MR
Q
D
MR
Qm
Pm
MC
Pm, Qm isMonopolyoutcome
Qmc
Pmc
Pmc, Qmc is theEfficient outcome
ATC
Qf
PfPf, Qf is the“fair” rate ofreturn
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Regulation of natural monopoly
monopoly outcome: P(m), Q(m)
marginal-cost pricing: P(mc), Q(mc)
“fair-rate of return” pricing system: P(f), Q(f)
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summary: monopoly
unique good, barriers to entry Natural, actions by firms, actions by gov’t
choose Q where MR = MC but MR < P
may use price discrimination Qm lower, Pm higher than competition
Inefficient, deadwt. loss May be regulated