monopoly
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MonopolyMonopoly
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OutlineOutline
I. Introduction
A. Definition
B. Barriers to Entry
II. Monopoly in the Short-Run
A. Demand
B. Profit Maximization in the Short-Run
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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
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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.
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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
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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.
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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
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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
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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
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Monopoly and Total RevenueMonopoly and Total Revenue
Total Revenue
Demand
$
$
Q
Q
Elasticity = 1Elastic
Inelastic
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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
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Total Revenue and Total CostTotal Revenue and Total Cost
$
Q
TC
TR
Q*
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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
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D and MRD and MR
Qd P ($)0 101 82 63 44 25 0
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D and MRD and MR
Qd P ($) TR ($)0 10 01 8 82 6 123 4 124 2 85 0 0
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D and MRD and MR
Qd P ($) TR ($) MR ($)0 10 0 ---1 8 8 82 6 12 43 4 12 04 2 8 -45 0 0 -8
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D and MRD and MR
P
Q5
$10
D
0 1 2 3 4
24
6
8
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D and MRD and MR
P
Q5
$10
D
0 1 2 3 4
24
6
8
MR
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
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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*
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
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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?
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
ATC
AVC
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
ATC
AVCatc*
p*
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Profit MaximizingProfit Maximizing
MCP
Q5
$10
D
0 1 2 3 4
24
6
8
MR
ATC
AVCatc*
p*
Profit
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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.
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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*
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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
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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
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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
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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.
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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
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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
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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)
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Natural MonopolyNatural Monopoly
P
QDMR
ATC
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Natural MonopolyNatural Monopoly
P
QDMR
MC
ATC
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Benefits of MonopolyBenefits of Monopoly
• Technological Innovations• Incentive for monopoly profits gives firm an
incentive to innovate.
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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
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Producer SurplusProducer SurplusP
Q
MCp
Q
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Producer SurplusProducer Surplus
P
Q
MCp
Q
The Shaded Area is the Producer Surplus
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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.
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Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.
P
Q
D
0
MR
MC
QMonop
PMonop
Qperf comp
Pperf comp
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Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.
P
Q
D
0
MR
MC
QMonop
PMonop
Qperf comp
Pperf comp
Total Surplusfor PerfectCompetition
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Monopoly vs Perfect Comp.Monopoly vs Perfect Comp.
P
Q
D
0
MR
MC
QMonop
PMonop
Qperf comp
Pperf comp
Total Surplusfor Monopoly
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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
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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
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Disadvantages of MonopolyDisadvantages of Monopoly
• Inefficient Allocation of Resources• Allocatively Inefficient (P > MC)• Productively Inefficient (P not = min ATC)
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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
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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
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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
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Perfect Price DiscriminationPerfect Price Discrimination
Note that in this case there is no dead weight loss AND the firm is allocatively efficient