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Monopoly

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Theresa Mae Maliksi

on 12 November 2012

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Transcript of Monopoly

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Images from Shutterstock.com Sources The most important characteristic of a monopolized market is barriers to entry. MONOPOLY Barriers to entry are restrictions on the entry of new firms into an industry. A monopoly is the sole supplier of a product with no close substitutes Legal restrictions
Economies of scale
Control of an essential resource Barriers to entry 2. Economies of Scale 1. Legal Restrictions 3. Control of Essential Resources Local Monopolies Local monopolies are more common than national or international monopolies However, long-lasting monopolies are rare because a profitable monopoly attracts competitors. Revenue for the Monopolist Because a monopoly, by definition, supplies the entire market, the demand for goods or services produced by a monopolist is also the market demand Price Discrimination A monopolist can sometimes increase economic profit by charging higher prices to customers who value the product more

The practice of charging difference prices to different customers when the price differences are not justified by differences in cost is called price discrimination The demand curve for the firm’s product must slope downward the firm has some market power and control over price
There are at least two groups of consumers for the product, each with a different price elasticity of demand
The producer must be able, at little cost, to charge each group a different price for essentially the same product
The producer must be able to prevent those who pay the lower price from reselling the product to those who pay the higher price Examples of Price Discrimination Because business people face unpredictable yet urgent demands for travel and communication, and because employers pay such expenses, businesspeople are less sensitive to price than householders
Telephone companies are able to sort out their customers by charging different rates based on the time of day Perfect Price Discrimination If a monopolist could charge a different price for each unit sold, the firm’s marginal revenue curve from selling one more unit would equal the price of that unit the demand curve would become the marginal revenue curve
A perfectly discriminating monopolist charges a different price for each unit of the good The effects of price discrimination At a given price, the price elasticity of demand in panel b(elastic) is greater than in panel a (inelastic). For simplicity, assume the firm produces at a constant long-run average and marginal cost of $1. This firm maximizes profits by finding the price in each market that equates marginal revenue with marginal cost consumers with the lower price elasticity pay $3 and those with the higher price elasticity pay $1.50 in markets with elastic demand the price will be lower than in markets where demand is inelastic. How Monopolies Make Production& Pricing Decisions Professional sports teams try to block the formation of competing leagues by signing the best athletes to long-term contracts
Alcoa was the sole U.S. maker of aluminum for a long period of time because it controlled the supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade Demand, Average and Marginal Revenue Long-Run Profit Maximization For a monopoly, the distinction between the long and short run is not as important
If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run
However, short-run profit is no guarantee of long-run profit faculty.apec.umn.edu/thurley/documents/APEC3001/.../Monopoly.p...
www.csupomona.edu/~bbrown/Mankiw5e_PPT/C15.ppt
www.swlearning.com/economics/.../powerpoint/monopoly.ppt One way to prevent new firms from entering a market is to make entry illegal.
Patents, licenses, and other legal restrictions imposed by the government provide some producers with legal protection against competition. Patent and
Invention Incentives A patent awards an inventor the exclusive right to produce a good or service for 20 years.
Patent laws
+ Encourage inventors to invest the time and money required to discover and develop new products and processes.
+ Also provide the stimulus to turn an invention into a marketable product, a process called innovation. Licenses and
Other Entry Restrictions Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service.
+ Broadcast TV and radio rights
+ State licensing of hospitals
+ Cable TV and electricity on local level Economies of
Scale As A Cause of Monopoly When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a
result, a single firm can produce any given
amount at the smallest cost. Monopoly versus competition
Monopoly
+ Price maker
+ Sole producer
+ Downward sloping demand
- Market demand curve
Competitive firm
+ Price taker
+ One producer of many
+ Demand – horizontal line (Price) Demand curves for competitive and monopoly firms Because competitive firms are price takers, they in effect face horizontal demand curves, as in panel (a). Because a monopoly firm is the sole producer in its market, it faces the downward-sloping market demand curve, as in panel (b). As a result, the monopoly has to accept a lower price if it wants to sell more output. (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve Another source of monopoly power is a firm’s control over some nonreproducible resource critical to production. Suppose De Beers controls the entire diamond market and suppose they can sell three diamonds a day at $7,000 each total revenue of $21,000.
Total revenue divided by quantity is the average revenue per diamond which is also $7,000.
Thus, the monopolist’s price equals the average revenue per diamond. To sell a fourth diamond, De Beers must lower the price to $6,750 total revenue for 4 diamonds is $27,000 and average revenue is again $6,750
The marginal revenue from selling the fourth diamond is $6,000 marginal revenue is less than the price or average revenue
Recall that these were equal for the perfectly competitive firm Loss or Gain from Selling One More Unit By selling another diamond, De Beers gains the revenue from that sale, $6,750 from the 4th diamond as shown by the blue-shaded vertical rectangle marked gain. However, to sell that 4th unit, De Beers must sell all four diamonds for $6,750 each it must sacrifice $250 on each of the first three diamonds which could have sold for $7,000 each. The loss in revenue from the first three units, $750, is shown by the red shaded horizontal rectangle marked Loss. The net change in total revenue from selling the 4th diamond equals the gain minus the loss $6,750 - $750 = $6,000. Revenue Schedule The first two columns contain the pertinent price and quantity information.Total revenue (quantity times price) is provided in the third column. As De Beers expands output, total revenue increases until quantity reaches 15 diamonds when total revenue tops out. Marginal revenue (the change in total revenue from selling one more diamond) appears in the fourth column. Note that for all units of output except the first, marginal revenue is less than the price, and the gap between the two widens as the price declines because the loss from selling all diamonds at this lower price increases. Long-Run Profit Maximization A monopolist that earns economic profit in the short-run may find that profit can be increased in the long run by adjusting the scale of the firm
Conversely, a monopoly that suffers a loss in the short run may be able to eliminate that loss in the long run by adjusting to a more efficient size Conditions for Price Discrimination Perfect Price Discrimination A perfectly discriminating monopolist would maximize profits at point e where marginal revenue equals marginal cost price set at point e Perfect Price Discrimination Perfect price discrimination gets high marks based on allocative efficiency
Because such a monopolist does not have to lower price to all customers when output expands, there is no reason to restrict output
In fact, because this is a constant-cost industry, Q is the same quantity produced in perfect competition Perfect Price Discrimination As in perfect competition, the marginal benefit of the final unit of output produced just equals its marginal cost
And although perfect price discrimination yields no consumer surplus, the total benefits consumers derive just equal the total amount they pay for the good
Since the monopolist does not restrict output, there is no deadweight loss Competition versus monopoly: A summary comparison
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