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Monopoly
Introduction
The Chapter Ambassador Bridge separating Detroit, Michigan from Windsor, Ontario is owned by a private company. Clearly, this is a firm that owns a resource with few close substitutes. How does a firm in this situation, known as a monopoly, determine the price to charge for its product?
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Learning Objectives
Identify situations that can give rise to monopoly Describe the demand and marginal revenue conditions a monopolist faces Discuss how a monopolist determines how much output to produce and what price to charge Evaluate the profits earned by a monopolist Understand price discrimination Explain the social cost of monopolies
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Chapter Outline
Definition of a Monopolist Barriers to Entry The Demand Curve a Monopolist Faces Elasticity and Monopoly Cost and Monopoly Profit Maximization Calculating Monopoly Profit On Making Higher Profits: Price Discrimination The Social Cost of Monopolies
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Did You Know That...
A monopoly can arise whenever sellers are given exclusive rights to distribute a good? A law intended to "help New York wineries" creates a situation called monopoly?
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Definition of a Monopolist
Monopolist
A single supplier of a good or service for
which there is no close substitute
The monopolist therefore constitutes the
entire industry.
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Barriers to Entry
Question
How does a firm obtain monopoly power?
Answers
Barriers to entry that allow the firm to make
long-run economic profits
Barriers to entry are restrictions on who
can start as well as stay in business.
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Barriers to Entry (cont'd)
Barriers to entry include
Ownership of resources without
close substitutes
Economies of scale Legal or governmental restrictions
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Barriers to Entry (cont'd)
Ownership of resources without close substitutes
The Aluminum Company of America
(ALCOA) at one time owned most of of the world's bauxite.
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Barriers to Entry (cont'd)
Economies of scale
Low unit costs and prices drive out rivals. The largest firm can produce at the lowest
average total cost.
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Barriers to Entry (cont'd)
Natural Monopoly
A monopoly that arises from the peculiar
production characteristics in an industry
It usually arises when there are large
economies of scale
One firm can produce at a lower
average cost than can be achieved by multiple firms
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Figure 25-1 The Cost Curves That Might Lead to a Natural Monopoly
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Barriers to Entry (cont'd)
Legal or governmental restrictions
Licenses, franchises, and certificates
of convenience
Examples include
Electrical Radio
utilities
and television broadcasting
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International Policy Example: Malaysia's Drug-Labeling Monopoly
Sellers of drugs and medical products are required to affix holographic labels providing information on usage. To obtain these labels, sellers have only one choice. They must buy the labels from a company called Mediharta. This company is the only label manufacturer that Malaysia's Registrar of Companies has approved to produce holographic labels.
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Barriers to Entry (cont'd)
Legal or governmental restrictions
Patents
Intellectual
property
Tariffs
Taxes
on imported goods
Regulation
Safety
and quality
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Barriers to Entry (cont'd)
Cartels
An association of producers in an industry
that agree to set common prices and output quotas to prevent competition
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The Demand Curve a Monopolist Faces
The monopolist faces the industry demand curve because the monopolist is the entire industry.
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The Demand Curve a Monopolist Faces (cont'd)
Recall that under perfect competition
Firm faces perfectly elastic demand curve,
it is a price taker
The forces of supply and demand establish
the price per unit
Marginal revenue, average revenue, and
price are all the same
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The Demand Curve a Monopolist Faces (cont'd)
Perfect competition versus monopoly
The perfect competitor doesn't have to
worry about lowering price to sell more.
In a purely competitive situation, the firm
accounts for a small part of the market.
It
can sell its entire output, whatever that may be, at the same price.
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The Demand Curve a Monopolist Faces (cont'd)
Perfect competition versus monopoly
The more the monopolist wants to sell, the
lower the price it has to charge on the last unit sold.
To sell the last unit, the monopolist has to
lower the price because it is facing a downward sloping demand curve.
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Figure 25-2 Demand Curves for the Perfect Competitor and the Monopolist
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The Demand Curve a Monopolist Faces (cont'd)
Monopoly
Single seller Faces entire industry demand Must lower price to sell more Not all units sold for same price (MR < P)
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Perfect Competition
Many sellers Faces perfectly elastic demand Must produce more to sell more All units sold for same price (P = MR)
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Figure 25-3 Marginal Revenue: Always Less Than Price
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Elasticity and Monopoly
The monopolist faces a downwardsloping demand curve, and cannot charge any price.
A common misconception
Thus, depending on the price charged a different quantity will be demanded.
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Elasticity and Monopoly (cont'd)
Question
If a monopoly raises price, what will
happen to quantity demanded?
Hint
Remember how consumers respond to a
change in price.
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Elasticity and Monopoly (cont'd)
Recall
Monopolist is a single seller of a
well-defined good or service with no close substitute.
Think
of some imperfect substitutes.
The demand curve slopes downward
because individuals compare marginal satisfaction to cost.
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Elasticity and Monopoly (cont'd)
After all, consumers have limited incomes and unlimited wants.
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Cost and Monopoly Profit Maximization
We assume profit maximization is the goal of the pure monopolist, just as it is for the prefect competitor.
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Cost and Monopoly Profit Maximization Perfect (cont'd)
competitor has only to decide on the profit-maximizing output rate because price is given.
The perfect competitor is a price taker.
For the pure monopolist, we must seek a profit-maximizing price output combination.
The monopolist is a price searcher.
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Cost and Monopoly Profit Maximization (cont'd)
Price Searcher
A firm that must determine the price-output
combination that maximizes profit because it faces a downward-sloping demand curve
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Cost and Monopoly Profit Maximization (cont'd)
We can determine the profit-maximizing price-output combination with either of two equivalent approaches.
By looking at total revenues and total costs
or by looking at marginal revenues and marginal costs
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Cost and Monopoly Profit Maximization (cont'd)
Total revenues-total costs approach
Maximize the positive difference between
total revenues and total costs
Marginal revenue-marginal cost approach
Profit maximization will also occur where
marginal revenue equals marginal cost.
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Cost and Monopoly Profit Maximization (cont'd)
Question
Why produce where marginal revenue
equals marginal cost?
Answer
This is where the greatest positive
difference between total revenue and total cost occurs.
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Figure 25-4 Monopoly Costs, Revenues, and Profits, Panel (a)
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Figure 25-4 Monopoly Costs, Revenues, and Profits, Panels (b) and (c)
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Cost and Monopoly Profit Maximization (cont'd)
Producing past where MR = MC
Incremental cost exceeds
incremental revenue
Producing less than where MR = MC
Monopolist not maximizing profits
here either
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Figure 25-5 Maximizing Profits
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Calculating Monopoly Profit
Monopoly profit is given by the shaded area, which is equal to total revenues (P Q) minus total costs (ATC Q).
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Figure 25-6 Monopoly Profit
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Calculating Monopoly Profit (cont'd)
No guarantee of profit
The term monopoly conjures up the notion
of a greedy firm ripping off the public.
If
ATC is everywhere above AR, or demand
No price-output combination allows the monopolist to cover costs
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Figure 25-7 Monopolies: Not Always Profitable
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On Making Higher Profits: Price Discrimination
Price Discrimination
Selling a given product at more than one
price, with the difference being unrelated to differences in cost
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On Making Higher Profits: Price Discrimination (cont'd)
Price Differentiation
Establishing different prices for similar
products to reflect differences in marginal cost in providing those commodities to different groups of buyers
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On Making Higher Profits: Price Discrimination (cont'd)
Necessary conditions for price discrimination
1. The firm must face a downward-sloping
demand curve.
2. The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with predictably different elasticities of demand. product or service.
3. The firm must be able to prevent resale of the
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Example: Why Students Pay Different Prices to Attend College
Out-of-pocket tuition rates for any two college students can differ by considerable amounts. The reason is that colleges offer students diverse financial aid packages depending on their "financial need." The college determines prices that families are most likely to pay, so that it can engage in price discrimination.
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Figure 25-8 Toward Perfect Price Discrimination in College Tuition Rates
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