CHAPTER 13Monopoly and How It ArisesA monopolyis a market: -That produces a good or service for which no close substitute exists-In which there is one supplier that is protected from competition by a barrier to entrypreventing the entry of new firms:oNaturaloOwnershipoLegalNatural barriers to entry create a natural monopoly:an industry in which economies of scale enable onefirm to supply the entire market at the lowest possible cost.The LRAC is still sloping down at intersection with market demand.-Hasn’t reached minimum efficient scaleOwnership Barriers to EntryAn ownership barrier to entry occurs if one firm owns a significant portion of a key resource.Most examples are in industries that sell natural resources (diamonds, nickel, gravel, etc.)Legal Barriers to EntryLegal barriers to entry create a legal monopoly.A legal monopolyis a market in which competition and entry are restricted by the granting of a-Public franchise-Government license-Patent or copyrightMonopoly Price-Setting StrategiesTwo types of monopoly price-setting strategies:A single-price monopolyis a firm that must sell each unit of its output for the same price to all its customers.Price discriminationis the practice of selling different units of a good or service for different prices.(Many firms price discriminate, but not all of them are monopoly firms.)
A Single-Price Monopoly’s Output and Price DecisionPrice and Marginal RevenueA monopoly is a price setter.The reason is: -Demand for the monopoly’s output is market demand-To sell more output, a monopoly must set a lower priceTotal revenue, TR, is the price, P, multiplied by the quantity sold, Q.Marginal revenue, MR, is the change in total revenue that results from a one-unit increase in the quantity sold.For a single-price monopoly, marginal revenue is less than price at each level of output. That is,MR < P.What happens to MR when the monopolist lowers price?You can see that MR < P at each quantity.Marginal Revenue and ElasticityA single-price monopoly’s marginal revenue is related to the elasticity of demand for its good:If demand is elastic, a fall in price brings an increase in total revenue.The increase in revenue from the increase in quantity sold outweighs the decrease in revenue from the lower price per unit, and MR is positive.As the price falls, total revenue increases.If demand is inelastic, a fall in price brings a decrease in total revenue.The rise in revenue from the increase in quantity sold is outweighed by the fall in revenue from the lower price per unit, and MR is negative.As the price falls, total revenue decreases.A single-price monopoly never produces an output at which demand is inelastic.
If demand is unit elastic, a fall in price does not change total revenue.