Chapter 13: Monopoly Monopoly and How It Arises A monopoly is 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 preventing the entry of new firms. How Monopoly Arises A monopoly has two key features: No close substitute Barriers to entry No Close Substitutes If a good has a close substitute, even if it is produced by only one firm, that firm effectively faces competition from the producers of the substitute. A monopoly sells a good that has no close substitutes. Barriers to Entry A constraint that protects a firm from potential competitors is called a barrier to entry . Three types of barriers to entry are: Natural Ownership Legal Natural Barriers to Entry Natural barriers to entry create natural monopoly. A natural monopoly is a market in which economies of scale enable one firm to supply the entire market at the lowest possible cost. One firm can produce 4 million units of output at 5 cents per unit. Two firms can produce 4 million units—2 units each—at 10 cents per unit. In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the entire market demand is met. The LRAC curve is still sloping downward when it meets the demand curve Ownership Barriers to Entry An ownership barrier to entry occurs if one firm owns a significant portion of a key resource. During the last century, De Beers owned 90 percent of the world’s diamonds. Legal Barriers to Entry Legal barriers to entry create a legal monopoly. A legal monopoly is a market in which competition and entry are restricted by the granting of a: Public franchise (like Canada Post, LCBO) Government license (like a license to practice law or medicine)
Patent of copyright Monopoly Price-Setting Strategies For a monopoly firm to determine the quantity it sells, it must choose the appropriate price. There are two types of monopoly price-setting strategies: A single-price monopoly is a firm that must sell each unit of its output for the same price to all its customers. Price discrimination is 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 Decision Price and Marginal Revenue A monopoly is a price setter, not a price taker like a firm in perfect competition. The reason is that the demand for the monopoly’s output is the market demand. To sell a larger output, a monopoly must set a lower price. Recall: TR=P x Q Marginal revenue, MR is the change in total revenue that results from a one-unit increase in the quantity sold.
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