Monopoly - Monopoly You will not be responsible for...

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Monopoly You will not be responsible for monopoly and quality
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Monopoly A monopoly is a single supplier to a market Barriers to entry are the source of all monopoly power There are two general types of barriers to entry technical barriers legal barriers
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Technical Barriers to Entry Production may exhibit decreasing marginal and average costs over a wide range of output levels In some industries relatively large-scale firms are low-cost producers firms may find it profitable to drive others out of the industry by cutting prices this situation is known as natural monopoly once the monopoly is established, entry of new firms will be difficult
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Technical barriers and natural monopoly P P Case 1: This market can support many firms. If firms are able to enter, then no firm will have a monopoly Case 2: Economies of scale mean that this industry will consist of one firm q AC q AC D D
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Technical Barriers to Entry Another technical basis of monopoly is special knowledge of a low-cost productive technique it may be difficult to keep this knowledge out of the hands of other firms Ownership of unique resources may also be a lasting basis for maintaining a monopoly
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Low-cost productive technique or a unique resource P Suppose there are no fixed costs and one firm (firm 1) has a marginal cost of MC(1) and all others have a marginal cost of MC(2). Then firm 1 has a monopoly if it charges a price below MC(2). q D MC(1) MC(2) This is not a natural monopoly. The monopolist will set the price that maximizes subject to P < MC(2) in order to deter entry.
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What about Microsoft?? Why did Microsoft have a monopoly? Did they have a low cost (or high quality)? A resource no one else had? A natural monopoly? One argument is that Microsoft had a “network externality:” The value of using an operating system is increasing in the number of programs written for the OS. And the value of writing a program for an OS is increasing in the number of people who use the OS. Thus, the market for OS could be argued to be a natural monopoly.
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Legal Barriers to Entry Many pure monopolies are created as a matter of law with a patent, the basic technology for a product is assigned to one firm the government may also award a firm an exclusive franchise to serve a market
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Profit Maximization To maximize profits, a monopolist will choose to produce the output level for which marginal revenue is equal to marginal cost Profit: Π(q) = R(q) –C(q) = qP(q) –C(q) Differentiate profit with respect to “q”: Π’(q)=qP’(q) + P(q)–C’(q) Equate to zero: MR= qP’(q) + P(q) = C’(q) = MC
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Profit Maximization AC MC Price The monopolist will maximize profits where MR = MC P* The firm will charge a price C Profits can be found in the shaded rectangle D MR Quantity Q* of P *
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The Inverse Elasticity Rule The gap between a firm’s price and its marginal cost is inversely related to the price elasticity of demand facing the firm P Q e P MC P , 1 - = - P Q e MC P , 1 1 + = How do we get this? Recall that
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