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Micro10 - Chapter 10 Monopoly and Monopsony Monopoly A...

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Chapter 10 Monopoly and Monopsony Monopoly: A monopoly is a business that produces or sells a good or a service for which no close substitute exists. Examples: Local telephone, electric, or water companies. Two Main Characteristics of Monopoly: No Substitute for the Good & No Entry to Market How Monopoly Arises: Economies of Scale and Barriers to Entry. Natural Monopoly: Natural monopolies are due to economies of scale. Economies of scale arises when increase in inputs decreases the average total cost to the extent that one firm can supply the entire market at a lower price than two or more firms.
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Chapter 10 Monopoly and Monopsony Natural monopolies may benefit consumers by keeping the costs and prices low. However, to limit the monopoly power, these monopolies are usually regulated by government agencies. Economies of Scale And Natural Monopoly
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Chapter 10 Monopoly and Monopsony Barriers to Entry: Legal constraints that protect a firm from potential competition. Examples of barriers to entry are public franchise ( US Postal Service has exclusive right to carry first-class mail ), government license ( medical practice, dentistry, or law ), patent ( exclusive right to an inventor for 20 years ), and copyright . Objective of monopoly: Like any other business, maximize profit . Monopoly faces the market demand. Therefore, to sell more quantities, the monopoly has to lower the price of the product. This makes the marginal revenue of the monopoly to differ from the price. That is, MR < P .
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Chapter 10 Monopoly and Monopsony Example: Let’s assume that a local telephone company sets the price of the local telephone calls at $20 per call. This may result in zero quantity demanded for the calls. To increase the quantity demanded, the telephone company has to reduce the price. P Q TR MR 20 0 0 - 18 1 18 18 16 2 32 14 14 3 42 10 12 4 48 6 10 5 50 2 8 6 48 -2
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Chapter 10 Monopoly and Monopsony Graphically, the relationship between demand, total revenue, and marginal revenue of the monopoly can be presented as:
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Chapter 10 Monopoly and Monopsony Profit-Maximizing Monopoly: Like any other business, monopoly compares marginal revenue (MR) of selling a good with the marginal cost (MC) of producing it. If MR > MC , monopoly should sell more to increase the profit. But to sell more the monopoly has to lower the price . Thus, MR > MC implies that the monopoly should reduce the price. If MR < MC , the monopoly should sell less to increase the profit. To sell less , the monopoly has to raise the price . At Q1 (see the next graph) MR > MC, therefore, prices should be lowered to sell more. At Q2 MR < MC, therefore, prices should be raised to sell less. The optimum quantity and price combination is decided simultaneously by setting MR = MC . This is represented by the point Qe on the following graph.
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Chapter 10 Monopoly and Monopsony Profit-Maximizing Monopoly:
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Chapter 10 Monopoly and Monopsony When MR = MC , the monopoly is optimizing. That is, if ATC < P , the monopoly is maximizing profit. Otherwise, the monopoly is minimizing the loss.
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