Lecture 8 notes - Monopoly: Chapter Review Introduction...

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BE 530 Page 1 of 4 Lecture 8 Monopoly: Chapter Review Introduction Monopolists have market power because they can influence the price of their output. That is, monopolists are price makers as opposed to price takers . While competitive firms choose to produce a quantity of output such that the given market price equals the marginal cost of production, monopolists charge prices that exceed marginal cost. In this chapter we examine the production and pricing decisions of monopolists, the social implications of their market power, and the ways in which governments might respond to the problems caused by monopolists. Why Monopolies Arise A monopoly is a firm that is the sole seller of a product without close substitutes. A monopoly is able to remain the only seller in a market only if there are barriers to entry . That is, other firms are unable to enter the market and compete with it. There are three sources of barriers to entry: A key resource is owned by a single firm . For example, if a firm owns the only well in town, it has a monopoly for the sale of water. DeBeers essentially has a monopoly in the market for diamonds because it controls 80 percent of the world’s production of diamonds. This source of monopoly is somewhat rare. The government gives a single firm the exclusive right to produce some good . When the government grants patents (which last for 20 years) to inventors and copyrights to authors, it is giving someone the right to be the sole producer of that good. The benefit is that it increases incentives for creative activity. The costs will be discussed later in the chapter. The costs of production make a single producer more efficient than a large number of producers . A natural monopoly arises when a single firm can supply a good to an entire market at an smaller cost than could two or more firms. This happens when there are economies of scale over the relevant range of output. That is, the average-total-cost curve for an individual firm continually declines at least to the quantity that could supply the entire market. This cost advantage is a natural barrier to entry because firms with higher costs find it undesirable to enter the market. Common examples are utilities such as water and electricity distribution.
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BE 530 Page 2 of 4 Lecture 8 How Monopolies Make Production and Pricing Decisions A competitive firm is small relative to the market so it takes the price of the good it produces as given. Since it can sell as much as it chooses at the given market price, the competitive firm faces a demand curve that is perfectly elastic at the market price. A monopoly is the sole producer in its market so it faces the entire downward-sloping market demand curve. The monopolist can choose any price/quantity combination on the demand curve by choosing the quantity and seeing what price buyers will pay. As with competitive firms, monopolies choose a quantity of output that maximizes profit (total revenue minus total cost).
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Lecture 8 notes - Monopoly: Chapter Review Introduction...

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