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Unformatted text preview: C H A P T E R 23 Monopoly With this chapter, we leave the world of perfectly competitive markets and begin our analysis of violations of the final of the first welfare theorem conditions we first outlined in Chapter 15. To be more precise, we have so far always assumed that everyone is small relative to the economy and that everyone therefore acts as a price taker. An equilibrium could therefore be described as a situation in which everyone is doing the best he/she can given the circumstances he/she faces. When individuals become large relative to the economic environment, however, this definition of an equilibrium no longer holds. This is because now the individual has some control over the circumstances he/she is facing and doing the best he/she can now involves using his/her market power to optimally arrange his/her circumstances. We begin in this chapter with the simplest and most extreme case of such market power: the case of a monopoly. Chapter Highlights The main points of the chapter are: 1. A firm enjoys a monopoly if it produces a product that has no close substi- tutes in an environment where potential competitors face high barriers to entry . 2. When charging a single per-unit price to all customers, a monopolist will choose to sell on the point on the demand curve where marginal revenue is equal to marginal cost which logically implies that it will not produce some goods that are valued more by consumers than they cost to produce. This creates a deadweight loss. 3. If a monopolist can identify different consumer types with different demand curves, and if the monopolist can prevent consumers from re-selling the prod- uct they buy, the firm will engage in market segmentation through either first-degree or third-degree price discrimination. Under first-degree price discrimination, the monopolist captures the entire surplus while producing 555 23A. Solutions to Within-Chapter-Exercises for Part A the efficient quantity; under third-degree price discrimination, the monopo- list charges different per-unit prices to different consumer types. 4. If a monopolist cannot identify different consumer types but knows the pro- portion of each type in the population, the firm will engage in second-degree price discrimination under which different output/price packages are de- signed in such a way so as to get consumers to reveal which type they are. 5. In the presence of downward sloping average cost curves (that arise from ei- ther increasing returns to scale technologies or high fixed entry costs), it is of- ten natural for a single firm to dominate the market. Such cases are known as natural monopolies . For such monopolies, the barriers to entry arise from the nature of the underlying production technology. Alternatively, barriers to entry can arise from legal protection offered to firms through the political process....
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