Suppose you are taking a long drive along a route

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Unformatted text preview: is small, neighborhood store have a monopoly? monopoly firm finds the highest price at which it can sell its entire output. Suppose you are taking a long drive along a route that has only one gas station. The sign reads: Last Chance for Gas for 100 Miles. Gasoline is a product with very few substitutes. You can’t put water in your gas tank and hope that the car will run. The gas station is a local monopolist; in other words, it’s not that it is the only gas station in the world, but it is the only gas station in a certain small part of the world. The gas station owner decided that the best quantity of gas for her to sell is 400 gallons. Now, of course, she wants to find the highest price per gallon at which she can sell all 400 gallons. She may have to “search” for this price. Is $2.76 too low? Is $3.18 too high? It is likely that through trial and error she will eventually figure out what the highest price is at which she can sell all 400 gallons of gas. EXAMPLE: QUESTION: You mentioned that the gas station is a local monopolist. I am interested in the word “local” here. Do you mean to imply that a seller might be a monopolist in one area but not in another? ANSWER: Yes. Think of a small grocery store instead of a gas station. The small grocery store might be the only grocery store in 10 square miles, but not the only grocery store in 20 square miles. Or think of a bookstore on a university campus. Many university campuses have only one bookstore that sells the textbooks that students buy. Some would consider the bookstore in this setting a monopolist. Of course, with the introduction of the Internet, this bookstore isn’t as much a monopolist today as it might have been in years gone by. Today, students can buy many of their textbooks online, either directly from the publisher or from an online bookstore. How Selling Corn or Stock Differs from Selling Cable Television Service Perhaps nothing brings home the difference between a perfectly competitive seller (a price taker) and a monopoly seller (a price searcher) than placing yourself in the role of each. First, suppose you are a corn farmer in Iowa. You just harvested 100,000 bushels of corn, and you want to sell them as quickly as possible. It’s easy to determine at what price you sell your corn: you just check the newspaper or listen to the crop report on the radio or TV news to see what price corn is selling at. That’s the price you take for your corn. Now say you own a cable television company. In many towns only one cable company Section 2 A Monopolistic Market 195 11/17/05 5:27 PM Page 196 is allowed to serve a certain geographic area; therefore, you are a monopolist. (Although with satellite TV, the local cable company is probably less of a monopolist than it once was.) The cable wire has been laid across town, and you are ready for business. What do you charge for your cable service? The answer is not so easy this time. No “cable television report” provides the market with information the way a crop report does. Thus, even though it is rather easy for firms to determine their selling prices in perfectly competitive markets, price determination is not so easy in monopolistic markets. Is the Sky the Limit for the Monopolist? Suppose a pharmaceutical company recently invented a new medicine that cures arthritis. With respect to this medicine, the pharmaceutical company is a monopolist; it is the only seller of a medicine that has no close substitutes. Can the pharmaceutical company charge any price it wants for the medicine? For example, can it charge $5,000 for one bottle (24 pills) of medicine? If your answer is yes, ask yourself whether the company can charge $10,000 for one bottle. If your answer is still yes, ask yourself whether the company can charge $20,000 for one bottle. The purpose of these questions is to get you to realize that monopolists do face a limit as to how high a price they can charge. The sky is not the limit. At some high prices in our example, no one, not even someone who suffers greatly from arthritis pain, is willing to buy the medicine. The monopolist is limited by the “height” of the demand curve it faces. What do we mean by the “height” of the demand curve? Suppose the demand curve in Exhibit 8-1 is the demand curve for the medicine that cures arthritis and that the pharmaceutical company has decided to produce 500,000 bottles of medicine. As you can see, the highest price (per bottle) that can be charged for each bottle of 500,000 bottles is determined by the height of the demand curve, $100 per bottle. The sky is not the limit; the height of the demand curve (at the quantity of output the firm wants to sell) is the limit. 196 Chapter 8 Competition and Markets A Monopoly Seller Is Not Guaranteed Profits Most people think that if a firm is a monopoly seller, it is guaranteed to earn profits. This assumption is not true, however; no monopoly seller is guaranteed profits. A firm earns profits only if the price it sells its good for is...
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