In this chapter you will learn why some markets have only one seller, analyze how a monopoly determines the quantity to produce and the price to charge, see how the monopoly’s decisions affect economic well-being, consider the various public policies aimed at solving the problem of monopoly, see why monopolies try to charge different prices to different customers.
Monopoly Chapter 15 Copyright © 2001 by Harcourt, Inc All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, Monopoly While a competitive firm is a price taker, a monopoly firm is a price maker Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Monopoly A firm is considered a monopoly if . . it is the sole seller of its product its product does not have close substitutes Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Why Monopolies Arise The fundamental cause of monopoly is barriers to entry Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Why Monopolies Arise Barriers to entry have three sources: Ownership of a key resource This tends to be rare. De Beers is an example The government gives a single firm the exclusive right to produce some good Patents, Copyrights and Government Licensing Costs of production make a single producer more efficient than a large number of producers Natural Monopolies Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Economies of Scale as a Cause of Monopoly Cost Average total cost Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Quantity of Output Monopoly versus Competition Monopoly Is the sole producer Has a downward sloping demand curve Is a price maker Reduces price to increase sales Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Competitive Firm Is one of many producers Has a horizontal demand curve Is a price taker Sells as much or as little at same price Demand Curves for Competitive and Monopoly Firms Price (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve Price Demand Demand Quantity of Output Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Quantity of Output A Monopoly’s Revenue Total Revenue P x Q = TR Average Revenue TR/Q = AR = P Marginal Revenue TR/ Q = MR Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc A Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less than the price of its good The demand curve is downward sloping When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc A Monopoly’s Total, Average, and Marginal Revenue Quantity (Q) Price (P) $11.00 $10.00 $9.00 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 Total Revenue (TR=PxQ) $0.00 $10.00 $18.00 $24.00 $28.00 $30.00 $30.00 $28.00 $24.00 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Average Revenue (AR=TR/Q) Marginal Revenue TR / Q (MR= ) $10.00 $9.00 $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $10.00 $8.00 $6.00 $4.00 $2.00 $0.00 -$2.00 -$4.00 A Monopoly’s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q) The output effect—more output is sold, so Q is higher The price effect—price falls, so P is lower Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Demand and Marginal Revenue Curves for a Monopoly Price $11 10 -1 -2 -3 -4 Demand (average revenue) Marginal revenue Quantity of Water Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Profit-Maximization for a Monopoly 2. and then the demand curve shows the price consistent with this quantity Costs and Revenue B Monopoly price 1. The intersection of the marginalrevenue curve and the marginal cost curve determines the profitmaximizing quantity Average total cost A Demand Marginal cost Marginal revenue QMAX Quantity Comparing Monopoly and Competition For a competitive firm, price equals marginal cost P = MR = MC For a monopoly firm, price exceeds marginal cost P > MR = MC Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc A Monopoly’s Profit Profit equals total revenue minus total costs Profit = TR TC Profit = (TR/Q TC/Q) x Q Profit = (P ATC) x Q Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc The Monopolist’s Profit Costs and Revenue Marginal cost Average total cost D B y ol op t on fi M pro Monopoly E price Average total cost C Demand Marginal revenue QMAX Quantity The Monopolist’s Profit The monopolist will receive economic profits as long as price is greater than average total cost Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Public Policy Toward Monopolies Government responds to the problem of monopoly in one of four ways Making monopolized industries more competitive Regulating the behavior of monopolies Turning some private monopolies into public enterprises Doing nothing at all Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Two Important Antitrust Laws Sherman Antitrust Act (1890) Reduced the market power of the large and powerful “trusts” of that time period Clayton Act (1914) Strengthened the government’s powers and authorized private lawsuits Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Marginal-Cost Pricing for a Natural Monopoly Price Average total cost Regulated price Loss Average total cost Marginal cost Demand Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Quantity Price Discrimination Price discrimination is the practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. In order to do this, the firm must have market power Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Price Discrimination Two important effects of price discrimination: It can increase the monopolist’s profits It can reduce deadweight loss But in order to price discriminate, the firm must Be able to separate the customers on the basis of willingness to pay Prevent the customers from reselling the product Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc ... Curves for a Monopoly Price $11 10 -1 -2 -3 -4 Demand (average revenue) Marginal revenue Quantity of Water Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Profit-Maximization... Scale as a Cause of Monopoly Cost Average total cost Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc Quantity of Output Monopoly versus Competition Monopoly Is the sole producer... $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $10.00 $8.00 $6.00 $4.00 $2.00 $0.00 -$ 2.00 -$ 4.00 A Monopoly s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q)