Chapter 14 - Monopoly and monopolistic competition. After reading this chapter, you should be able to: Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms; determine a monopolist''s price, output, and profit graphically and numerically; show graphically the welfare loss from monopoly; explain why there would be no monopoly without barriers to entry.
Introduction: Thinking Like an Economist CHAPTER 2 CHAPTER 14 12 Monopoly and Monopolistic Competition Monopoly is business at the end of its journey — Henry Demarest Lloyd McGrawHill/Irwin Copyright © 2013 by The McGrawHill Companies, Inc. All rights reserved Monopoly and Monopolistic Competition 14 Chapter Goals Ø Ø Ø Ø Ø Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms Determine a monopolist’s price, output, and profit graphically and numerically Show graphically the welfare loss from monopoly Explain why there would be no monopoly without barriers to entry Explain how monopolistic competition differs from monopoly and perfect competition 142 Monopoly and Monopolistic Competition 14 A Monopolistic Market Monopoly is a market structure in which one firm makes up the entire market Ø Ø Ø Ø Barriers to entry into the market prevent competition Barriers to entry can be: • Legal • Sociological • Natural • Technological There are no close substitutes for the monopolist’s product 143 Monopoly and Monopolistic Competition 14 The Key Difference Between a Monopolist and a Perfect Competitor Ø A monopolistic firm’s marginal revenue is not its price • • Ø Ø Marginal revenue is always below its price Marginal revenue changes as output changes and is not equal to the price A monopolistic firm’s output decision can affect price There is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit 144 Monopoly and Monopolistic Competition 14 Determining the Monopolist’s Price and Output Numerically Ø Ø Ø Ø The goal of the monopolistic firm is to maximize profits, the difference between total revenue and total cost The monopoly maximizes profit when marginal revenue equals marginal cost Marginal revenue (MR) is the change in total revenue associated with a change in quantity Marginal cost (MC) is the change in total cost associated with a change in quantity 145 Monopoly and Monopolistic Competition 14 Determining the Monopolist’s Price and Output Numerically Ø The profit-maximizing condition of a monopolistic firm is: • MR = MC Ø For a monopolistic firm, MR < P Ø A monopolistic firm maximizes total profit, not profit per unit If MR > MC, • The monopoly can increase profit by increasing output If MR < MC, • The monopoly can increase profit by decreasing its output 146 Monopoly and Monopolistic Competition Q Monopolistic Profit Maximization Table P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($) 36 47 33 33 33 48 30 60 27 50 27 81 24 96 21 105 18 108 15 105 12 96 9 81 21 15 -3 54 62 78 102 - -47 48.00 -15 25.00 10 18.00 27 15.50 34 15.60 27 17.00 -37 16 54 40 -9 142 56 20.29 -15 198 80 24.75 -102 30.89 -197 278 14 The profitmaximizing condition is: MR = MR If MC < MR, increase production Profit maximizing quantity is where MC = MR If MC > MR, decrease production 147 Monopoly and Monopolistic Competition 14 Welfare Loss from a Monopoly: The Normal Monopolist P • MC • P PPC M C D B A • MR QMQPC D Q The welfare loss from a monopoly is represented by the triangles B and D The rectangle C is a transfer of surplus from the consumer to the monopolist The area A represents the opportunity cost of diverted resources, which is not a loss to society 148 Monopoly and Monopolistic Competition 14 The Price-Discriminating Monopolist Ø Ø When a monopolist price discriminates, it charges different prices to different individuals or groups of individuals • Consumers with less elastic demands are charged higher prices • Consumers with more elastic demands are charged lower prices Price discrimination increases output and profits 149 Monopoly and Monopolistic Competition 14 The Price-Discriminating Monopolist Ø Ø Ø Examples of price discrimination • Movie discounts to senior citizens and children • Airline charge more to fly on Fridays and Sundays • Tracking consumer information and pricing accordingly It might seem unfair for a monopolist to charge different people different prices, but doing so eliminates welfare loss from monopoly For a price-discriminating monopolist, because it can charge what consumers are willing to pay, all consumer surplus is captured by the monopolist 1410 Monopoly and Monopolistic Competition 14 Barriers to Entry Ø Ø Ø Ø Natural Ability • A firm is better at producing the good than anyone else Natural Monopolies • Natural monopoly is when a single firm can produce at a lower cost than can two or more firms Government-Created Monopolies • Patents If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits 1411 Monopoly and Monopolistic Competition 14 Characteristics of Monopolistic Competition Four distinguishing characteristics: Many sellers that not take into account rivals’ reactions Product differentiation where the goods that are sold aren’t homogenous Multiple dimensions of competition make it harder to analyze a specific industry, but these methods of competition follow the same two decision rules as price competition Ease of entry of new firms in the long run because there are no significant barriers to entry 1412 Monopoly and Monopolistic Competition 14 Output, Price, and Profit of a Monopolistic Competitor Ø Like a monopoly, • • • Ø The monopolistic competitive firm has some monopoly power so the firm faces a downward sloping demand curve Marginal revenue is below price At profit maximizing output, marginal cost will be less than price Like a perfect competitor, zero economic profits exist in the long run 1413 Monopoly and Monopolistic Competition 14 Comparing Monopolistic Competition with Monopoly Ø Ø Ø It is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entry No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entry For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR) 1414 Monopoly and Monopolistic Competition 14 Advertising and Monopolistic Competition Ø Ø Ø Ø Perfectly competitive firms have no incentive to advertise, but monopolistic competitors The goals of advertising are to increase demand and make demand more inelastic Advertising increases ATC The increase in cost of a monopolistically competitive product is the cost of “differentness” 1415 Monopoly and Monopolistic Competition 14 Chapter Summary Ø Ø Ø Ø Ø A monopolist maximizes profit or minimizes losses where MR=MC To determine a monopolist’s profit or loss: Find output where MR=MC; Determine price and ATC at that output; Profit or loss = (P – ATC) * Q Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society Monopoly output is lower and price is higher than in competitive markets Natural monopolies exist in industries with strong economies of scale 1416 Monopoly and Monopolistic Competition 14 Chapter Summary Ø Ø Ø Ø A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demand Three important barriers to entry are natural ability, economies of scale, and government restrictions Monopolistic competition is characterized by many sellers, differentiated products, multiple dimensions of competition, and ease of entry for new firms A monopolistic competitor differs from a monopolist in that a monopolistic competitor makes zero economic profit in long-run equilibrium 1417 ... 108 15 105 12 96 9 81 21 15 -3 54 62 78 102 - -4 7 48.00 -1 5 25.00 10 18.00 27 15.50 34 15.60 27 17.00 -3 7 16 54 40 -9 142 56 20.29 -1 5 198 80 24.75 -1 02 30.89 -1 97 278 14 The profitmaximizing condition... Government-Created Monopolies • Patents If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits 14 11 Monopoly and Monopolistic Competition 14 Characteristics... monopolies exist in industries with strong economies of scale 14 16 Monopoly and Monopolistic Competition 14 Chapter Summary Ø Ø Ø Ø A price-discriminating monopolist earns more profit than a normal