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Chapter 14 - Monopoly, in this chapter you will learn: Why monopolies exist and how they cause barriers to entry? Why monopolists are constrained by demand? How monopolists set price and quantity? What social welfare losses are associated with monopolies?....
Chapter14 Monopoly â2014byMcGrawHillEducation Whatwillyoulearninthischapter? ã Whymonopoliesexistandhowtheycause barrierstoentry ã Whymonopolistsareconstrainedbydemand • How monopolists set price and quantity • What social welfare losses are associated with monopolies • What the common public policy responses to monopolies are • Why firms have incentives to price discriminate © 2014 by McGraw‐Hill Education Why do monopolies exist? • A monopoly refers to a firm that is the only producer of a good or service with no close substitutes – A firm is a perfect monopoly if it controls the entire market – A firm has monopoly power if it can manipulate the price • Monopolies exist because of barriers to entry that prevent other firms from entering the market. Scarce resources Governmental intervention Economies of scale Aggressive business tactics • A natural monopoly refers to a market where a single firm can produce the entire market quantity demanded at a lower cost than multiple firms © 2014 by McGraw‐Hill Education Active Learning: Identify the barrier to entry For each of the following, identify which barrier to entry permits monopoly power H2O Company owns all of the water rights to a town’s drinking water supply XYZ Pharmaceuticals is awarded a patent for their new asthma drug National Brewing Company buys a successful, local microbrewery ABC Motor Company produces cars at a lower cost than smaller firms could © 2014 by McGraw‐Hill Education Monopolists and the demand curve Monopoly markets differ from perfectly competitive markets with regard to their demand curves Perfectly competitive firm’s demand curve Price ($) Monopolist’s demand curve Price ($) Competitive firms face a horizontal demand curve 2,500 D Monopolists face a downward‐ sloping demand curve 5,00 2,50 D 0 Quantity of diamonds Firms cannot affect the market price through their production decisions © 2014 by McGraw‐Hill Education Quantity of diamonds Monopolists can affect the market price, but are constrained by the market demand curve Monopoly revenue • When a monopolist produces more of a good, the market price is driven down. • Therefore, producing an additional unit of output has two effects on total revenue: Quantity effect: Total revenue increases Price effect: Total revenue decreases • Total revenue might increase or decrease, depending on which effect is larger • In perfectly competitive markets, a firm can sell as much as it wants at the market price © 2014 by McGraw‐Hill Education Monopoly revenue • • • The following table displays total revenue, average revenue, and marginal revenue Total revenue is maximized when marginal revenue equals $0 Average revenue equals price and is greater than or equal to marginal revenue ( 1) (2) (3) (4) (5) P ric e Q ua nt it y s o ld T o t a l re v e nue M a rgina l re v e nue A v e ge R e v e nue ( $ / di a m on d ) ( Vi o l e t di a m o nd s) ( $) ( $) ( $ / d i a m o nd ) , 50 0 0 ,0 0 ,0 0 ,0 0 5, 50 11,0 0 5, 0 15, 0 , 50 18 , 0 ,0 0 ,0 0 , 50 1, 0 ,0 0 5,0 0 5, 50 ,0 0 5,0 0 ,0 0 ,50 ,0 0 ,0 0 1, 0 ,50 0 ,0 0 1, 0 , 50 ,0 0 ,0 0 18 , 0 ,0 0 - 1,0 0 ,50 - ,0 0 ,0 0 - ,0 0 1, 50 10 15, 0 1,50 © 2014 by McGraw‐Hill Education Monopoly revenue The total revenue maximizing point is identified where MR = $0 TR, AR, MR ($) 1. A monopolist's total revenue first increases 25,000 2. then decreases 20,000 15,000 TR 10,000 The MR curve intersects the x‐axis at the revenue‐maximizing quantity 5,000 AR 25,000 The average revenue equals the price at any quantity sold. 11 12 Quantity of violet diamonds MR © 2014 by McGraw‐Hill Education Active Learning: Determine revenue‐maximizing quantity Fill in the following table and identify the monopolist’s revenue‐maximizing level of production P ric e Q ua nt it y s o ld T o t a l re v e nue M a rgina l re v e nue A v e ge R e v e nue ( $ / t e x t b oo k ) ( T e x t b oo k s) ( $) ( $) ( $ / t e x t b oo k ) 10 0 18 18 150 300 12 360 90 360 60 300 30 18 © 2014 by McGraw‐Hill Education Monopoly profit‐maximizing quantity • While revenue is important, firms maximize profits • The profit‐maximizing quantity of output for a monopoly is found where marginal revenue equals marginal cost – This is the same marginal decision‐making analysis used in perfectly competitive markets. © 2014 by McGraw‐Hill Education 10 Monopoly profit maximization A monopolist’s profit maximizing price and quantity can be found graphically MC, MR, ATC ($) 8,000 • The profit‐maximizing quantity is identified where MR = MC, point B ATC • The price is determined by the point on the demand curve that corresponds to the profit‐maximizing D quantity, point A • Price is set higher than the marginal 10 revenue 11 MC 7,000 6,000 5,000 4,500 4,000 A 3,000 B 2,000 1,000 MR Quantityofvioletdiamonds â2014byMcGrawHillEducation Monopolyprofitmaximization Amonopolistsprofitscanbefoundgraphically MC,MR,ATC($) ã Profitperunit= P ATC ã Verticaldistance betweenAandB ã Profit=(P ATC)ì Q • Since P > MC and barriers to entry exist, monopolists earn positive economic profits in the long‐run Monopolist’s profit 8,000 7,000 MC Profit per unit 6,000 ATC 5,000 4,500 4,000 A 3,000 B 2,000 D 1,000 MR 10 Quantity of violet diamonds © 2014 by McGraw‐Hill Education 12 Active Learning: Determine profit‐maximizing price and quantity and profit Use the following graph to determine a coffee‐producing monopolist’s profit‐maximizing price and quantity and profit P 12 11 10 MC = ATC D MR 10 Q â2014byMcGrawHillEducation 13 Problemswithmonopoly ã Monopolypowerbenefitsmonopolistsbutcauses socialwelfarelosses ã In a competitive market, the equilibrium price and quantity maximize total surplus • Monopolists produce at a lower quantity than the efficient level – – – – Total surplus is not maximized Producer surplus (monopolist profit) increases Consumer surplus decreases The loss of total surplus is a deadweight loss equal to the total surplus under perfect competition minus the total surplus under a monopoly © 2014 by McGraw‐Hill Education 14 The welfare costs of monopoly Efficient market equilibrium Inefficient monopoly market MC, MR ($) MC, MR ($) Consumer surplus Consumer surplus Producer surplus Producer surplus Deadweight loss MC MC C 4,500 A 3,500 B 2,250 D D MR Quantityofvioletdiamonds ã Totalsurplusismaximizedandthereis nodeadweightloss â2014byMcGrawHillEducation MR Quantityofvioletdiamonds • Consumer surplus decreases because of the lower quantity and higher price • Monopolists earn positive economic profits • Society suffers a deadweight loss 15 The welfare costs of monopoly • The welfare costs associated with monopolies is a positive statement. • Many voters and policy‐makers make normative statements concerning monopolies: – Extraprofitstomonopolies Benefitsofmaintainingaparticularmonopoly outweighthesocialwelfarecosts â2014byMcGrawHillEducation 16 Publicpolicyresponses ã Pressurefromboththegovernmentand consumerscanleadtoadecreasein monopoly power • Policy responses are often imperfect and controversial • The goals of policy responses are typically: – Break up existing monopolies – Prevent new monopolies from forming Easetheeffectofmonopolypoweron consumers â2014byMcGrawHillEducation 17 Publicpolicyresponses:Antitrustlaws ã Onepublicpolicyresponseistoenactantitrust lawsthatinvestigateandprosecute corporationsthatengageinanticompetitive practices – Sherman Antitrust Act of 1890 – Clayton Antitrust Act of 1914 • Critics of antitrust laws argue that they: – Are typically politically motivated – Causemoreinefficiencythantheycreate. â2014byMcGrawHillEducation 18 Publicpolicyresponses:Publicownership ã Naturalmonopoliesoccurwhenonefirmcan achievelowercostsofproductionthan multiplefirms ã A public policy response to natural monopolies is to allow the government to run them Costs • Political pressure • Loss of profit incentive potentially leading to inefficiencies Benefits • Provide broader services • Set prices lower than unregulated monopolies © 2014 by McGraw‐Hill Education 19 Public policy responses: Public ownership Below provide the effect of price regulation of a natural monopolist Price (cents per kilowatt hour) Monopoly profit Price (cents per kilowatt hour) Monopoly loss Deadweight loss Efficient price: (P = MC) Ceiling ATC MC D 20 MR 5,600 Millions of kilowatt hours of electricity ATC MC D MR 6,350 Millions of kilowatt hours of electricity • Price ceiling set above the monopolist’s ATC • Monopolist produces where price intersects average revenue (identical to demand) • Price regulated to marginal cost • Monopoly is producing at a loss because P