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Monopoly
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Monopoly
While a competitive firm is apricetaker, a monopoly firm is aprice
maker.
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A firm is considered amonopolyif ...
It is the sole seller of its product. Its product does not have close
substitutes.
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WHY MONOPOLIES ARISE The fundamental cause of monopoly
is barriers to entry.
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WHY MONOPOLIES ARISE Barriers to entry have three
sources:
Ownership of a key resource. The government gives a single firm the
exclusive right to produce some good.
Costs of production make a singleproducer more efficient than a largenumber of producers.
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Monopoly Resources Although exclusive ownership of a
key resource is a potential source of
monopoly, in practice monopoliesrarely arise for this reason.
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Government-Created Monopolies Governments may restrict entry by
giving a single firm the exclusive
right to sell a particular good incertain markets.
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Government-Created Monopolies Patent and copyright laws are two
important examples of how
government creates a monopoly toserve the public interest.
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Natural Monopolies An industry is a natural monopoly
when a single firm can supply a
good or service to an entire marketat a smaller cost than could two ormore firms.
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Natural Monopolies A natural monopolyarises when
there are economies of scale over
the relevant range of output.
Fi 1 E i f S l C f
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Figure 1 Economies of Scale as a Cause ofMonopoly
Copyright 2004 South-Western
Quantity of Output
Averagetotalcost
0
Cost
HOW MONOPOLIES MAKE
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HOW MONOPOLIES MAKEPRODUCTION AND PRICINGDECISIONS Monopoly versus Competition
Monopoly Is the sole producer
Faces a downward-sloping demand curve Is a price maker
Reduces price to increase sales Competitive Firm
Is one of many producers
Faces a horizontal demand curve
Is a price taker
Sells as much or as little at same price
Fi 2 D d C f C titi
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Figure 2 Demand Curves for Competitiveand Monopoly Firms
Copyright 2004 South-Western
Quantity of Output
Demand
(a) A Competitive Firms Demand Curve (b) A Monopolists Demand Curve
0
Price
Quantity of Output0
Price
Demand
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A Monopolys Revenue Total Revenue
P Q = TR
Average Revenue
TR/Q = AR = P
Marginal Revenue
DTR/DQ = MR
T 1 A M T t A
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Ta e 1 A Monopo y s Tota , Average,and Marginal Revenue
Copyright2004 South-Western
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A Monopolys Revenue A Monopolys Marginal Revenue
A monopolists marginal revenue is
always less than the price of its good. The demand curve is downward sloping.
When a monopoly drops the price to sellone more unit, the revenue received from
previously sold units also decreases.
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A Monopolys Revenue A Monopolys Marginal Revenue
When a monopoly increases the
amount it sells, it has two effects ontotal revenue (PQ).
The output effectmore output is sold, soQ is higher.
The price effectprice falls, so Pis lower.
Figure 3 Demand and Marginal Revenue
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Figure 3 Demand and Marginal-RevenueCurves for a Monopoly
Copyright 2004 South-Western
Quantity of Water
Price$11
109876543210
12
3
4
Demand(averagerevenue)
Marginalrevenue
1 2 3 4 5 6 7 8
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Profit Maximization A monopoly maximizes profit by
producing the quantity at which
marginal revenue equals marginalcost.
It then uses the demand curve to
find the price that will induceconsumers to buy that quantity.
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Figure 4 Profit Maximization for a Monopoly
Copyright 2004 South-Western
QuantityQ Q0
Costs andRevenue
Demand
Average total cost
Marginal revenue
Marginalcost
Monopolyprice
QMAX
B
1. The intersection of themarginal-revenue curveand the marginal-costcurve determines theprofit-maximizingquantity . . .
A
2. . . . and then the demandcurve shows the priceconsistent with this quantity.
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Profit Maximization
Comparing Monopoly andCompetition For a competitive firm, price equals
marginal cost.
P = MR = MC
For a monopoly firm, price exceedsmarginal cost.
P > MR = MC
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A Monopolys Profit Profit equals total revenue minus
total costs.
Profit = TR - TC Profit = (TR/Q - TC/Q) Q
Profit = (P-ATC) Q
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Figure 5 The Monopolists Profit
Copyright 2004 South-Western
Monopolyprofit
Averagetotalcost
Quantity
Monopolyprice
QMAX
0
Costs andRevenue
Demand
Marginal cost
Marginal revenue
Average total cost
B
C
E
D
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A Monopolists Profit The monopolist will receive
economic profits as long as price is
greater than average total cost.
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Figure 6 The Market for Drugs
Copyright 2004 South-Western
Quantity0
Costs andRevenue
DemandMarginalrevenue
Priceduringpatent life
Monopolyquantity
Price afterpatent
expiresMarginalcost
Competitivequantity
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THE WELFARE COST OFMONOPOLY In contrast to a competitive firm, the
monopoly charges a price above themarginal cost.
From the standpoint of consumers, thishigh price makes monopoly undesirable.
However, from the standpoint of the
owners of the firm, the high price makesmonopoly very desirable.
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Figure 7 The Efficient Level of Output
Copyright 2004 South-Western
Quantity0
Price
Demand(value to buyers)
Marginal cost
Value to buyersis greater thancost to seller.
Value to buyersis less thancost to seller.
Costto
monopolist
Costto
monopolistValue
tobuyers
Valueto
buyers
Efficientquantity
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The Deadweight Loss Because a monopoly sets its price
above marginal cost, it places a
wedge between the consumerswillingness to pay and theproducers cost.
This wedge causes the quantity sold tofall short of the social optimum.
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Figure 8 The Inefficiency of Monopoly
Copyright 2004 South-Western
Quantity0
PriceDeadweight
loss
DemandMarginalrevenue
Marginal cost
Efficientquantity
Monopolyprice
Monopolyquantity
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The Deadweight Loss
The Inefficiency of Monopoly The monopolist produces less than the
socially efficient quantity of output.
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The Deadweight Loss The deadweight loss caused by a
monopoly is similar to the
deadweight loss caused by a tax. The difference between the two
cases is that the government gets
the revenue from a tax, whereas aprivate firm gets the monopolyprofit.
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PUBLIC POLICY TOWARDMONOPOLIES Government responds to the
problem of monopoly in one of fourways. Making monopolized industries more
competitive.
Regulating the behavior of monopolies.
Turning some private monopolies intopublic enterprises.
Doing nothing at all.
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Antitrust Laws/ MRTP Antitrust laws are a collection of statutes
aimed at curbing monopoly power.
Antitrust laws give government variousways to promote competition.
They allow government to prevent mergers.
They allow government to break up
companies. They prevent companies from performing
activities that make markets less competitive.
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Regulation Government may regulate the prices
that the monopoly charges.
The allocation of resources will beefficient if price is set to equal marginalcost.
Figure 9 Marginal-Cost Pricing for a Natural
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Figure 9 Marginal Cost Pricing for a NaturalMonopoly
Copyright 2004 South-Western
Loss
Quantity0
Price
Demand
Average total costRegulated
price Marginal cost
Average totalcost
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Regulation In practice, regulators will allow
monopolists to keep some of the
benefits from lower costs in the formof higher profit, a practice thatrequires some departure frommarginal-cost pricing.
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Public Ownership Rather than regulating a natural
monopolythat is run by a private
firm, the government can run themonopoly itself (e.g. in India, thegovernment runs the Postal Service,Railways).
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Doing Nothing Government can do nothing at all if
the market failure is deemed small
compared to the imperfections ofpublic policies.
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PRICE DISCRIMINATION Price discrimination is the business
practice of selling the same good at
different prices to differentcustomers, even though the costsfor producing for the two customersare the same.
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PRICE DISCRIMINATION Price discrimination is not possible when a
good is sold in a competitive market sincethere are many firms all selling at the
market price. In order to pricediscriminate, the firm must have somemarket power.
Perfect Price Discrimination Perfect price discrimination refers to the
situation when the monopolist knows exactlythe willingness to pay of each customer andcan charge each customer a different price.
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PRICE DISCRIMINATION Two important effects of price
discrimination:
It can increase the monopolists profits. It can reduce deadweight loss.
Figure 10 Welfare with and without Price
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Figure 10 Welfare with and without PriceDiscrimination
Copyright 2004 South-Western
Profit
(a) Monopolist with Single PricePrice
0 Quantity
Deadweightloss
DemandMarginalrevenue
Consumersurplus
Quantity sold
Monopolyprice
Marginal cost
Figure 10 Welfare with and without Price
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Figure 10 Welfare with and without PriceDiscrimination
Copyright 2004 South-Western
Profit
(b) Monopolist with Perfect Price DiscriminationPrice
0 Quantity
DemandMarginal cost
Quantity sold
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PRICE DISCRIMINATION Examples of Price Discrimination
Movie tickets
Airline prices Discount coupons
Financial aid
Quantity discounts
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PREVALENCE OFMONOPOLY How prevalent are the problems of
monopolies?
Monopolies are common. Most firms have some control over their
prices because of differentiatedproducts.
Firms with substantial monopoly powerare rare.
Few goods are truly unique.
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Summary A monopoly is a firm that is the sole
seller in its market.
It faces a downward-sloping demandcurve for its product.
A monopolys marginal revenue is
always below the price of its good.
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Summary Like a competitive firm, a monopoly
maximizes profit by producing the
quantity at which marginal cost andmarginal revenue are equal.
Unlike a competitive firm, its price
exceeds its marginal revenue, so itsprice exceeds marginal cost.
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Summary A monopolists profit-maximizing
level of output is below the level
that maximizes the sum ofconsumer and producer surplus.
A monopoly causes deadweight
losses similar to the deadweightlosses caused by taxes.
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Summary Policymakers can respond to the
inefficiencies of monopoly behavior
with antitrust laws, regulation ofprices, or by turning the monopolyinto a government-run enterprise.
If the market failure is deemedsmall, policymakers may decide todo nothing at all.
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Summary Monopolists can raise their profits by
charging different prices to different
buyers based on their willingness topay.
Price discrimination can raise
economic welfare and lessendeadweight losses.