CHAPTER 15 MONOPOLY

WHAT IS A MONOPOLY? Firm that is sole seller of product

without close substitutes Price Maker not a Price Taker There are barriers to entry thru:

Monopoly Resources, Gov’t Regulation or Production Process

Will produce when P > MC

MONOPOLY RESOURCES One firm has sole ownership of a key

resource used in production of a good DeBeers is good example with diamonds

GOVERNMENT-CREATED MONOPOLIES Usually created because of use of

patents and copyrights Trade-off is less competition, but

encourages research & development

NATURAL MONOPOLIES A single firm can supply a good/service

to a market at a smaller cost than 2 or more firms could

There are economies of scale, ATC falls as scale becomes larger

HOW MONOPOLIES MAKE PRODUCTION & PRICING DECISIONS

Demand curve for monopolist is downward sloping, not perfectly elastic as in a competitive market

A MONOPOLY’S REVENUE MR is always less than P for monopolist True because of downward shaped D

curve When monopolist increases Q, there is

an output effect (higher Q, increases TR) and a price effect (lower P, decreases TR)

MR can even be negative if price effect is greater than output effect

DEMAND & MR CURVES

PROFIT MAXIMIZATION Also produce where MR = MC just like

competitive markets However for a monopoly:

P > MR = MC So monopolist sets Q where MR = MC

then goes up to Demand curve to set P

PROFIT MAXIMIZATION

MONOPOLY’S PROFIT Profit = (P – ATC) x Q

WELFARE COST OF MONOPOLIES

Does a monopoly maximize total surplus?

To do this, we would need to produce where Demand & MC intersect

DEADWEIGHT LOSS Monopolist produces less than the

socially efficient quantity of output Similar to situation with a tax, but

instead of tax revenue it is profit to the monopolist

MONOPOLY’S PROFIT: SOCIAL COST? Monopoly’s profit gives producers more

surplus than consumers’ surplus, but keeps same total surplus as it would have had

Deadweight loss is created by inefficiently low level of output, not really the higher price

PRICE DISCRIMINATION Selling the same good at different prices

to different customers Ex: Hardback vs. Paperback Novels Strategy for monopolists to increase

profit Requires ability to separate customers

based on their willingness to pay Can raise economic welfare by lowering

DWL, shows up as higher producer surplus

ARBITRAGE Buying a good at a lower price in one

market and reselling it in another market at a higher price

This prevents price discrimination by monopolists

PERFECT PRICE DISCRIMINATION

Monopolist knows exactly each customer’s willingness to pay and can charge each person a different price

In this case, consumer surplus is zero and total surplus equals the firm’s profit – no DWL

EXAMPLES OF PRICE DISCRIMINATION

Movie tickets Airline prices Discount coupons Financial aid Quantity discounts

PUBLIC POLICY1. Antitrust Laws- Sherman Antitrust Act (1890)- Clayton Antitrust Act (1914)• Allows gov’t to prevent mergers that

limit competition, and can break up companies that reduce social welfare

• Can the gov’t effectively judge social benefit vs. social cost?

PUBLIC POLICY2. Regulation- Often regulate prices of natural

monopolies (PUCO)- Where does the gov’t set the price? MC

pricing?• Problem with that is MC < ATC for

monopolist, so this would mean the company loses $

REGULATION Alternatives:1. Subsidize the monopoly: but this

creates need for taxes to pay for it & more DWL

2. Average-cost pricing: like a tax on the good because P no longer = MC

3. MC-pricing also gives no incentive to monopolist to lower costs (unless you let them keep part of cost savings as profit)

PUBLIC POLICY3. Public Ownership- Common in Europe; in U.S., we do this

with Post Office- Problem again is creating incentive to

cut costs

PUBLIC POLICY4. Doing Nothing- All “solutions” to monopolies have their

drawbacks, so many economists prefer doing nothing