Monopoly

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Monopoly

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  • 1. Chapter Monopoly12 CHAPTER OUTLINEI. Explain how monopoly arises and distinguish between single-pricemonopoly and price-discriminating monopoly.A. How Monopoly Arises1. No Close Substitutes2. A Barrier to Entrya. Natural Barrier to Entryb. Ownership Barrier to Entryc. Legal Barrier to EntryB. Monopoly Price-Setting Strategies1. Single-Price2. Price Discrimination2. Explain how a single-price monopoly determines its output and price.A. Price and Marginal RevenueB. Marginal Revenue and ElasticityC. Output and Price Decision3. Compare the performance of a single-price monopoly with that of perfectcompetition.A. Output and PriceB. Is Monopoly Efficient?C. Is Monopoly Fair?D. Rent Seeking1. Buy a MonopolyE. Create a MonopolyF. Rent-Seeking Equilibrium4. Explain how price discrimination increases profit.A. Price Discrimination and Consumer Surplus1. Discriminating Among Groups of Buyers2. Discriminating Among Units of a GoodB. Profiting by Price DiscriminatingC. Perfect Price Discrimination 2013 Pearson Education, Inc. Publishing as Addison Wesley

2. 194 Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCED. Price Discrimination and Efficiency5. Explain why natural monopoly is regulated and the effects of regulation.A. Efficient Regulation of a Natural MonopolyB. Second-Best Regulation of a Natural Monopoly1. Average Cost Pricing2. Government Subsidy3. And the Second-Best Is 4. Rate of Return Regulation5. Price Cap Regulation Whats New in this Edition?The material in Chapter 12 is largely unchanged from thefifth edition, though the Eye applications have been updatedand slightly rewritten. Where We AreIn this chapter, we examine another market structure:monopoly. We discuss how monopoly arises and how amonopoly (single-price or price-discriminating) chooses itsprofit-maximizing output and price. Recognizing thatmonopoly creates a deadweight loss, we discuss whethermonopoly is efficient and fair. The concept of rent seeking isexamined and reveals that rent seeking is likely to extract allof the economic profit made by a monopoly. Finally,regulation of natural of monopoly is covered. Where Weve BeenThe previous chapter studied perfectly competitive firmsdemand and marginal revenue curves. We combined themwith the cost curve analysis in Chapter 14 to determineperfectly competitive firms profit-maximizing output andprice decisions. Where Were GoingAfter this chapter we examine two more market structures:monopolistic competition and oligopoly in Chapter 13. 2013 Pearson Education, Inc. Publishing as Addison Wesley 3. Chapter 12 . Monopoly 195IN THE CLASSROOM Class Time NeededBecause the students are familiar with firm behavior in perfect competition, thischapter is somewhat easier to present. Even so, there is a lot of importantmaterial, so you should spend approximately three to four class sessions on thismaterial.An estimate of the time per checkpoint is: 12.1 Monopoly and How It Arises15 minutes 12.2 Single-Price Monopoly30 to 50 minutes 12.3 Monopoly and Competition Compared20 to 30 minutes 12.4 Price Discrimination30 to 40 minutes 12.5 Monopoly Regulation30 to 40 minutesClassroom Activity: After defining a monopoly, you can ask your students to discuss theeconomic factors which lead to the development of monopolies. To what extent are thoseconditions products of the free market? In which case, students can debate the role ofgovernment with regard to monopoly. If it is the result of natural coalescence in a freemarket, then is it equitable and/or efficient to intervene? Clearly there is no definitivelycorrect answer to these questions, which is perhaps why they are so much fun to debate!There are many examples of government licensing. Licensing can protect consumers fromfraud and abuse, but they can also hurt consumers by preventing competition fromproducing an efficient allocation of resources. Have the students debate the merits of thefollowing licensing arrangements: 1) Doctors can receive a medical license to practicemedicine only by graduating from an AMA approved medical program; 2) Lawyers canpractice law only after passing an extensive Bar Exam; 3) Cab drivers in New York City canoperate a taxi only if they have purchased a medallion from the city, of which there are afinite number; 4) Beauticians in many states cannot operate a beauty parlor without a statecertification that requires training in sanitary practices as well as other courses completelyunrelated to their profession (such as civics and history courses). 2013 Pearson Education, Inc. Publishing as Addison Wesley 4. 196 Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCECHAPTER LECTURE 12.1 Monopoly and How It ArisesLecture Launcher: Students love monopoly! Many of your students are taking an economicscourse because they think it will help them either get a better job or run a better business.Indeed, it is likely that many of your students are aspiring entrepreneurs. Youve just hadthem slog through a heavy chapter on perfect competition, the bottom line of which is thatthe bottom line is miserable. Normal profit might be the best that many people can achievebut it is not very exciting. This chapter teaches the students how to make a seriousentrepreneurial income. Innovate, create a monopoly that produces something that peoplevalue much more than the cost of producing it, and price discriminate as much as possible.Lecture Launcher: Explain that the monopoly model is a benchmark model - similar to the case ofperfect competition. Although no real-world industry satisfies the full definition of amonopoly market, the behavior of firms in many real world industries can be predicted byusing the monopoly model. Mention that this chapter examines the least competitive end ofthe spectrum of markets, just like Chapter 15 discussed the most competitive end.A monopoly has two key features: No Close Substitutes: There are no close substitutes for the good or service. Barriers to Entry: Legal or natural constraints that protect a firm from potentialcompetition are called barriers to entry. Monopolies are protected by barriers to entry. Natural barriers to entry create a natural monopoly, which is an industry in whichone firm can supply the entire market at a lower price than two or more firms can. When one firm owns all (or most) of a natural resource, it creates an ownership barrierto entry. Legal barriers to entry create a legal monopoly, which is a market in whichcompetition and entry are restricted by the granting of a public franchise (an exclusiveright is granted to a firm to supply a good or servicethe U.S. Postal Service has apublic franchise to deliver first-class mail), a government license (when thegovernment controls entry into particular occupations, professions and industriesalicense is required to practice law), a patent (an exclusive right granted to the inventorof a product or service) or a copyright (exclusive right granted to the author orcomposer of a literary, musical, dramatic, or artistic work).Monopoly Price-Setting Strategies A single-price monopoly is a firm that must sell each unit of its output for the same priceto all its customers. Price discrimination is the practice of selling different units of a good or service fordifferent prices. Many firms price discriminate, but not all of them are monopoly firms. 2013 Pearson Education, Inc. Publishing as Addison Wesley 5. Chapter 12 . Monopoly 197 12.2 Single-Price MonopolyPrice and Marginal Revenue The demand curve facing amonopoly firm is the marketdemand curve. Total revenue (TR) isthe price (P ) multiplied by thequantity sold (Q ). Marginal revenue(MR ) is the change in total revenueresulting from a one-unit increase inthe quantity sold. The table showsthe calculation of TR and MR. A key feature of a single-pricePriceQuantitydemandedTotalrevenuemonopoly is that MR < P at eachquantity so, as illustrated in thefigure below, the MR curve lies below the demand curve. MR < P because a singlepricemonopoly must lower its price on all units sold to sell an additional unit of output. Land Mine: Marginal revenue can be a sticking point for many students.Students find it easier to see the difference between the monopolysdemand and marginal revenue curves if you take two steps. First develop atotal revenue schedule using price and quantity data. Then add anothercolumn showing marginal revenue. Place the marginal revenue valuesbetween the quantity values. In the next step, draw the demand andmarginal revenue curves. Again, emphasize that marginal revenue isplotted between two quantity levels. By explicitly graphing the data, youalso have the framework for showing that the price of the good is alwaysless than marginal revenue of a monopoly.Marginal Revenue and Elasticity When demand is inelastic, fall in pricedecreases total revenue. A monopolynever profitably produces along theinelastic range of its demand curvebecause it could increase total revenueby raising the price and selling a smallerquantity.Output and Price Decisions To maximize its profit, a monopolyproduces the level of output whereMR = MC. The monopoly then uses itsdemand curve to set the price at themaximum possible price for which itwill be able to sell the quantity itproduces. In the figure, which uses the 2013 Pearson Education, Inc. Publishing as Addison WesleyMarginalrevenue$4 0 $0$3$3 2 $6$1$2 4 $8-$1$1 6 $6 6. 198 Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCEdemand and MR schedules from the table above, the firm produces 200 units of outputand sets a price of $160 per unit. The firm makes an economic profit if P> ATC, which is the case for the firm in the figure.The monopoly can make the economic profit even in the long run because the barriers toentry protect the firm from competition. However, a monopoly firm is not guaranteed aneconomic profit. In the short run and/or long run, it might make zero economic profit,(P = ATC) or in the short run, it might incur an economic loss (P