Chap 008

Chapter 8: Pure Monopoly

Characteristics of a Pure Monopoly • Single supplier: the firm is the sole producer of a specific product. • No close substitutes: this product is unique. • Price maker: the firm has considerable control over price because it controls the total quantity supplied. • Blocked entry: there is no immediate competition because there are barriers to entry. • Those barriers may be economic (economies of scale create n a t u r al m o n o p o l i es   ), technological, legal, or of some other type.

Examples: local telephone company, local gas and electric company, small town gas station. LO: 8-1

Monopoly Demand and Marginal Revenue • Because monopoly is the only supplier, the monopoly demand is the market demand. • Because market demand slopes downward, in order for a monopolist to increase sales it must lower its price. • If the monopolist increases output by one more unit, the price charged for all units sold will fall. • Each additional unit of output sold increases total revenue by an amount equal to its own price less the sum of the price cuts that apply to all price units of output.

• Consequently, marginal revenue is less than price for every level of output except the first. LO: 8-2

Monopoly Demand and Marginal Revenue • A monopolist is selling 3 units at $142. • To sell more (4), price must be lowered to $132. • All customers must pay the same price. • TR increases $132 minus $30 (3x$10).

$142 132 122 112

D

102

Gain = $132

92 82

0 LO: 8-2

Loss = $30

1

2

3

4

5

6

Marginal Revenue is Less than Price • A monopolist is selling 3 units at $142. • To sell more (4), price $142 must be lowered to $132. 132 • All customers must pay 122 the same price. • TR increases $132 minus 112

$30 (3x$10).

• $102 becomes a point

on the MR curve. • Try other prices to determine other MR points.

D

102

Gain = $132

92 82

MR

0 LO: 8-2

Loss = $30

1

2

3

4

5

6

Monopolist’s Profit Maximization • Each output is associated with a unique price; by changing the market output, a monopolist is indirectly determining the market price. • To determine the price-quantity combination that will maximize profit, cost data is needed. •  A monopolist will employ the MR = MC Rule in order to maximize profit. •  A monopolist produces a level of output where MR = MC. This determines the profit maximizing output, Qm. • Price (Pm) is determined by the market demand curve. LO: 8-2

Monopolist’s Profit Maximization Cost Data

Revenue Data (2) (1) Price Quantity (Average Of Output Revenue)

0 1 2 3 4 5 6 7 8 9 10 LO: 8-2

$172 162 152 142 132 122 112 102 92 82 72

(3) Total Revenue (1) X (2)

$0 ] 162 ] 304 ] 426 ] 528 ] 610 ] 672 ] 714 ] 736 ] 738 ] 720

(4) Marginal Revenue

$162 142 122 102 82 62 42 22 2 -18

(5) (6) (7) (8) Average Total Cost Marginal Profit (+) Total Cost (1) X (5) Cost or Loss (-)

$190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00

$100 ] 190 ] 270 ] 340 ] 400 ] 470 ] 550 ] 640 ] 750 ] 880 ] 1030

$90 80 70 60 70 80 90 110 130 150

Can you See Profit Maximization?

$-100 -28 +34 +86 +128 +140 +122 +74 -14 -142 -310

Monopolist’s Profit Maximization $200  e  u  n  e  v  e   R   d  n  a  ,  s   t  s  o   C  ,  e  c   i  r   P

175

MC

150 Pm =$122 125 100 75

Economic Profit

ATC

AT C  =$94

D MR=MC

50 25

MR

Q m =5

0 LO: 8-2

1

2

3

4

5

6

Quantity

7

8

9

10

Misconceptions about Monopoly • Not the Highest Price • The “highest price possible” is not ideal because it results in lower output and reduces total revenue.

• Total, Not Unit, Profit • The monopolist seeks to maximize total profit, not unit profit.

• Profitability Is Not Assured •  A monopolist may suffer from weak demand, bad market conditions, or resource cost increases and thus experience short-term losses. LO: 8-2

Inefficiency of Monopoly • Compared to pure competition, a monopoly lacks productive efficiency and allocative efficiency. It is in efficient (compared to pure competitions in which P = MC = minimum ATC). •  A monopolist charges a higher price and sells a smaller level of output than firms in a purely competitive industry. • Pm exceeds MC • Pm exceeds ATC LO: 8-3

Pure Competition is Efficient, Monopoly is Inefficient Pure Monopoly

Purely Competitive Market S=  MC

MC b

P  m

P=MC= Minimum ATC

P  c

c

P  c a

D

D

MR Q c

LO: 8-3

Q m

Q c

Other Aspects of Monopoly’s Inefficiency • Monopoly increases income inequality because monopoly profits are not equally distributed. • Monopolists levy a “private tax” on consumers by transferring income from consumers to shareholders who own the monopoly.

• Cost may be different in monopoly and pure competition. • Economies of scale may make monopoly’s costs lower. •  X-inefficiency  – prices higher than ATC allow for various cost increases. • Rent-seeking expenditures are required to maintain barriers to entry. • Monopolists can afford to lag in technological advances. LO: 8-3

Price Discrimination • In order to engage in p r i c e d i s c r i m i n at i o n  , the firm must: • have monopoly power • be able to segregate the market into different groups • be able to prevent resale of the product

• Price discrimination allows monopoly to increase its profits. P r ic e d i s c r i m i n a t i o n    is the business practice of

selling the same good at different prices to different consumers when the price differences are not justified by differences in costs. LO: 8-4

Monopoly and Antitrust Policy • Monopoly is not widespread because barriers to entry are seldom completely successful. • If the monopoly appears to be unsustainable over a long period of time, say, because of emerging new technology, society can simply choose to ignore it. • In contrast, the government may want to file charges against a monopoly under the a n t i tr u s t l aw s   if • the monopoly was achieved through anticompetitive actions, • it creates substantial economic inefficiency, • it appears to be long-lasting. LO: 8-5

 Antitrust Law • The antitrust law is the Sherman Act of 1890, which has two main provisions: • Section 1 “Every contract, combination in the form of a trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations is declared to be illegal.” • Section 2 “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony . . .” (as later amended from “misdemeanor”).

• The Department of Justice enforces the antitrust law in the U.S. LO: 8-5