MONOPOLY

Monopoly

Recall characteristics of a perfectly competitive market:

– many buyers and sellers

– market participants are “price takers”

– economic profit = 0 in long run

NoneNone of these features are present in a monopoly market

Monopoly

• Word means “one seller” – the opposite of competition (and no close substitutes)

• A monopolist can “set” market price:

– A monopolist is a price setter NOT a price taker

• Unlike firms in a perfectly competitive market, a monopolist can earn profits in the long-run

Monopoly Conditions

BARRIERS TO ENTRY: means of eliminating or discouraging competition, allowing firm to operate as monopoly

All monopolies are protected by some kind of barrier to entry. Main sources:

• Ownership of key resource– DeBeers diamond cartel

• Government grants exclusive rights to market– Patents and copyrights

• Cost of production such that single producer more efficient than many producers– Natural monopolies

“Economies of Scale” and Natural Monopoly

Quantity

ATC

Q0

ATC0

q1 = q2

ATC1

ECONOMIES OF SCALE: falling long-run Average Total Cost (ATC) as output increases. When a firm’s ATC curve continually declines the firm is a natural monopoly. If production is divided among two firms (Firm 1 and Firm 2 below), each firm must produce less and ATC rises. Thus, it is more efficient to have a single firm.

Price

Pricing and Output Decisions of a Firm in a Perfectly Competitive Market

• A competitive firm is small relative to the market and takes the price of its output as given.

– Because a competitive firm sells a product with many perfect substitutes, it faces a perfectly elastic (horizontal) demand curve.

– If a competitive firm tries to sell its product at a price higher than the market price, demand falls to zero.

– For a competitive firm, MR=AR=P

Demand Curve Facing a Firm in a Perfectly Competitive Market

Competitive Firms are Price Takers and Face a Horizontal Demand Curve:

q

P

P0 = MR

MC

q0

Pricing and Output Decisions of Monopolists

• A monopolist is the only firm in the market and therefore can alter the price of its good by altering output.

– Because a monopolists makes up the entire market, it faces a downward sloping (market) demand curve.

– Because the demand curve for its product is downward sloping, when a monopolist raises output by one unit, price will fall.

– As a result, for a monopolist, marginal revenue is less than price.

Total and Marginal Revenue of a Monopolist

Quantity Price TR MR0 $10 01 9 9 92 8 16 73 7 21 54 6 24 35 5 25 16 4 24 -1

Thingamajigs Are Us is a monopolist that controls the market for thingamajigs (are really cool product)

Quantity

Price

D

MR

Demand and Marginal Revenue Curves for a Monopolist

Profit Maximizing Monopoly

• Basic profit maximization condition the same as with competitive firms:

MR = MC

But now MR Price…

…MR < Price.

Q

P

D

MR

MC

QM

PM

A monopolist maximizes profits where MR=MC. Note that at Q*, price is greater than MR.

Q

P

D

MR

MC

QM

PM ATC

Monopoly Profit

A Monopolist’s Profits

ATC

Monopoly: Welfare Analysis

• Monopolist charges P > MC (and P > ATC)

• Monopoly profits can be earned in long run, because no entry by competitors

• Monopoly clearly a better outcome than competition from FIRM’SFIRM’S point of view…

… but what about SOCIAL WELFARESOCIAL WELFARE?

Market Efficiency

Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.

– If an allocation of resources is efficient it is impossible to make anyone better off without making someone else worse off

Major Point:

The equilibrium in a competitive market maximizes the total welfare of buyers and sellers.

Quantity

Price

Demand

Supply

Q1

P1

Q2

A

B

A = loss in consumer surplus from under production.

Why A Competitive Equilibrium is Efficient

B = loss in producer surplus from under production.

Quantity

P

D

MR

MC

QM

PM

Monopoly Deadweight Loss

(Competitive Supply)

QC

Public Policy Toward Monopoly

• Monopoly is bad for consumers

– Price is higher than with competition

– Quantity supplied is lower than with competition

• Monopoly is inefficient from society’s standpoint

– Deadweight loss

– Monopolist’s market power is a source of “market failure”

So what, if anything, should government do about it?

Public Policy I: Anti-Trust Law

• Sherman Anti-Trust Act (1890)

• Clayton Act (1917)

• These acts of congress, as interpreted since by the courts, give power to US Federal Government to promote competition by:

– approving mergers

– breaking up dominant firms

– Imposing fines for “price-fixing”, other collusion

Public Policy II: Regulated Natural Monopolies

• With natural monopoly, one firm can produce output at minimum cost (good)

• Unregulated, a natural monopolist will charge an inefficiently high price (bad)

• Compromise: “Average Cost Pricing”, or “Rate of Return Regulation”

– Allow firm to charge P = ATC, where ATC includes a set return on capital invested

– Traditional form of regulation of public utilities (SDG&E)

Q

P

D

MR

MC

QM

PRATC

PM

QR

Unregulated Monopoly Profit