monopoly1 monopoly eco 2023 principles of microeconomics dr. mccaleb

Monopoly 1

MONOPOLY

ECO 2023Principles of Microeconomics

Dr. McCaleb

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TOPIC OUTLINE

I. Sources of Monopoly

II. Monopoly Equilibrium

III. Monopoly and Competition

IV. Price Discrimination

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Sources of Monopoly

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SOURCES OF MONOPOLY

Characteristics of a Monopoly Market

Definition

A market with a single supplier of a good or service that has no close substitutes and in which there are economic or legal barriers to the entry of new competition.

Two key features

• No close substitutes

• Barriers to entry

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SOURCES OF MONOPOLY


Absence of close substitutes

Even a single seller in a market faces competition from substitute goods outside its market. The closer the available substitutes, the greater the competition and the less market power the monopolist can exercise.

If a good has a close substitute, even though there is only one seller, the market is effectively competitive. The single seller is unable to exercise any significant degree of market power.

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Barriers to entry

Anything that protects a seller from new competition, for example

• Exclusive ownership of an essential resource

• Economies of scale

• Government grant of an exclusive franchise.

SOURCES OF MONOPOLY

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Barriers to Entry

Exclusive ownership of an essential resource

A seller can create its own barrier to entry if it owns a significant portion of a key resource required for the production of the good or service.

In practice, monopolies rarely arise for this reason. The market for most resources is national or even international, and ownership of most resources is dispersed among a large number of people and nations.

SOURCES OF MONOPOLY

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Barriers to Entry

Economies of scale

Economies of scale arise when a single seller can supply the entire market at lower average total cost than two or more sellers.

A monopoly that arises because of economies of scale is called a natural monopoly. Natural monopoly provides an economic argument for regulated public utilities.

Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market.

SOURCES OF MONOPOLY

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SOURCES OF MONOPOLY

10 cents a kilowatt-hour with two sellers, or . . .

Because of economies of scale, one seller can meet the market demand at a lower average cost than two or more sellers.

15 cents a kilowatt-hour with four sellers.

The cost to distribute 4 million kilowatt hours of electric power is

Economies of Scale

5 cents a kilowatt-hour with one seller in the market, or . . .

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Barriers to Entry

Government grant of an exclusive franchise

Legal barriers to entry are the source of most present-day monopolies.

Entry into the market or competition within the market are restricted by the granting of a public franchise, government license, patent, or copyright.

SOURCES OF MONOPOLY

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Monopoly Equilibrium

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MONOPOLY EQUILIBRIUM

Demand and Marginal Revenue

Demand and marginal revenue are negatively-sloped

Demand

Market demand is negatively-sloped. The monopolist faces a tradeoff between price and quantity sold.

To obtain a higher price, the monopolist must lower quantity. Or, if it wants to sell a larger quantity, it must lower price.

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Demand and Marginal Revenue

Marginal revenue is less than price

An increase in quantity has two opposing effects on total revenue: Output effect: An increase in TR equal to the price of the additional quantity sold, which is partly offset by the

Price effect: A decrease in total revenue equal to the decrease in price required to sell the additional quantity, multiplied by the quantity sold before the price decrease.

The marginal revenue curve is negatively-sloped but lies below the demand curve at each quantity: MR<P at all Q.

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Calculate the marginal revenue generated along the demand curve.


Example: Demand and Marginal Revenue

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If the price is $16, quantity demanded is 2 haircuts per hour.



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If the price is $14, quantity demanded is 3 haircuts per hour.



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Total revenue from two haircuts per hour decreases by $4.



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Total revenue from the additional haircut is $14.



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Marginal revenue from the additional haircut is $10.



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The marginal revenue curve is negatively-sloped and lies below the demand curve. Marginal revenue is less than price at each quantity.



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The diagram shows the monopolist’s

• marginal cost (MC),• demand (D),• and marginal revenue (MR).

Profit Maximization by a Monopolist

• average total cost (ATC),

The monopolist maximizes profits or minimizes losses by producing the quantity at which marginal revenue equals marginal cost.

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The equilibrium quantity is 3 haircuts per hour where MR=MC, andthe equilibrium price is $14, shown by the demand at the quantity 3.

The ATC of 3 haircuts is $10.

Profit Maximization by a Monopolist

Because P>ATC at the equilibrium quantity, the monopolist earns a profit of $4 per haircut or $12 per hour.

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Profit Maximization by a Monopolist: Numerical Example

The data in the table below verify that 3 haircuts per hour maximizes the monopolist’s profit.

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Short-Run and Long-Run Equilibria

When a monopolist earns short-run profits

Because new competitors are barred from entering the market, a monopolist’s short-run profits are not competed away. They persist into the long-run.

Without new competition to increase quantity and lower price, the monopolist’s long-run equilibrium quantity and price are the same as the short-run equilibrium quantity and price.

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Short-Run and Long-Run Equilibria

When a monopolist incurs short-run losses

However, if a monopolist incurs economic losses in the short-run, it exits the market in the long-run. The long-run equilibrium quantity is zero.

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Monopoly and Competition

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MONOPOLY AND COMPETITION

The competitive market equilibrium is where quantity demanded equals quantity supplied.

The market demand curve is D.

The market supply curve is S.

Competitive Equilibrium

The competitive equilibrium quantity is QC and the equilibrium price is PC.

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The competitive market supply curve, S, is the monopolist’s marginal cost curve, MC.

The monopolist’s marginal revenue curve is MR.

Monopoly Equilibrium

The monopolist’s equilibrium quantity is QM where marginal revenue equals marginal cost. The equilibrium price is PM , shown by the demand at QM.

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Competitive and Monopolistic Equilibria

Monopoly quantity is lower and price is higher

A monopolist supplies a smaller quantity than a competitive market would supply at a higher price.

The higher price allows a monopolist to earn positive long-run economic profits.

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Economic Consequences of Monopoly

The absence of competition results in

• Inefficiency and deadweight loss

• Redistribution of wealth

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The competitive equilibrium price, PC, brings consumers’ marginal benefit into equality with producers’ marginal cost.

Therefore, the competitive equilibrium quantity, QC, is efficient. The sum of consumer surplus and producer surplus is maximized.

Efficiency of Competitive Equilibrium

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Marginal benefit in the monopoly equilibrium (equals to the monopoly equilibrium price, PM) exceeds marginal cost.

Therefore, the monopoly equilibrium quantity, QM, is inefficient because of underproduction. Monopoly results in a deadweight loss.

Inefficiency of Monopoly

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Economic Consequences of Monopoly

Redistribution of wealth

Because of barriers to entry, a monopolist may earn positive long-run economic profits--more than a normal accounting profit.

Unlike short-run profits (or losses) in a competitive market, a monopolist’s positive long-run economic profits perform no useful economic function. They provide no incentive for increasing the supply of the good because new sellers cannot enter the market.

Positive long-run profits in a monopoly market only redistribute wealth from consumers to the monopoly’s workers, managers, or investors.

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The deadweight loss of monopoly arises from a net loss in both consumer and producer surplus compared with the competitive equilibrium.

In addition to the net loss in the total surplus, monopoly also redistributes some of the remaining surplus from consumers to the monopolist.

Monopoly Redistributes Wealth

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Price Discrimination

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PRICE DISCRIMINATION Characteristics of Price Discrimination

Definition

Selling a good or service at a number of different prices where the price differences do not reflect differences in cost but instead reflect differences in consumers’ price elasticities of demand.

Successful price discrimination requires

• Market segmentation—the seller is able to identify different types of buyers based on differences in their demand elasticities.

• Costly arbitrage—it is costly for one consumer to buy the good at a lower price and resell to another consumer at a higher price

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PRICE DISCRIMINATION

Characteristics of Price Discrimination

Two types of price discrimination

Discriminating among groups of consumers

Different prices for consumers with different elasticities. The market is segmented based on some easily distinguished characteristic of consumers—age, for example.

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Discriminating among units of a good

The seller charges the same prices to all consumers but offers each consumer a lower price for a larger number of units bought—volume discounts, for example.

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Comments

There is nothing evil or illegal about economic price discrimination. It simply means charging different prices for the same good or service unrelated to differences in cost.

Price discrimination is common in all markets other than perfectly competitive markets.

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Effects of Price Discrimination

Price discrimination may

• Increase seller’s profit, at least in the short run

• Enhance economic efficiency

• Conserve on scarce resources.

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Increases seller’s profits

Reducing price to buyers with elastic demands increases revenues.

Raising price to buyers with inelastic demands also increases revenues.

If total quantity is unchanged, then costs are unchanged but revenues and profits are higher.

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PRICE DISCRIMINATION Effects of Price Discrimination

Enhances economic efficiency

Monopoly is inefficient because of underproduction. Too little of the good—less than the efficient quantity—is supplied by the monopolist.

A price-discriminating monopolist is able to sell a larger quantity than a single-price monopolist by reducing price only on the additional units sold, not on all units sold.

Because the problem with monopoly is underproduction, increasing quantity enhances efficiency. The sum of producer and consumer surplus is higher in a monopoly market with price discrimination than in a market with a single-price monopolist.

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Enhances Economic Efficiency

A non-discriminating monopolist sets a price of $12 and sells 3,000 units.

Consumer surplus is shown by the green area. Producer surplus is shown by the blue area.

The deadweight loss of monopoly is shown by the purple area. The deadweight loss is a measure of the inefficiency because of underproduction by the monopolist.

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Enhances Economic Efficiency

If the monopolist discriminates by charging $12 for the first 3,000 units and $9 for any additional units, consumers buy 4,500 units.

The deadweight loss disappears.

A portion of the deadweight loss is added to producer surplus, and . . .the rest of the deadweight loss is added to consumer surplus.

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Price discrimination in this example benefits both sellers and buyers.

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Conserves on scarce resources

In many markets, demand fluctuates systematically, often by time of day or day of the week or seasonally.

Demand fluctuations result in crowding of facilities during peak periods and excess capacity during off-peak periods.

Price discrimination reallocates demand from peak times to off-peak times. With lower demand during peak times, the capacity of a facility needed to serve the market is smaller and fewer resources are required to satisfy consumer demand.

monopoly1 monopoly eco 2023 principles of microeconomics dr. mccaleb

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