Monopoly Monopoly and perfect competition Profit maximization by a monopolist Inefficiency of a monopoly Why do monopolies occur Natural Monopolies Monopoly and Perfect Competition Perfect competition each firm takes market price as given and decides how much to produce Monopoly does not take market price as given when deciding quantity Figures that higher production will lead to different price Monopoly and Perfect Competition Demand Curves p p 0 y Profit Maximization Monopolist maximizes profits max r y c y y Profit Maximization Revenue Competitive firm Monopolist r y p y r y pD y y Profit Maximization Solve max r y c y y Optimality condition r y c y MR y MC y y y Profit Maximization Optimality condition r y c y y y Marginal revenue r y pD y y pD y pD y y y y y Profit Maximization Competitive firm pD MC y Monopolist pD y pD y y MC y y Profit Maximization Example Inverse market demand pD y 1 000 4 y Marginal revenue 1 000 4 y MR y 1 000 4 y y y 1 000 4 y 4 y 1 000 8 y Profit Maximization Example pD y 1 000 pD y 1 000 4 y 100 MC y 100 2 y MR y 1 000 8 y 125 250 y Profit Maximization Example pD MC y p 640 MC y 280 MR y y 90 pD y y Profit Maximization Example AC y pD MC y 640 AC y 280 MR y 0 90 pD y y Profit Maximization Markup Pricing Price exceeds marginal cost pD y pD y y MC y y Rearrange 1 pD y y pD y 1 MC y y pD y Profit Maximization Markup Pricing Markup pricing 1 pD y 1 MC y Price marginal cost markup pD y 1 1 MC y 1 1 Inefficiency of a Monopoly pD MC y pM pC MR y yM pD y yC y Inefficiency of a Monopoly Deadweight Loss pD MC y pM pC MR y yM pD y yC y Inefficiency of a Monopoly What about Inventions Patents in the US grant monopoly to a company over an innovative product or process for 17 years Company will sell the product for 17 years at monopoly prices deadweight loss Inefficiency of a Monopoly What about Inventions No patent protection incentive to innovate little Too strong patent protection 1 Deadweight loss for longer time 2 Low incentives to innovate Optimal patent life balances these conflicting effects Why Do Monopolies Occur Cartels 2 Patents 3 Incumbent s strategy of threatening potential entrants in industry to engage in a price war 4 Relationship between the Minimum Efficient Scale and the Demand Curve 1 Minimum Efficient Scale and Demand p p p p MES y MES y Antitrust Laws Sherman Act of 1890 Section 1 prohibits contracts and conspiracies explicit or implicit to restraint trade by fixing prices or restrict output Section 2 illegal to monopolize or attempt to monopolize a market Antitrust Laws Clayton Act of 1914 Illegal for a firm with a large market share to require a buyer not to buy from a competitor Prohibits mergers and acquisitions if they substantially lessen competition Illegal to sell a product at different prices to different buyers if this injures competition Regulation Natural Monopoly Some monopolies can be regulated government sets price equal to marginal cost Problems with this policy 1 incentives to invest in research and innovation decrease 2 At that price monopoly could be making negative profits Regulation Natural Monopoly AC y pD MC y pM AC yC pC pD y 0 yM yC y Regulating Natural Monopolies Examples phone companies gas companies public utilities in general Regulations 1 Let monopolist charge price equal to average cost What is a firm s cost function 2 Government operates service price equal marginal cost and subsidy to the firm to cover losses