Econ Notes: Chapter 15Introductiona monopoly is a firm that is the sole seller of a product without close substitutesin this chapter, we study monopoly and contrast it with perfect competitionthe key difference: A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market powerWhy Monopolies AriseThe main cause of monopolies is barriers to entry- other firms cannot enter the marketThree sources of barriers to entry:1. A single firm owns a key resource.e.g., DeBeers owns most of the world's diamond mines2. The gov’t gives a single firm the exclusive right to produce the goode.g., patents, copyright laws3. Natural Monopoly: a single firm can produce the entire market Q at lower cost than could several firmsexample: 1000 homes need electricityATC slopes downward due to huge FC and small MCATC is always fallingATC is lower if one firm services all 1000 homes than if two firms each service 500 homesMonopoly vs. Competition: Demand CurvesIn a competitive market, the market demand curve slopes downward.But the demand curve for any individual firm's product is horizontal at the market price.The firm can increase Q without lowering Plook at graph in cs notes (a competitive firm's demand curve)so MR = P for the competitive firmLook at graph of a monopolist's demand curve in cs notebookA monopolist is the only seller, so it faces the market demand curveTo sell a larger Q, the firm must reduce PThus, MR does not equal pActive learning 1: a monopoly's revenue look in notesCharacteristicsMarginal revenue declines as the sell more output** (characteristics)Marginal revenue is always less than priceUnderstanding the Monopolist's MRIncreasing Q has two effects on revenue:Output effect: higher output raises revenuePrice effect: lower price reduces revenueTo sell a larger Q, the monopolist must reduce the price on all the units it sells*Hence, MR < PMR could even be negative if the price effect exceeds the output effecte.g., when common grounds increases Q from 5 to 6Profit-MaximizationLike a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MCOnce the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity.It finds this price from the D curveLook at graph in notes1. The profit-maximizing Q is where MR = MC2. Find P from the demand curve at this Qthat is the highest price that costumers are willing to payGet the price from the demand curveAlways want to look where ATC is in relationship to price at the profit-maximizing pointAs with a competitive firm, the monopolist's profit equals(P - ATC) x QA monopoly can make a loss*A Monopoly Does Not Have a S curveA competitive firmTakes P as givenHas a supply curve (its MC curve) that shows how its Q depends on PA monopoly firmis a "price-maker", not a "price-taker"Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand curveOutput does is not determined by price but MC, MR and the demand curveSo there is not supply curve for monopolyCase Study: Monopoly vs. Generic Drugslook at the graph in notespatents on new drugs give a temporary monopoly to the sellerwhen the patent expires, the market becomes competitive, generics appearThe Welfare Cost of MonopolyRecall: In a competitive market equilibrium, P=MC and total surplus is maximized.In the monopoly eq'm P > MR = MCThe value to buyers of an additional unit P exceeds the cost of the recourses need to produce that unit (MC).The monopoly Q is too low- could increase total surplus with a larger QThus, monopoly results in a deadweight loss.DWL in a monopoly is because they produce a lower quantity and charge a higher price.Look at graph in notesThe demand curve is flat for the individual competitive firm but for the market the demand curve isn't flatPatents of new drugs give a temporary monopoly to the seller.When the patent expires the market becomes competitive, generics appear.Generic drug is a prescription drug that has lost its patentPublic Policy Toward MonopoliesIncreasing competition with antitrust lawsBan some anticompetitive practices, allow gov’t to break up monopolies.e.g., Sherman Antitrust Act (1890), Clayton Act (1914)Master Card and Visa controlled 80% of credit cards (banks can now issue AMEX and discovery)RegulationGov’t agencies set the monopolist's price (Power Companies must have gov’t approve their increase in there price)Gov’t may require natural monopolies to set P = MC (called marginal cost pricing); however since MC < ATC at all Q, losses would resultIf so, regulators might subsidize the monopolist or set P = ATC (called average cost pricing) for zero economic profitPublic ownershipGov’t comes in and takes over a companyExample: U.S. Postal ServiceProblem: Public ownership is usually less efficient since no profit motive to minimize costsDoing nothingThe foregoing policies all have drawbacks, so the best policy may be no policyPrice DiscriminationDiscrimination: treating people differently based on some characteristic, e.g. race or genderPrice discrimination: selling the same good at different prices to different buyersThe characteristic used to price discrimination is willingness to pay (WTP)A firm can increase profit by charging a higher price to buyers with higher WTPPerfect Price Discrimination vs. Single Price MonopolyLook at graph in cs notesHere, the monopolist produces the competitive quantity but charges each buyer his or her WTP (the second graph)This is called perfect price discriminationThe monopolist captures all CS as profitBut there's no DWLPrice Discrimination in the Real WorldIn the real world, perfect price discrimination is not possible:no firm knows every buyer's WTPBuyers do not announce it to sellersso, firms divide customers into groups based on some observable trait that is likely related to WTP, such as ageExamples of Price Discriminationmovie ticketsdiscounts for seniors, students, and people who can attend during weekday afternoons. They are all more likely to have lower WTP than people who pay full price on Friday night.airline pricesdiscounts for Saturday-night stayovers help distinguish business travelers, who usually have higher WTP, from more price-sensitive leisure travelers.discount couponspeople who have time to clip and organize coupons are more likely to have lower income and lower WTP than others.Need-based financial aidlow income families have