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UW-Madison ECON 101 - Monopoly

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MonopolyA. Characteristics of monopolies1. Only one seller2. No close substitutes for the product B. Goal of the firm1. Profit maximization a. What output and what price??**** b. to profit maximize, produce that output where MR= MC and charge the price where demand is for that quantity1. Demand curve for the monopolist is the market demand curve since there is only 1 producer2. Marginal revenue lies beneath the demand curve, but where? a. to sell a greater quantity, the monopolist must lower its price:1. TR up due to increase in Q2. TR down due to decrease in price C. Entry barriers to maintain monopolies1. Natural a. Economies of scale where you need a really large scale of operation 1. call this a natural monopoly- when demand conditions allow only 1 firm to cover its cost while producing at smallest efficient scale of operation b. Control of an essential natural resourcec. set up costs- entering the market, developing the product, establishing a brand image, getting a dealer network is very difficult and costly 2. Createda. Patent law- create a property rights1. incentive for research and development b. Charter or franchise- licensingc. Threat of force or sabotageD. Schumpeter 1. Monopolies create "Creative destruction"a. the existence of monopoly power is a major incentive to economic growth E. Compare Perfect competition and monopoly1. Allocative efficiency: P= MC for last unit produceda. Sum of CS and PS is maximized F. Natural Monopolies 1. Those monopolies which exist because one firm can supply the market at a lower price than can 2 or more firms 2. Market power of natural monopoly is usually limited by regulation or state ownership G. Price discrimination (PD)1. The practice of charging different consumers different prices, or a particular consumer different prices for different quantities purchased 2. P.D. is if the price differences do not reflect cost differences 3. Examples:a. Senior citizen discounts, airline tickets, coupons, mail- in rebates, ladies night bar specials, bookstore discounts for professors 4. First degree price discriminationa. Suppose the monopolist knows the max. amount each and every consumer will pay for each unit of the commodity and there is no reselling with perfect price discrimination 1. monopolist charges each consumer a different price2. monopolist will "capture" all of the consumer surplus3. monopolist will produce the socially optimal amount of output where P=MC for last unit produced and it will be allocatively efficient, and DWL= 05. Second degree price discriminationa. Monopolist will capture part of CS by charging 2 or more different prices1. $60/ unit for the first 40 units and $40/ unit for the next 20 units 6. Third degree price discrimination a. EX: ladies night at the bars, airline tickets, movie ticket pricesb. what we need:1. Buyers fall into different classes of buyers based on differences in their price elasticity of demanda. Elastic class: sensitive to price changesb. inelastic class: not so sensitive to price changes 2. classes can be economically identified and segregated at moderate costs 3. classes can't transfer the commodity from one class to


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