Monopoly A firm is considered a monopoly if it is the sole seller of its product its product does not have close substitutes Why Monopolies Arise The fundamental cause of monopoly is barriers to entry While a competitive firm is a price taker a monopoly firm is a price maker Why Monopolies Arise Barriers to entry have three sources Ownership of a key resource The government gives a single firm the exclusive right to produce some good Costs of production make a single producer more efficient than a large number of producers Government Created Monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest Monopoly Resources Although exclusive ownership of a key resource is a potential source of monopoly in practice monopolies rarely arise for this reason Natural Monopolies An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms A natural monopoly arises when there are economies of scale over the relevant range of output 1 Economies of Scale as a Cause of Monopoly Monopoly versus Competition Monopoly Is the sole producer Has a downward sloping demand curve Is a price maker Reduces price to increase sales Competitive Firm Is one of many producers Has a horizontal demand curve Is a price taker Sells as much or as little at same price Cost Average total cost 0 Quantity of Output A Monopoly is Price Maker Output Choice for A Monopoly Since the monopoly is the ONLY seller it DOES have control over the price it charges The profit maximizing level of output is where MR MC It is called a price maker or a price setter We call this ability to set your own price MARKET POWER or monopoly power Same as for a perfectly competitive firm For a monopoly MR is not equal to price Although market power DOES mean the firm can charge high price it does NOT mean it can charge any price it wants Different from a perfectly competitive firm The cost curves depend on the production technology and do not depend on whether the firm is perfectly competitive Why doesn t Microsoft charge 500 for Windows Or better yet 5000 or 50 million Marginal Revenue MR is the extra revenue earned from selling one more unit MR does depend on whether the firm is perfectly competitive For a perfectly competitive firm MR P always because firms are price takers Unlike a price taking firm a monopoly must LOWER its price to sell more units Demand Curves for Competitive and Monopoly Firms Price a A Competitive Firm s Demand Curve b A Monopolist s Demand Curve Price Demand Demand 0 Quantity of Output 0 Quantity of Output 2 Marginal Revenue A Monopoly s Total Average and Marginal Revenue Cutting price to increase sales has to effects Good news the firm sells more Bad news the firms earns less per unit including on the units it would have been able to sell even at the higher price Quantity Q 0 1 2 3 4 5 6 7 8 Demand and Marginal Revenue Curves for a Monopoly Price 11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 Price P 11 00 10 00 9 00 8 00 7 00 6 00 5 00 4 00 3 00 2 3 4 B 6 7 8 1 The intersection of the marginal revenue curve and the marginalcost curve determines the profit maximizing quantity Demand Marginal cost Marginal revenue 0 For a competitive firm price equals marginal cost P MR MC For a monopoly firm price exceeds marginal cost P MR MC 10 00 8 00 6 00 4 00 2 00 0 00 2 00 4 00 A Quantity of Water Comparing Monopoly and Competition 10 00 9 00 8 00 7 00 6 00 5 00 4 00 3 00 Average total cost Demand average revenue 5 Marginal Revenue MR TR Q 2 and then the demand curve shows the price consistent with this quantity Monopoly price 1 Average Revenue AR TR Q Profit Maximization for a Monopoly Costs and Revenue Marginal revenue Total Revenue TR PxQ 0 00 10 00 18 00 24 00 28 00 30 00 30 00 28 00 24 00 QMAX Quantity A Monopoly s Profit Profit equals total revenue minus total costs Profit TR TC Profit TR Q TC Q x Q Profit P ATC x Q The monopolist will receive economic profits as long as price is greater than average total cost 3 The Monopolist s Profit The Welfare Cost of Monopoly Costs and Revenue Marginal cost Average total cost D B y ol op it on f M pr o Monopoly E price Average total cost C Demand In contrast to a competitive firm the monopoly charges a price above the marginal cost From the standpoint of consumers this high price makes monopoly undesirable However from the standpoint of the owners of the firm the high price makes monopoly very desirable Marginal revenue 0 QMAX Quantity The Inefficiency of Monopoly Price Deadweight loss The Deadweight Loss Marginal cost Monopoly price Marginal revenue 0 The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax The difference between the two cases is that the government gets the revenue from a tax whereas a private firm gets the monopoly profit Demand Monopoly Efficient quantity quantity Quantity Public Policy Toward Monopolies Government responds to the problem of monopoly in one of four ways Making monopolized industries more competitive Regulating the behavior of monopolies Turning some private monopolies into public enterprises Doing nothing at all Increasing Competition with Antitrust Laws Antitrust laws are a collection of statutes aimed at curbing monopoly power Antitrust laws give government various ways to promote competition They allow government to prevent mergers They allow government to break up companies They prevent companies from performing activities which make markets less competitive 4 Regulation Two Important Antitrust Laws Sherman Antitrust Act 1890 Reduced the market power of the large and powerful trusts of that time period Clayton Act 1914 In practice regulators will allow monopolists to keep some of the benefits from lower costs in the form of higher profit a practice that requires some departure from marginal cost pricing Strengthened the government s powers and authorized private lawsuits Marginal Cost Pricing for a Natural Monopoly Price Average total cost Regulated price Government may regulate the prices that the monopoly charges the allocation of resources will be efficient if price is set to equal marginal cost Public Ownership Rather than regulating a natural monopoly that is run by a private firm the government can run the monopoly itself e g in the U S the