Chapter 15 Vocab Monopoly A firm that is the sole seller of a product without close substitutes DOWNWARD SLOPING DEMAND CURVE AVERAGE REVENUE CURVE Barriers to entry A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it Natural Monopoly A monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms Arises when there are economies of scale over the relevant range of output Less concerned about new entrants on its monopoly power because a firm has trouble maintaining a monopoly position without ownership of a key resource or protection from the government Declining ATC Government agencies regulate prices Synergies When companies merge to lower costs through more efficient joint production Price Discrimination The business practice of selling the same good at different prices to different customers Not possible in a competitive market Perfect Price Discrimination a situation where the monopolist knows exactly each consumers willingness to pay and can charge each customer a different price Impossible Monopolists charges each customer exactly his or her willingness to pay and the monopolist gets the entire surplus in every transaction Without price discrimination the firm charges a single price above marginal cost as shown in panel a Because some potential customers who value the good at more than marginal cost do not buy it at this high price the monopoly causes a deadweight loss Yet when a firm can perfectly price discriminate as shown in panel b each customer who values the good at more than marginal cost buys the good and is charged his or her willingness to pay All mutually beneficial trades take place no deadweight loss occurs and the entire surplus derived from the market goes to the monopoly producer in the form of profit Arbitrage The process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference Prevents firms from price discriminating Output Effect More output is sold so Q is higher which tends to increase total revenue Price Effect The price falls so P is lower which tends to decrease total revenue Patent Gives a company the exclusive right to manufacture and sell the product for 25 years When a patent runs out new firms are encouraged to enter due to previous profit in the market which causes it to become competitive and P should fall to MC When a patent runs out the monopolist does not lose all market power because some consumers remain loyal to the brand name drug which results in the former monopolist can continue to charge a price about the price charged by its new competitors Copyright A Government guarantee that no one can sell the work without the author s permission Info Monopolies are price makers Market power alters the relationship between a firms cost and the price at which it sells its product A monopoly firm can control the price of the good it sells but because a high price reduces the quantity that its consumers buy the monopoly profits are not unlimited Barriers to entry Monopoly Resources A key resource required for production is owned by a single firm Government Regulation The Government gives a single firm the exclusive right to produce some good or service The Production Process A single firm can produce output at a lower cost than a larger number of producers DeBeers south African diamond company founded in 1888 by Cecil Rhodes Not likely to own a firm which produces a product that doesn t have close English substitutes books Monopolies arise because Government has given one person firm the exclusive right to sell some good or service Drug companies are allowed to be monopolists to encourage research Authors are allowed to be monopolists to encourage them to write more For any given amount of output a larger number of firms leads to less output per firm and higher average cost How a Natural Monopoly can become more of a Competitive Market When a population is small a bridge may be a Natural Monopoly because a single bridge can satisfy the entire demand for trips across the river at lowest cost When a population grows and the bridge becomes congested satisfying the entire demand may require 2 or more bridges across the same river creating more of a Competitive Market Because a monopoly is the sole producer in its market it can alter the price of its good by adjusting the quantity it supplies to the market If a monopolist reduces the quantity of output it produces and sells the The market demand curve provides a constraint on a monopolies ability to price of its output increases profit from its market power DEMAND AR P In a Monopoly Marginal Revenue is ALWAYS LESS than price MR P Marginal revenue is lower than the price because a monopoly faces a downward sloping demand curve When a monopoly increases production by 1 unit it must reduce the price it charges for every unit it sells this cut in price reduces revenue on the units it was already selling Price Average Revenue P AR These 2 curves always start at the same point on the Y axis because the MR of the first unit sold price of the good Marginal Revenue is negative when the price effect on revenue is greater than the output effect When a firm produces an extra unit of output the price falls by enough to cause the firms total revenue to decline even though the firm is selling more units Social efficiency quantity is found where the demand curve and MC curve intersect These curves contain all the information we need to determine the level of output that a profit maximizing monopolist will choose Suppose first that the firm is producing at a low level of output such as Q 1 In this case marginal cost is less than marginal revenue If the firm increased production by 1 unit the additional revenue would exceed the additional costs and profit would rise Thus when marginal cost is less than marginal revenue the firm can increase profit by producing more units A similar argument applies at high levels of output such as Q 2 In this case marginal cost is greater than marginal revenue If the firm reduced production by 1 unit the costs saved would exceed the revenue lost Thus if marginal cost is greater than marginal revenue the firm can raise profit by reducing production A monopolist s profit MAXIMIZING QUANTITY of output is determined by the intersection of the MR curve and MC curve After quantity
View Full Document
Unlocking...