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Chapter 15Vocab: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 itNatural 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 pricesSynergies- When companies merge to lower costs through more efficient joint productionPrice 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 thegood 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 willingnessto 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 itin 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 revenuePrice Effect- The price falls, so P is lower, which tends to decrease total revenuePatent- 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 resultsin 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 permissionInfo:• 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 highprice 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 (English)• Not likely to own a firm which produces a product that doesn’t have close substitutes.• 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 books• For any given amount of output, a larger number of firms leads to less output per firm and higher average costHow 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 sameriver, creating more of a Competitive Market.• Because a monopoly is the sole producer in its market, it can alter the priceof its good by adjusting the quantity it supplies to the market• If a monopolist reduces the quantity of output it produces and sells, the price of its output increases• The market demand curve provides a constraint on a monopolies ability to 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


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UMD ECON 200 - Chapter 15

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