Chapter 15 Monopoly 1 Why Monopolies Arise a Introduction Monopoly Fundamental cause of monopoly is barriers to entry a firm that is the sole seller of a product without close substitutes o Monopoly resources a key resource required for production is owned by a single firm o Government regulation the government gives a single firm the exclusive right to produce some o The production process a single firm can produce output at a lower cost than can a large good or service number of producers b Monopoly Resources The simplest way for a monopoly to arise is for a single firm to own a key resource If a single firm owns a necessary resource for a product they can still drive up price even if marginal cost is low Although exclusive ownership of a key resource is a potential cause of monopoly in practice monopolies rarely arise for this reason economies are large and resources are owned by many people c Government Created Monopolies Two important examples are patents and copyright laws which give exclusive ownership of new and original ideas or products so that no one can sell or reproduce without permission Laws governing patents and copyrights have benefits and costs o The benefits of the patent and copyright laws are the increase incentives for creative activity o The benefits are offset to some extent by the costs of monopoly ricing d Natural Monopolies entire market at a smaller cost than could two or more firmss Natural Monopoly a monopoly that arises because a single firm can supply a good or service to an When a firm is a natural monopoly it is less concerned about new entrants eroding its monopoly power Normally a firm has trouble maintaining a monopoly position without ownership of a key resource or protection from the government Entering a market in which another firm has a natural monopoly is unattractive because the would be entrants know they would not achieve the same low costs that the monopolist enjoys because after entry each firm would have a smaller piece of the market 2 How Monopolies Make Production and Pricing Decisions a Monopoly Versus Competition The key difference between a competitive firm and a monopoly is the monopoly s ability to influence the price of its output Because a monopoly is the sole producer in its market its demand curve is the market demand curve By adjusting the quantity produced or equivalently the price charged the monopolist can choose any point on the demand curve but it cannot choose a point off the demand curve Market demand curve describes the combinations of price and quantity that are available to a monopoly firm Monopoly has to accept a lower price if it wants to sell more output b A Monopoly s Revenue Total revenue is still P x Q Marginal revenue is important to look at which is the amount of revenue that the firm receives for each additional unit of output A monopolist s marginal revenue is always less than the price of its good When a monopoly increases the amount it sells this action has two effects on total revenue P x Q o The output effect more output is sold so Q is higher which tends to increase total revenue o The price effect the price falls so P is lower which tends to decrease total revenue Competitive firms do not have price effect because a firm can sell all it wants at the market price o When it increases production by 1 unit it receives the market price for that unit and it does not receive any less for the units it was already selling price taker When a monopoly increases production by 1 unit it must reduce the price it charges for every unit it sells and this cut in price reduces revenue on the units it was already selling As a result marginal revenue is less than its price Marginal revenue and demand start at the same point but MR lies below its demand o Marginal revenue can be negative when the price effect on revenue is greater than the output effect c Profit Maximization For monopolies more units production o When marginal cost is less than marginal revenue the firm can increase profit by producing o When marginal cost is greater than marginal revenue the firm can raise profit by reducing Monopolist s profit maximizing quantity of output is determined by the intersection of the marginal revenue and the marginal cost cure For a competitive firm P MR MC For a monopoly firm P MR MC In competitive markets price equals marginal cost In monopolized markets price exceeds marginal cost d A Monopoly s Profit Profit P ATC x Q 3 The Welfare Cost of Monopolies a The Deadweight Loss The socially efficient quantity is found where the demand curve and the marginal cost curve intersect Because a monopoly charges a price above marginal cost not all consumers who value the good at more than its cost by it Thus the quantity produced and sold by a monopoly is below the socially efficient level The deadweight loss is represented by the area of the triangle between the demand curve and the marginal cost curve 4 Price Discrimination a Details Three lessons can be learned about price discrimination o Price discrimination is a rational strategy for a profit maximizing monopolist That is by charging different prices to different customers a monopolist can increase its profit o Price discrimination requires the ability to separate customers according to their willingness to pay o Price discrimination can raise economic welfare b Examples of Price Discrimination Movie Tickets theatres charge a lower price for children and senior citizens than for other patrons Discount Coupons not all customers are willing to spend time clipping coupons and thus by charging a Airline Prices lower price only to those customers who clip coupons firms can successfully price discriminate Financial Aid By charging high tuition and selectively offering financial aid schools in effect charge prices to customers based on the value they place on going to that school Quantity Discounts often successfully because a customer s willingness to pay for an additional unit declines as the customer buys more units ex 50 cents for each donut but 5 for a dozen 5 Public Policy toward Monopolies a Increasing Competition with Antitrust Laws The government derives power over private industry from the antitrust laws a collection of statuses aimed at curbing monopoly power o Give the government various ways to promote competition o Allow the government to prevent mergers o Allow government to break up companies o Prevent companies from coordinating their activities in ways that