Chapter 15:Monopoly1. Why Monopolies Arisea) Introduction- Monopoly : a firm that is the sole seller of a product without close substitutes- Fundamental cause of monopoly is barriers to entry: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 good or service.o The production process: a single firm can produce output at a lower cost than can a large 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 costis low.- Although exclusive ownership of a key resource is a potential cause of monopoly, in practice monopoliesrarely 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- 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 firmss- 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 Decisionsa) 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 monopolyfirm.- 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 eachadditional 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 revenueo 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:o When marginal cost is less than marginal revenue, the firm can increase profit by producing more unitso When marginal cost is greater than marginal revenue, the firm can raise profit by reducing production.- 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 Q3. The Welfare Cost of Monopoliesa) 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 morethan 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 Discriminationa) Details- Three lessons can be learned about price discriminationo Price discrimination is a rational strategy for a profit-maximizing monopolist. That is, by chargingdifferent prices to different customers, a monopolist can increase its profito 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. - Airline Prices- Discount Coupons: not all customers are willing to spend time clipping coupons and thus, by charging a 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 Monopoliesa) 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