Chapter 15 Monopoly Monopoly firm is a price maker A monopoly charges a price that exceeds marginal cost Outcome in a market with a monopoly is not necessarily in the best interest of society Why Monopolies Arise Monopoly a firm that is the sole seller of a product without close substitutes Fundamental cause of a 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 Patent for drugs copyright for books Can encourage research encourage authors to write o The production process a single firm can produce output at a lower cost than can a larger number of producers 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 2 or more firms arises when there are economies of scale over the relevant range of output How Monopolies Make Production and Pricing Decisions Competitive market demand curve is horizontal perfectly elastic Monopoly demand curve is market demand curve slopes downward o Since the demand curve is the market demand monopolies must accept a lower price if it wants to sell more output Total revenue price times quantity Average revenue total revenue divided by quantity Marginal revenue change in total revenue divided by change in quantity A monopolist s marginal revenue is always less than the price of the good o Because a monopoly faces a downward sloping demand curve o To increase the amount sold a monopoly firm must lower the price it chargers to all customers When a monopoly increase the amount it sells it has two effects on total revenue o Output effect more output is old so Q is higher which tends to increase total revenue o Price effect price falls so P is lower which tends to decrease total revenue market price o Competitive firms have no price effect bc it can sell all it wants at the o However when a monopoly increase production by one unit it must reduce the price it charges for every unit it sells The monopolist s profit maximizing quantity of output is determined by the intersection of the marginal revenue curve and the marginal cost curve Once the monopoly chooses the quantity of output that equates marginal cost and marginal revenue it uses the demand curve to find the highest price it can charge for that quantity For a competitive firm P MR MC For a monopoly P MR MC Monopolies profit is same as competitive firm profit P ATC times quantity o On a graph height of the box price minus average total cost while width is the quantity sold The Welfare Cost of Monopolies High prices a monopoly charges is beneficial for producers but not for The socially efficient quantity is found where the demand curve and the consumers marginal cost curve intersect o Below this quantity an extra unit to consumers exceeds the cost of providing it so increasing output would raise total surplus o Above this quantity the cost of producing an extra unit exceeds the value of that unit to consumers so decreasing output would raise total surplus o At this quantity the value of an extra unit to consumers exactly equals the marginal cost of production A monopoly produces less than the socially efficient quantity of output Monopoly is inefficient The monopoly profit is not a social problem doesn t decrease size of economic pie or total surplus just a bigger slice for producers and a smaller slice for consumers The problem in monopolized markets is when the firm produces and sells a quantity below the level that maximizes total surplus deadweight loss measures how much the economic pie shrinks Price Discrimination Price discrimination the business practice of selling the same good at different prices to different customers 3 lessons about price discrimination o Price discrimination is a rational strategy for a profit maximizing monopolist o Price discrimination requires the ability to separate customers according to their willingness to pay certain market forces can prevent firms from price discriminating 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 o Price discrimination can raise economic welfare Perfect price discrimination describes a situation in which the monopolist knows exactly each customer s willingness to pay and can charge each customer a different price Examples of price discrimination o Movie tickets o Airline prices o Discount coupons o Financial aid o Quantity discount Public Policy Towards Monopolies Government can respond to monopolies by o 1 Trying to make monopolized industries more competitive o 2 Regulating the behavior of the monopolies o 3 Turning some private monopolies into public enterprises o 4 Doing nothing at all 1 Antitrust laws a collection of statutes aimed at curbing monopoly power o Sherman Antitrust Act 1890 reduce market power of the large and powerful trusts o Clayton Antitrust Act 1914 strengthened the government s powers and authorized private lawsuits o These laws give the government various ways to promote competition Government can prevent mergers and break up companies o These laws also prevent companies from coordinating their activities in ways that make markets less competitive o Costs of antitrust laws Synergies two companies merge to reduce costs 2 Government regulates prices o Downside 1 because a natural monopoly has declining average total cost marginal cost is less than average total cost Therefore if regulators require a natural monopoly to charge a price equal to marginal cost price will be below average total cost and the monopoly will loose money o Can respond to this problem by Subsidizing the monopolist Allow monopoly to charge a price higher than marginal cost o Downside 2 gives the monopolist no incentive to reduce costs 3 Public ownership rather than regulating a monopoly that is run by a private firm the government can run the monopoly itself however economists prefer private to public ownership bc private owners have an incentive to minimize costs as long as they reap part of the benefit in the form of higher profit 4 Doing nothing all the policies have drawbacks sometimes best to do nothing
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