NU ECON 1116 - Principles of Microeconomics: Chapter 15

Unformatted text preview:

Principles of Microeconomics: Chapter 15A monopoly firm is a price maker. A monopoly firm charges a price that exceeds marginal cost. A monopoly can set a price high, but because a high price reduces the quantity its customers buy, the monopoly's profits are not unlimited. Monopoly firms are unchecked by competition. Monopoly: a firm that is the sole seller of a product without close substitutes. E.g., MicrosoftA monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. 3 main sources of 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 can a larger number of producers.Government-Created Monopolies:Patent and copyright laws - if the government deems a product to be truly original, it will approve a patent, giving a firm the exclusive rightto manufacture and sell the drug for 20 years. For copyrights, no one can print and sell someone else's product without the author's permission. Because these laws give one producer a monopoly over one product,they lead to higher prices than would occur under competition. ^but by allowing these monopolistic things to happen, the laws also encourage increased incentives for creative activity. Natural MonopoliesNatural monopoly: a monopoly that arises because a single firm cansupply 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 ofoutput. In this case, a single firm can produce any amount of output at least cost. Monopolist's profit attracts entrants into the market, making it more competitive. But entering a market in which another firm has a natural monopoly is unattractive because entrants know that they cannot achieve the same low costs that the monopolists enjoy (as more firms enter, each firm would have a smaller piece of the market).As a market expands, one firm might not be able to produce enough to meet demand, allowing the market to evolve into competition. Monopoly vs. CompetitionA competitive firm is small relative to the market in which it operates and has no power to manipulate market price. 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. Because a competitive firm can sell as much or as little as it wants at a price, it faces a horizontal demand curve (perfectly elastic) because its product has many perfect substitutes. A monopoly's demand curve is the market demand curve because it is the sole producer of its product. Its demand curve will slope downward as usual (if price rises, qD will diminish)^market demand curve is a constraint on monopoly's ability to profit from market power; if the monopoly sets a very high price for its good, qD will fall. A Monopoly's RevenueAverage revenue = price of the good (for a monopoly)A monopolist's revenue is always less than the price of its good due to the downward sloping demand curve (to increase q sold, a monopoly firm must lower the price it charges to all customers). Tosell another unit of output, the monopolist will get $x less revenue foreach of the previous units. When a monopoly increases the amount it sells (remember, revenue = P x Q):• the output effect: more output is sold, so Q is higher, which tends to increase total revenue• the price effect: the price falls, so P is lower, which tends to decrease total revenueFor competitive firms, they can sell all they want at market price with no price effect because they are price takers (marginal revenue = price)For monopolies, they must reduce the price they charge for every unitthey sell (reducing revenue on the units they were already selling). This makes a monopoly's marginal revenue less than price. The demand and marginal revenue curves of a monopoly start off at the same point on the y-axis because the marginal revenue of the first unit sold will equal the unit's price. As units sold increases, the curves diverge and marginal revenue will always be under demand. Profit MaximizationWhen marginal cost is less than marginal revenue, a firm can increase production (and profit) because the extra revenue wouldexceed the extra costs. When marginal cost is greater than marginal revenue, a firm can decrease production because the costs saved would exceed the revenue lost. In order to maximize profit, a firm will adjust qS until it reaches a pointat which marginal revenue equals marginal cost (or the intersection of the two lines). Competitive firm: P = MR = MCMonopoly firm: P> MR = MCA Monopoly's ProfitProfit = TR - TCORProfit = (P - ATC) x QThe Welfare Cost of Monopolies: The DWLThe socially efficient quantity is found where the demand curve and the marginal-cost curve intersect. The value of an extra unit to consumers is equal to the marginal cost of production. ^below this quantity, an extra unit to consumers exceeds the cost of providing it, so increasing output would raise total surplus (and vice versa when above qEfficient)Since monopolies choose to produce the quantity at which themarginal-cost curve and marginal revenue curve intersect, it is lowerthan qEfficient. This results in a DWL from the efficient point to the qMonopoly, equaling the total surplus lost. Monopoly profit (in terms of total surplus) is not a social problem; totalsurplus will not change. But when the firm produces and sells a quantity that is below qEfficient, total surplus will shrink. Price DiscriminationPrice discrimination: the business practice of selling the same goodat different prices to different customersFor a firm to price discriminate, it must have some market power. Price discrimination is a rational strategy for a profit-maximizing monopolist (charge each customer a price closer to his/her willingness to pay than is possible with a single price). Price discrimination requires ability to separate customers according to their willingness to pay. Certain maker forces can prevent firms from price discriminating (e.g.arbitrage: process of buyers a good in one market at a low price and then selling it in a different market for a higher price)Price discrimination can raise economic welfare.An increase in total surplus is entirely on the side of


View Full Document

NU ECON 1116 - Principles of Microeconomics: Chapter 15

Download Principles of Microeconomics: Chapter 15
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...
Login

Join to view Principles of Microeconomics: Chapter 15 and access 3M+ class-specific study document.

or
We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Principles of Microeconomics: Chapter 15 2 2 and access 3M+ class-specific study document.

or

By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?