Chapter 13 Monopoly a market with a single firm that produces a good or service for which no close substitute exists and that is protected by a barrier that prevents other firms from selling that good or service HHI 10 000 FFCR 100 Monopoly arises for two key reasons No close substitute exists Barrier to entry o Barrier to entry a constraint that protects a firm from potential competitors o Three types of barrier to entry are Natural Ownership Natural monopoly a market in which economies of scale enable one firm to supply the entire market at the lowest possible cost Examples firms that deliver gas water and electricity to our homes Example De Beers diamonds Occurs if one firm owns a significant portion of a key resource Legal A legal barrier to entry creates a monopoly o Legal monopoly a market in which competition and entry are restricted by the granting of a public franchise government license patent or copyright Public franchise an exclusive right granted to a firm to supply a good or service o i e U S post service government license controls entry into particular occupations professions and industries o i e medicine law dentistry patent an exclusive right granted to the inventor of a product or service o encourage the invention of new products and production methods copyright an exclusive right granted to the author or composer of a literary musical dramatic or artistic work There are two monopoly situations that create two pricing strategies single price o single price monopoly is a firm that must sell each unit of its output for the same price to all its customers o i e De Beers sells diamonds to everyone at the same price price discrimination prices Price and Marginal Revenue o price discrimination when a firm sells different units of a good or service for different o i e people with store members may pay a different price than non members marginal revenue is less than the price because when the price is lowered to sell one more unit two opposing forces affect total revenue o the lower price results in a revenue loss and the increased quantity sold results in a revenue gain to calculate marginal revenue one must deduct this amount from the revenue gain Marginal Revenue and Elasticity a single price monopoly s marginal revenue is related to the elasticity of demand for its good demand is elastic if a 1 percent fall in the price brings a greater than 1 percent increase in the quantity demanded demand is inelastic if a 1 percent fall in the price brings a less than 1 percent increase in the quantity demanded if demand is elastic a fall in the price brings an increase in total revenue and marginal revenue is positive if demand is inelastic a fall in the price brings a decrease in total revenue and marginal revenue is negative if demand is unit elastic total revenue does not change and marginal revenue is zero In Monopoly demand is always elastic A monopoly sets its price and output at the levels that maximize economic profit Economic profit which equals TR TC increases at small output levels reaches a maximum and then decreases When MR exceeds MC profit increases if output increases When MC exceeds MR profit increases if output decreases When MC equals MR profit is maximized Maximum Price the market will bear A monopoly produces the profit maximizing quantity and sells that quantity for the highest price it can get Price exceeds both marginal revenue and marginal cost Monopolies always incur a profit unless the fixed cost increases Comparing price and output marginal cost Monopoly maximizes profit by producing the quantity at which marginal revenue equals When a market is overcome by a single firm the competitive market s supply curve becomes the monopoly s marginal cost curve Compared to a perfectly competitive market a single price monopoly produces a smaller output and charges a higher price Efficiency comparison At the competitive equilibrium marginal social benefit equals marginal social cost total surplus is maximized firms produce at the lowest possible long run average cost and resource use is efficient A monopoly produces QM and sells its output for PM Monopolies are inefficient because consumer surplus shrinks o Consumers lose by having to pay more for the good This loss to consumers is a gain for monopoly and increases the producer surplus o Consumers lose by getting less of the good and this loss is part of the deadweight loss o Although the monopoly gains from a higher price it loses some producer surplus because it produces a smaller output that loss is another part of deadweight loss A monopoly produces less increases the cost of production and raises the price by more than the increased cost of production Rent seeking Economic rent any surplus consumer surplus producer surplus or economic profit Rent seeking the pursuit of wealth by capturing economic rent The pursuit of economic profit by a monopoly is rent seeking Rent seekers pursue their goals in two main ways They might o Buy a monopoly o Create a monopoly To rent seek by buying a monopoly a person searches for a monopoly that is for sale at a lower price than the monopoly s economic profit Rent seeking by creating a monopoly is mainly a political activity takes the form of lobbying and trying to influence the political process Rent seeking equilibrium There is no barrier to entry into rent seeking rent seeking is like perfect competition If an economic profit is available a new rent seeker will try to get some of it Rent seeking and rent seeking costs increase to the point at which no economic profit is made The ATC shifts upward until it just touches the demand curve economic profit is 0 The deadweight loss from monopoly is larger Price discrimination Price discrimination selling a good or service at a number of different prices Not all price differences are price discrimination some goods that are similar have different prices because they have different costs of production o Cereal is cheaper if you buy in bulk Capturing consumer surplus Price discrimination captures consumer surplus and converts it into economic profit Firms price discriminate in two ways They discriminate o Among groups of buyers People differ in the value they place on a good their marginal benefit and willingness to pay Some of these differences are correlated with features such as age employment status and other easily distinguished characteristics o Among units of a good If all the units of the good are sold for a single price