Chapter 14: Monopoly

Economics 2420

In this chapter, you will :

Learn why some markets have one seller

Analyze how a monopolist determines the quantity to produce and the price to charge

See how the monopolist’s decisions affect the economic well being of consumers

See why monopolists try to charge different prices to different customers (monopoly price discrimination).

1. A monopoly is a one firm industry

2. Examples: Microsoft (Windows operating system) Local electric department Local gas company

3. Basic Features of Monopoly . There is only one firm in the industry- with a significant market power i.e. ability to influence price (a price maker or setter) . Its products do not have close substitutes . Entry into the monopoly market is restricted by a number of barriers

4. Barriers to entry into monopoly market

A key resource is owned by a single firm(DeBeers Diamond monopoly)

The government gives a single firm the exclusive right to produce some good or service- copy rights

The cost of production makes a single producer more efficient than a large number of producers.

5. The demand for a monopolist is downward sloping=> if the monopolist wants sell more quantity, it has to reduce price. The monopolist is a price searcher i.e. price that maximizes profit

The monopolist doesn’t necessarily charge the highest price

For the monopolist, Price=AR=D>MR Why is Price > MR for a monopolist?

It is because the monopolist has to reduce the price it charges for every additional unit it sells.

This price cut reduces the additional revenue on the units it was already selling.

Monopoly’s Total ,Average, and Marginal Revenue

Quantity ofwater

PRICE TotalRevenue

AverageRevenue

MarginalRevenue

Q (gallon) P($) (TR=P.Q)($) AR=TR/Q($) MR= TR/ Q($)

0 11 0 -1 10 10 10 102 9 18 9 83 8 24 8 64 7 28 7 45 6 30 6 26 5 30 5 07 4 28 4 -28 3 24 3 -4

6. The short run price and output decisions for a monopolist

a. The profit making case: Price > ATC

b. The break-even case : Price = ATC

c. Loss minimization by staying in business: AVC<Price<ATC

d. Loss minimization by going out of business: Price<AVC

7. In the long-run, the monopolist may make profit or just break-even. Why is the monopolist able to make profit in the long-run?

8a. Monopoly Price Discrimination The goal is to maximize profits legally.

. is the business practice of selling the same good or service at different prices to different customer group

b. Examples .A 10% discount for faculty at the book store .Airline fares for personal and business travelers .Quantity discounts(rates on residential and commercial electricity) .Movie ticket for children and adults .In-state vs. out of tuition

c. Conditions which make the price discrimination practice successful

No arbitrage- no buying at low price and selling at high price

The monopolist should be able to separate the market according to the price elasticity of demand i.e. charge a lower price in a market with elastic demand and a higher price in a market with less elastic demand.

d. Price -output decisions are made where MR1=MR2=...MRN=MC See Graph.

9a. A regulated or natural monopoly

. is a firm which makes its own production decisions subject to rate (price) regulation.

b. Examples

. Local cable company

. Local electric department

. Local gas company

c. Forms of monopoly regulation

1) Average cost-pricing or “fair return” pricing - the monopolist is required to charge a rate which is just sufficient to cover the per unit cost of production Price = ATC => most common form because the regulatory agency does not have to worry about bailing out the monopolist if it fails.

2)Marginal-cost pricing or “socially optimal pricing- the monopolist is required to charge a rate which is only sufficient to cover the marginal cost of production. Price = MC => not very popular because the regulatory agency may be required to bail out the monopolist if it fails i.e. price < ATC

10) The Performance of Monopoly

Consumers pay higher price for goods and services than in a competitive market

Monopoly output is smaller than a competitive firm’s output

Inefficiency in resource allocation is evident in monopoly as implied by : monopoly price > MC .