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Pure Monopoly
10
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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An Introduction to Pure Monopoly
• Single seller – a sole producer
• No close substitutes – unique product
• Price maker – control over price
• Blocked entry – strong barriers to entry block potential competition
• Non-price competition – mostly PR or advertising the product
LO1 10-2
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Examples of Monopoly
• Public utility companies
• Natural Gas
• Electric
• Water
• Near monopolies
• Intel
• Wham-O
• Professional Sports TeamsLO1 10-3
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Barriers to Entry
• Barrier to Entry: a factor that keeps firms from entering an industry.
• Economies of Scale
• Legal Barriers: Patents and Licenses
• Ownership of Essential Resources
• Pricing
LO1 10-4
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Economies of Scale
LO1
10
15
$20
50 100 200
ATC
10-5
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Monopoly Demand
• The pure monopolist is the industry
• Demand curve is the market demand curve
• Downsloping demand curve
• Marginal revenue is less than price
LO1 10-6
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Table 10.1 Revenue and Cost Data of a Pure Monopolist
Revenue Data Cost Data
(1) Quantity of Output
(2) Price
(Average Revenue)
(3)Total
Revenue(1) X (2)
(4) Marginal Revenue
(5)Average
Total Cost
(6)Total Cost(1) X (5)
(7)Marginal
Cost
(8)Profit (+)
orLoss (-)
0 $ 172 $0 $ 100 $ -100
1 162 162 $ 162 $ 190.00 190 $ 90 -28
2 152 304 142 135.00 270 80 +34
3 142 426 122 113.33 340 70 +86
4 132 528 102 100.00 400 60 +128
5 122 610 82 94.00 470 70 +140
6 112 672 62 91.67 550 80 +122
7 102 714 42 91.43 640 90 +74
8 92 736 22 93.75 750 110 -14
9 82 738 2 97.78 880 130 -142
10 72 720 -18 103.00 1030 150 -310
Monopoly Demand
LO1 10-7
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Monopoly Demand
LO1
D
Gain = $132
Loss = $30
• All customers must pay the same price
10-8
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D
Gain = $132
Loss = $30
Monopoly Demand
LO1
• All customers must pay the same price
MR
10-9
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Monopoly Demand
• Marginal Revenue < Price
• Monopolist is a price maker
• Monopolist sets prices in elastic region of demand curve
LO2 10-10
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Output and Price Determination
LO2
Elastic Inelastic
Demand and Marginal-Revenue Curves
Total-Revenue Curve
DMR
TR
10-11
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Output and Price Determination
LO2
Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing Price, and Economic Profits (if Any) in Pure Monopoly
Step 1 Determine the profit-maximizing output by finding where MR=MC.
Step 2
Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist’s demand curve.
Step 3Determine the pure monopolist’s economic profit by using one of two methods:
Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any).
Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any).
10-12
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$200
175
150
125
25
100
75
50Pri
ce,
Co
sts,
an
d R
even
ue
1 2 3 4 5 6 7 8 9 10Quantity
Output and Price Determination
LO2
0
D
MR
ATC
MC
MR=MCA=$94
EconomicProfit
Pm=$122
10-13
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Misconceptions of Monopoly Pricing
• Not highest price
• Total profit
• Possibility of losses
LO2 10-14
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Misconceptions of Monopoly Pricing
LO2
0
D
MR
ATC
MC
MR=MC
Loss
AVCPm
Qm
V
A
10-15
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Economic Effects of Monopoly
LO3
(a)Purely Competitive Market
(b)Pure Monopoly
D D
S=MC MC
P=MC=Minimum
ATC
MR
Pc
Qc
Pc
Pm
QcQm
Pure competition is efficientMonopoly is inefficient
a
b
cd
10-16
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Economic Effects of Monopoly
• Income transfer
• Cost complications
• Economies of scale
• X-Inefficiency
• Rent seeking expenditures
• Technological advance
LO3 10-17
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X-Inefficiency
LO3
ATC2
ATC1
ATCx
Q1 Q2
Averagetotal cost
X
X'ATCx'
10-18
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Assessment and Policy Options
• Antitrust laws
• Break up the firm
• Regulate it
• Government determines price and quantity
• Ignore it
• Let time and markets get rid of monopoly
LO3 10-19
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Global Perspective
LO3
Competition from Foreign Multinational Corporations
10-20
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Price Discrimination
• Price discrimination
• Charging different buyers different prices
• Price differences are not based on cost differences
• Conditions for success:
• Monopoly power
• Market segregation
• No resaleLO4 10-21
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Examples of Price Discrimination
• Business travel
• Electric utilities
• Movie theaters
• Golf courses
• Railroad companies
• Coupons
• International trade
LO4 10-22
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Graphical Analysis
LO4
MC = ATC MC = ATC
Qb
Qs
Ps
Pb
P P
MRbMRs
Db
Ds
(a) Small businesses (b) Students
Economic profit Economic
profit
10-23
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Regulated Monopoly
• Natural monopolies
• Socially optimal price
• Set price = marginal cost
• Fair return price
• Set price = ATC
LO5 10-24
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Regulated Monopoly
LO5
MonopolyPrice
Fair-ReturnPrice
SociallyOptimal
Price
Pr
D
r
f
b
aPf
Pm
Qm Qf Qr
MR
MC
ATC
10-25
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De Beers’s Diamonds
• De Beers once controlled about 80% of the world’s diamond market
• Monopoly position eroded over time
• New diamond discoveries
• Nearly perfect artificial diamonds
• Unfavorable media attention
• Now focus on increasing demand for diamonds rather than controlling supply
10-26