Chapter Twelve: Monopoly

Monopoly Defined Pure Monopoly: An industry in which there is only one supplier of a product for which there are no close substitutes and in which it is very hard or impossible for another firm to coexist Only one firm may exist in the industry No close substitutes for the monopolists products may exist There must be come reason why entry and survival of potential competitors is extremely unlikely Sources of Monopoly: Barriers to Entry and Cost Advantages Key requirement for preservation of a monopoly is exclusion of potential rivals from the market. Examples of impediments are: - Legal restrictions - Patents - Control of a scare resource of input - Deliberately erected entry barriers - Large sunk costs - Technical superiority - Economies of scale Natural Monopoly Natural Monopoly: An industry in which advantages of large-scale production make it possible for a singe firm to produce the entire output of the market at lower average cost than a number of firms each producing a smaller quantity What matters is the size of a single firm relative to the total market demand for the product Many public utilities operate as regulated monopoly suppliers to avoid the danger in a rise in prices once rivals have left the industry There are two basic reasons why a monopoly may exist: barriers to entry or large scale operation that lead to a natural monopoly. It is generally considered undesirable to break up a large firm whose costs are low because of scale economies. But barriers to entry are usually considered to be against the public interest except where they are believed to offer offsetting advantages, as in the case of patents. The Monopolists Supply Decision A monopoly is a price-maker that can raise the product price if so inclined. Demand curve is negative. A price rise will not cause the monopoly to lose all of its customers. The market cannot impose a price on a monopolist as it imposes a price on price-taking competitive firms. But the monopolist cannot select both price and the quantity it sells. In accord with the demand curve, the higher the price it sets, the less it can sell. To maximize profits, the monopolist must compare marginal revenue with marginal cost. The MR curve is always below the demand curve because MR is always less than price Determining the Profit-Maximizing Output To learn what price the monopoly charges, we must use the demand curve to find the price at which consumers are willing to purchase the profit-maximizing output - Find the output at which MR = MC to select the profit maximizing output level - Find the height of the demand curve at that level of output to determine the corresponding price - Compare the height of the demand curve with the height of the AC curve at that output to see whether the net result is an economic profit or a loss Comparing Monopoly and Perfect Competition A Monopolists Profit Persists: - Difference between competition and monopoly is a direct consequence of barriers to entry in monopoly. A competitive firm must earn zero economic profit to avoid entry in the long run

- A higher profit can exist under a monopoly the government sometimes regulates their profits Monopoly Restricts Output to Raise Short-Run Price - Compared with the perfectly competitive ideal, the monopolist restricts output and charges a higher price - Under a monopoly, the firm and the industry are exactly the same entity. But under perfect competition, any one firm is just a small portion of the industry. Monopoly Restricts Output to Raise Long-Run Price - MC curve has to be above the AC curve - MR curve must be above the demand AR curve - The point where MR meets MC (monopoly output) must always lie to the left of the output at which AC and AR meet (competitive industry output) Monopoly Leads to Inefficient Resource Allocation - A monopoly will charge a higher price and produce less than a competitive industry with the same demand and cost conditions - Because it is protected from entry, a monopoly firm may earn profits in excess of the opportunity cost of capital. At the same time, monopoly breeds inefficiency in resource allocation by producing too little output and charging too high a price. For these reasons, some of the virtues of laissez-faire evaporate if an industry becomes monopolized.

Monopoly is Likely to Shift Demand If a monopoly decides to advertise, it can shift the demand curve outward if consumers flock the market. Can result in an increase in price to consumers and no net gain for consumers. Monopoly is Likely to Shift Cost Curves Higher cost could result from advertising and the size of the organization A monopoly may be able to eliminate certain types of duplication that are unavoidable by small firms such as buying larger mass production equipment, hiring less employees, and take advantage of quantity discounts. Monopoly May Aid Innovation A monopoly has a strong motivation to research It the research is positive, the monopolists cost will be lower those than the competitive industry in the long run Natural Monopoly: Where Single-Firm Production is Cheapest Costs of production would be higher if the single large firm were broken up into many smaller firms Can benefit consumers Price Discrimination Under Monopoly Price Discrimination: The sale of a given product at different prices to different customers of the firm, where there is no difference in the cost of supplying different customers. Prices are also discriminatory if it costs more to supply one customer than another, but they are charged the same price. When a firm charges discriminatory prices, profits are normally higher than when the firm charges nondiscriminatory prices The marginal revenue from a sale to Group A customer must be the same as that from a sale to a Group B customer: MRa = MRb MRa = MRb = MC To find profit maximizing outputs and prices under price discrimination: - Draw the demand and marginal revenue curves for the different customer groups side by side - Draw in the pertinent marginal cost as a horizontal line if MC is constant - Find the profit maximizing sales quantity for each customer group where the horizontal MC line cuts the MR curve for that group, so that MC = MR for each group - Determine each customer groups profit-maximizing price by locating the point on the demand curve corresponding to the profit-maximizing quantity