Lecture 5: Market Structures - Monopoly

monopoly

a market structure with only one firm and no close substitutes; the sole seller of a product. In reality firms can exercise monopoly power by being the dominant firm in the market.

Arbitrage

the process of buying a good in one market at a low price and then selling it in another market at a higher price. Arbitrage will limit a monopolist's ability to price discriminate.

Market share

the proportion of total sales in a market accounted for by a particular firm.

The Efficient Level of Output

** graph with arrows To the left of the efficient quantity: Value to buyers > Cost to monopolist To the right: Value to buyers < Cost to monopolist Efficient Quantity: Value = Cost

A Monopoly's Marginal Revenue

A monopolist's marginal revenue is always less than the price of its good. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases. When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q).

Profit Maximization

A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost: MR = MC. Then uses the demand curve to find the price that will induce consumers to buy that quantity. Competitive Firm: P = MR = MC Monopoly Firm: P > MR = MC

Deadweight Loss

Because a monopoly sets its price above marginal cost, it places a wedge between the consumer's willingness to pay and the producer's cost. This wedge causes the quantity sold to fall short of the social optimum. The monopolist produces less than the socially efficient quantity of output. The private firm gets the monopoly profit.

Monopolist with Single Price

Consumer Surplus: Triangle BCF Profit: Rectangle ABCD Deadweight Loss: Triangle CDE

Public Policy Toward Monopolies

Government can... - make monopolized industries more competitive (prevent mergers, break up companies, Competition laws (anti-trust law) prevent companies from undertaking activities that make markets less competitive) - regulate the behavior of monopolies (the allocation of resources will be efficient if price is set to equal marginal cost) - turn some private monopolies into public enterprises (governments can run natural monopolies) - do nothing at all (if the market failure is deemed small compared to the imperfections of public policies)

Government - Created Monopolies

Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest. The benefits are the increased incentive for creative activity must be set against the costs of monopoly pricing.

The Welfare Cost of Monopoly

In contrast to a competitive firm, the monopoly charges a price above the marginal cost. From the standpoint of consumers, this high price makes monopoly undesirable. From the standpoint of the owners of the firm, the high price makes monopoly very desirable.

The Prevalence Of Monopoly

Monopolies are common. Most firms have some control over their prices because of differentiated products. Firms with substantial monopoly power are rare. Few goods are truly unique.

monopoly vs. competitive firm

Monopoly: - sole producer - downward sloping demand curve - price maker - reduces price to increase sales Competitive Firm: - one of many producers - horizontal demand curve - price taker - sell as much or as little as possible

Monopolist with Perfect Price Discrimination

Profit = Producer Surplus

A Monopoly's Profit

Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q ** this is for the graph

Marginal Cost Pricing for a Natural Monopoly

QU is the monopoly quantity. Blue box is the loss of charging a price below the average total cost. Loss = (ATC - Regulated Price) x Q

barriers to entry

The fundamental cause of monopoly 1 - Ownership of a key resource 2 - The government gives a single firm the exclusive right to produce some good 3 - Costs of production make a single producer more efficient than a large number of producers 4 - A firm is able to gain control of other firms in the market and thus grow in size

monopoly vs. competitive firm graphs

The key difference between a competitive firm and a monopoly is the monopoly's ability to control price. A monopoly faces a downward sloping demand curve. A Competitive firm has a horizontal demand curve. A monopoly can increase price and not lose all its sales.

Monopoly Drugs vs Generic Drugs

The market for pharmaceutical drugs takes on both monopoly characteristics and competitive characteristics. When a firm discovers a new drug, patent laws give the firm a monopoly on the sale of that drug. The patent eventually expires and any firm can make the drug, which causes the market to become competitive. Prices of drugs fall after patents expire.

Profit Maximization for a Monopoly

The monopolist will receive economic profits as long as price is greater than average total cost. P > ATC. Profit maximizing level is below the level that maximizes the sum of consumer and producer surplus.

A Monopoly's Revenue

Total Revenue: TR = P x Q Average Revenue: TR/Q = AR = P Demand curve = AR Marginal Revenue: dTR/dQ = MR

The Monopoly's Profit: A Social Cost?

Welfare in a market includes the welfare of both consumers and producers. The transfer of surplus from consumers to producers is therefore not a social loss. The deadweight loss from monopoly stems monopolies producing less than the socially efficient level of output.

The Market for Drugs

When the drug is patented, the Monopoly Quantity is produced (where MR = MC). The Price during patent life is the point on the demand curve that lines up with this quantity. After the patent expires, the price and quantity produced is where MC = Demand.

natural monopoly

a single firm that can supply a good or service to an entire market at a smaller cost than could two or more firms; occurs when there are economies of scale, implying that average total cost falls as the firm's scale becomes larger.

The output effect

more output is sold, so Q is higher, TR is higher

Examples of price Discrimination

movie tickets, airline prices, discount coupons, quantity discounts

Perfect Price Discrimination

occurs when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.

The price effect

price falls, so P is lower, TR is lower

Price discrimination

selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same. PD can increase the monopolist's profits, and reduce deadweight loss. In order to price discriminate, the firm must have some market power.

Market power

where a firm is able to raise the price of its product and not lose all its sales to rivals. a competitive firm is a price taker - a monopoly firm is a price maker.

Imperfect Competition

where firms differentiate their product in some way and so can have some influence over price (ex. monopoly)