Chapter 15: Monopoly

Barriers to Entry (Causes)

- Monopoly Resources: A key resource required for production is owned by a single firm. - Government Regulation: The government gives a single firm the exclusive right to produce some good or service. - The Production Process: A single firm can produce output at a lower cost than can a larger number of firms.

Lessons on Price Discrimination

1. Price discrimination is a rational strategy for a profit-maximizing monopolist. 2. Price discrimination requires the ability to separate customers according to their willingness to pay (dependent on arbitrage). 3. Price discrimination can raise economic welfare.

Monopoly Efficient Level of Output

A benevolent social planner maximizes total surplus in the market by choosing the level of output where the demand curve and marginal-cost curve intersect. Below this level, the value of the good to the marginal buyer (as reflected in the demand curve) exceeds the marginal cost of making the good. Above this level, the value to the marginal buyer is less than marginal cost.

Anti-Trust Laws

A collection of statutes aimed at curbing monopoly power. "A comprehensive charter of economic liberty aimed at preserving free and unfettered competition as the rule of trade." - Supreme Court

George Stigler

A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources. No real economy meets the exact conditions of the theorem, and all real economies will fall short of the ideal economy—a difference called "market failure." In my view, however, the degree of "market failure" for the American economy is much smaller than the "political failure" arising from the imperfections of economic policies found in real political systems.

Monopoly

A firm that is the sole seller of a product without any close substitutes.

Monopoly Behavior

A monopolist's marginal revenue is less than the price of its good because a monopoly faces a downward-sloping demand curve.

Profit Maximization for a Monopoly

A monopoly maximizes profit by choosing the quantity at which marginal revenue equals marginal cost (point A). It then uses the demand curve to find the price that will induce consumers to buy that quantity (point B).

Natural Monopoly

A type of monopoly that arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.

Average Revenue

AR = TR / Q

Fundamental Cause of Monopoly

Barriers to entry

Inefficiency of Monopoly

Because a monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it. Thus, the quantity produced and sold by a monopoly is below the socially efficient level. The deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer).

Marginal-Cost Pricing for a Natural Monopoly

Because a natural monopoly has a declining average total cost, marginal cost is less than average total cost. Therefore, if regulators require a natural monopoly to charge a price equal to marginal cost, the price will be below average total cost, and the monopoly will lose money.

Deadweight Loss Triangle

Because the demand curve reflects the value to consumers and the marginal-cost curve reflects the costs to the monopoly producer, the area of the deadweight loss triangle between the demand curve and the marginal-cost curve equals the total surplus lost because of monopoly pricing. It represents the reduction in economic well-being that results from the monopoly's use of its market power.

Public Policy Towards Monopoly Innefficiency

By trying to make monopolized industries more competitive By regulating the behavior of the monopolies By turning some private monopolies into public enterprises By doing nothing at all

Competitive Firm vs Monopoly Firm

Competitive: Price Taker Monopoly: Price Maker A monopoly has the ability to influence the price of its output. A competitive firm is small relative to the market in which it operates and, therefore, has no power to influence the price of its output. It takes the price as given by market conditions. By contrast, because a monopoly is the sole producer in its market, it can alter the price of its good by adjusting the quantity it supplies to the market (Increase quantity, decreased price).

Sherman Anti-Trust Laws

Congress passed in 1890 to reduce the market power of the large and powerful "trusts" that were viewed as dominating the economy at the time.

Consumer Surplus

Consumers' willingness to pay for a good minus the amount they actually pay for it.

Prices in Competitive and Monopoly Markets

In competitive markets, price equals marginal cost. In monopolized markets, price exceeds marginal cost.

Monopoly Deadweight Loss

Inefficiency that arises whenever a monopolist charges a price above marginal cost.

Marginal Revenue

MR = ΔTR / ΔQ R2 - R1

Examples of Price Discrimination

Movie tickets, airline prices, discount coupons, financial aid, and quantity discounts.

Does a monopoly have a supply curve?

No. Although monopoly firms make decisions about what quantity to supply, a monopoly does not have a supply curve. A supply curve tells us the quantity that firms choose to supply at any given price. This concept makes sense when we are analyzing competitive firms, which are price takers. But a monopoly firm is a price maker, not a price taker. It is not meaningful to ask what amount such a firm would produce at any given price because it cannot take the price as given. Instead, when the firm chooses the quantity to supply, that decision (along with the demand curve) determines the price.

Profit

P = TR - TC (P - ATC) x Q

Welfare with and Without Price Discrimination

Panel (a) shows a monopoly that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopoly that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm's profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.

Clayton Anti-Trust Laws

Passed in 1914 and strengthened the government's powers and authorized private lawsuits.

Profit Maximization for Monopolies and Competitive Firms

Profit maximization for both firms is determined by the intersection of marginal revenue and marginal cost. The marginal revenue of a competitive firm equals its price, whereas the marginal revenue of a monopoly is less than its price. Monopoly Firm: P > MR = MC Competitive Firm: P = MR = MC

Perfect Price Discrimination

Situation in which the monopolist knows exactly each customer's willingness to pay and can charge each customer a different price.

Total Revenue

TR = P x Q

Effects of Monopolies Increased Prices

The Output Effect: More output is sold, so Q is higher, which tends to increase total revenue. The Price Effect: The price falls, so P is lower, which tends to decrease total revenue.

Producer Surplus

The amount producers receive for a good minus their costs of producing it.

Price Discrimincation

The business practice of selling the same good at different prices to different customers. Not possible in a competitive market.

Demand and Marginal-Revenue Curves for a Monopoly

The demand curve shows how the quantity sold affects the price of the good. The marginal-revenue curve shows how the firm's revenue changes when the quantity increases by 1 unit. Because the price on all units sold must fall if the monopoly increases production, marginal revenue is less than the price.

Deadweight Loss

The fall in total surplus that results from a market distortion, such as a tax.

Arbitrage

The process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference.

Economies of Scale

The property whereby long-run average total cost falls as the quantity of output increases.

Total Surplus

The sum of consumer surplus and producer surplus.

The Market for Drugs

When a patent gives a firm a monopoly over the sale of a drug, the firm charges the monopoly price, which is well above the marginal cost of making the drug. When the patent on a drug runs out, new firms enter the market, making it more competitive. As a result, the price falls from the monopoly price to marginal cost.

Synergies

When companies merge not to reduce competition but to lower costs through more efficient joint production.