Chapter 13

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. Which area reflects consumer surplus under perfect competition?

Consumer surplus is the area under the demand curve and above price. In part a, we saw that the perfectly competitive price is E. Consumer surplus in perfect competition is therefore the triangle ARE.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. Which area reflects consumer surplus under single-price monopoly?

Consumer surplus is the area under the demand curve and above the price. In part c, we saw that the monopoly price is B. Consumer surplus in monopoly is therefore the triangle AFB.

Monopolist (387)

A firm that is the only producer of a good that has no close substitutes.

Monopsonist (405)

A firm that is the sole buyer in a market. Can affect the price of the good it buys: it captures surplus from sellers by reducing how much it purchases and thereby lowers the price. It creates deadweight loss by reducing the level of the good transacted to inefficiently low levels.

Deadweight losses

A monopoly creates these by charging a price above marginal cost: the loss in consumer surplus exceeds the monopolist's profit. Thus monopolies are a source of market failure and should be prevented or broken up, expect in the case of natural monopolies.

Key difference between monopoly and perfectly competitive industry

A single perfectly competitive firm faces a horizontal demand curve but a monopolist faces a downward-sloping demand curve.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. If the industry is a single-price monopoly, what quantity will the monopolist produce? Which price will it charge?

A single-price monopolist produces the quantity at which marginal cost equals marginal revenue, that is, quantity I. Accordingly, the monopolist charges price B, the highest price it can charge if it wants to sell quantity I.

Monopoly (387)

An industry controlled by a monopolist.

Difference between the monopolist and the perfectly competitive firm's profit-maximizing output level

At the monopolist's profit-maximizing output level, marginal cost equals marginal revenue, which is less than market price. At the perfectly competitive firm's profit-maximizing output level, marginal cost equals the market price. So in comparison to perfectly competitive industries, monopolies produce less, charger higher prices, and earns profits in both the short run and the long run.

Marginal Revenue of a Monopolist

Composed of a quantity effect (the price received from the additional unit) and a price effect (the reduction in the price at which all units are sold). Because of the price effect, a monopolist's marginal revenue is always less than the market price, and the marginal revenue curve lies below the demand curve.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. Which area reflects the deadweight loss to society from single price monopoly?

Deadweight loss is the surplus that would have been available (either to consumers or producers) under perfect competition but that is lost when there is a single-price monopolist. It is the triangle FRH.

Natural Monopoly (389)

Exists when increasing returns to scale provide a large cost advantage to a single firm that produces all of an industry's output. Can still cause deadweight losses. To limit these losses, governments sometimes impose public ownership and at other times impose price regulation.

Network Externality (390)

Exists when the value of a good or service to an individual is greater when many other people use the good or service as well.

Monopsony (405)

Exists when there is only one buyer of a good. More rare than cases of monopoly.

Patent (391)

Gives an inventor a temporary monopoly in the use or sale of an invention.

Copyright (391)

Gives the creator of a literary or artistic work sole rights to profit from that work.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. If the monopolist can price-discriminate perfectly, what quantity will the perfectly price-discriminating monopolist produce?

If a monopolist can price-discriminate perfectly, it will sell the first unit at price A, the second unit at a slightly lower price, and so forth. That is, it will extract from each consumer just that consumer's willingness to pay, as indicated by the demand curve. It will sell S units, because for the last unit, it can just make a consumer pay a price of E (equal to its marginal cost), and that just covers its marginal cost of producing that last unit. For any further units, it could not make any consumer pay more than its marginal cost, and it therefore stops selling units at quantity S.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. If the industry is perfectly competitive, what will be the total quantity produced? At what price?

In a perfectly competitive industry, each firm maximizes profit by producing the quantity at which price equals marginal cost. That is, all firms together produce a quantity S, corresponding to point R, where the marginal cost curve crosses the demand curve. Price will be equal to marginal cost, E.

Price Regulation (403)

Limits the price that a monopolist is allowed to charge. A price ceiling on a monopolist, as opposed to a perfectly competitive industry, need not cause shortages and can increase total surplus.

Single-Price Monopolist (407)

Offers its product to all consumers at the same price.

Price Discrimination (407)

Sellers engage in this when they charge different prices to different consumers for the same good. Monopolists, as well as oligopolists and monopolistic competitors, often engage in this to make higher profits, using various techniques to differentiate consumers based on their sensitivity to price and charging those with less elastic demand higher price.

Perfect Price Discrimination (410)

Takes place when a monopolist charges each consumer his or her willingness to pay- the maximum that the consumer is willing to pay. Charges each consumer a price equal to his or hr willingness to pay and captures the total surplus in the market. This creates no inefficiency but it's practically impossible to implement.

Market Power (388)

The ability of a firm to raise prices by reducing output compared to a perfectly competitive firm.

Public Ownership of a Monopoly (403)

The good is supplied by the government or by a firm owned by the government.

Consider an industry with the demand curve (D) and marginal cost curve (MC) shown in the accompanying diagram. There is no fixed cost. If the industry is a single-price monopoly, the monopolist's marginal revenue curve would be MR. Which area reflects the single-price monopolist's profit?

The single-price monopolist's profit per unit is the difference between price and the average total cost. Since there is no fixed cost and the marginal cost is constant (each unit costs the same to produce), the marginal cost is the same as the average total cost. That is, profit per unit is the distance BE. Since the monopolist sells I units, its profit is BE times I, or the rectangle BEHF.

Barrier to Entry (389)

To earn economic profits, a monopolist must be protected by a barrier to entry- something that prevents other firms from entering the industry. This can take the form of control of a natural resource or input, increasing returns to scale that give rise to natural monopoly, technological superiority, a network externality, or government rules that prevent entry by other firms, such as patents or copyrights.

Main types of market structure based on the number of firms in the industry and product differentiation

perfect competition, monopoly, oligopoly, and monopolistic competition.