pure monopoly
not highest price
because a monopolist can manipulate output and price, people often believe it will charge the higher price possible -that is incorrect -the monopolist seeks maximum total profit, not maximum total price -some high prices that could be charged would reduce sales and total revenue would suffer and total cost could not be covered
pricing and other strategic barriers to entry
entry can be blocked by way of how the monopolist responds to attempts by rivals to enter the industry the monopolist may "create an entry barrier" by slashing its price, stepping up its advertising, or taking other strategic actions to make it difficult for the entrant to succeed
pure monopoly
exists when a single firm is the sole producer of a product for which there are no close substitutes
assessment and policy options
if the monopoly is achieved and sustained through anticompetitive actions, if the monopoly is a natural monopoly, if the monopoly appears to be unsustainable because of emerging new technology
income transfer
in general, a monopoly transfers income from consumers to the owners of the monopoly the income is received by the owner as revenue -because a monopoly has market power, it can charge a higher price than would a purely competitive firm with the same costs -so the monopoly in effect levies a "private tax" on consumers -this private tax can often generate substantial economic profits that can persists because entry to the industry is blocked
3 implications of the downward sloping demand curve
marginal revenue is less than price, the monopolist is the price taker, the monopolist sets prices in the elastic region of demand
economies of scale
modern technology in some firms creates extensive economies of scale (decreasing ATC with added production) long run ATC will decline over a wide range of output only a few large firms, or in the extreme, only a single large firm can achieve low ATC
regulated monopoly
natural monopolies traditionally have been subject to rate regulation (price regulation) preventing the monopoly from becoming too powerful and prices from becoming too high and regulating inefficiency
socially optimal price: P = MC
one sensible goal for regulators would be to get the monopoly to produce the allocative efficient output level -determined by where the demand curve D intersects the MC curve -for each unit of output, the demand curve lies above the MC curve meaning MB > MC how is the monopoly motivated to produce this price? -the monopoly will end up producing not because it is socially minded but because it happens to be the output that either maximizes profits or minimizes losses - P = MC
cost complications
our evaluation of pure monopoly has les us to conclude that given identical costs, a purely monopolistic industry will charge a higher price, produce a smaller output, and allocate economic resources less efficiently than a purely competitive industry -these inferior results are rooted in the entry barriers characterizing monopolies -there are four reasons costs may differ 1. economies of scale 2. x-inefficiency 3. the need for monopoly preserving expenditures 4. the "very long run" perspective
patents and licenses
patents: the exclusive right of an inventor to use his/her invention licenses: owner is giving access to another individual to make, use, sell, etc. invention protects the inventor from rivals/competitors using the invention without having shared the effort and expense of developing it patents provide the inventor with a monopoly position for the life of the patent
network effects
present if the value of a product to each user, including existing users, increases as the total number of users rises ex; computer software, cell phones, and websites like Facebook -the greater the number of people connected to the system, the more the benefits of the product to each person are magnified -the focused demand permits their producers to grow rapidly and thus achieve economies of scale -even if natural monopoly develops, the monopolist is unlikely to pass cost reductions along to consumers as price reductions -so, perhaps a handful of expectations, economies of scale do not change the general conclusion that monopoly industries are inefficient relative to competitive industries
conditions of price discrimination
price discrimination is possible when the following conditions are met: -monopoly power -market segregation -no resale
economic effects of monopoly
price output and efficiency, income transfer, cost complications, x-inefficiency, assessment and policy options
if the monopoly is a natural monopoly....
society can allow it to continue to expand if no competition emerges from new products, the government may then decide to regulate its prices and operations
if the monopoly appears to be unsustainable because of emerging new technology....
society can simply choose to ignore it society simply lets the process of creative destruction do its work
the monopolist sets prices in the elastic region of demand
the TR test for price elasticity of demand is the basis for this implication the TR test reveals that when demand is elastic, a decline in price will increase TR. when demand is inelastic, a decline in price will decrease TR a monopolist will never choose a price-quantity combination in the inelastic portion (where TR decreases) and MR is negative the profit-maximizing monopolist will always want to avoid the inelastic segment of its demand curve in favor of some price-quantity segment in the elastic region why? -to get into the inelastic segment, the monopolist must lower price and increase output -in the inelastic region, a lower price means lower TR - increased output will always mean increased TR -less TR and higher TC yields lower profits
barriers to entry
the factors that prohibit firms from entering an industry: economies of scale, patents and licenses, ownership or control of essential resources, pricing/other strategic barriers to entry
total, not unit, profit
the monopolist seeks maximum total profit, not maximum unit profit a monopolist ill accept a lower than maximum per unit profit because additional sales more than compensate for the lower unit price
no resale
the original purchaser cannot resell the product or derive if buyers in the low-price discrimination strategy would create competition in the high price segment. competition would reduce the price in the high price segment and undermine price discrimination
misconceptions concerning monopoly price
there are many misconceptions concerning monopolies: not highest price and total not unit profit
monopoly demand
three assumptions: 1. patents, economies of scale, or ownership secures the firm's monopoly 2. no unit of gov. regulates the firm 3. single- priced monopolist: it charges the same price for all units of output crucial difference between a pure monopolist and a purely competitive seller lies on the demand side of the market: the demand curve for the monopolist is not perfectly elastic, so it is downward sloping quantity produced increases as price decreases also, only a single demand curve is needed in a pure monopoly because the industry is the firm
cost data
we will assume that the firm is a monopolist in the product market , it hires resources competitively, and employs the same technology
three forms of price discrimination
1. charging each customer in a single market the maximum price he/she is willing to pay -ex: car dealerships 2. charging each customer one price for the first set of units purchased and a lower price for the subsequent units purchased 3. charging some customer one price and other customers another price ex: movie tickets for kids, adults, and elderly
characteristics of a pure monopoly
1. single seller 2. no close substitutes 3. price maker 4. blocked entry 5. non-price competition
ownership or control of essential resources
a monopolist can use private property or control of resources as an obstacle to potential rivals a firm that owns or controls a resource essential to the production process can prohibit the entry of rival firms
MR = MC rule
a monopolist seeking to maximize total profit will employ the same rationale as a profit-seeking firm in a competitive industry if producing is preferable to shutting down, it will product up to the outwit which MR = MC
simultaneous consumption
a product's ability to satisfy a large number of consumers at the same time ex; microsoft software in every computer vs. dell having to make each computer individually
rent-seeking behavior
any activity designed to transfer income or wealth to a particular firm or resource supplier at someone else's or even society's expense a monopolist can obtain an economic profit in the long run -it is no surprise that a firm may go to the great expense to acquire or maintain a monopoly granted by gov. through legislation or an exclusive license -add nothing to firm's output and increases cost -rent seeking implies that monopoly involves even higher costs and even less efficiency
no monopoly supply curve
-the pure monopolist has no supply curve -there is no unique relationship between price and quantity supplied for a monopolist -the monopolist equates MR and MC to determine output, but for the monopolist MR < P -no single unique price is associated with each level of output, and so there is no supply curve
economies of scale
an industry of one/two firms would have a lower average total cost than would the same industry made up of numerous competitive firms at the extreme, only a single firm- a natural monopoly- might be bale to achieve the lowest long run ATC sometime firms relating to new information technology (computer software, internet service, wireless communication) have displayed economies of scale -as these firms grow their long run ATC declines -simultaneous consumption and network effects have reduced cost
possibility of losses by monopolist
barriers to entry mean that any economic profit realized by the monopolist can persist - in pure monopoly, there are no entrant to increase supply, drive down price, and eliminate economic profit -but, pure monopoly does not guarantee profit -the monopolist is not immune to changes in taste that reduces demand -nor is it immune to upward shifting cost curves caused by escalating resource prices -the monopolist will not persist in operating at a loss -faced with continuous losses in the long run, a firm's owners will move their resources to alternative industries that offer better profit opportunities -a monopolist must obtain a minimum of a normal profit in the long run or it will go out of business
dilemma of regulation
comparing socially optimal price and fair return price suggests a policy dilemma -when price is set to achieve allocative efficiency (P = MC), the regulated monopoly is likely to suffer losses -survival of the firm would depend on permanent public subsidies out of tax revenues -although fair return price (P = ATC) allow the monopolies to cover costs, it only partially resolves the under allocation of resources regulation can improve on the results of monopoly from the social point of view -price regulation, even at fair return price, can simultaneously reduce price, increase output, and reduce the economic profit of monopolies
output and price determination
in order to determine at which specific price-quantity combination will a profit-maximizing monopolist choose to operate production costs must be added to the analysis
technological advance
in the very long run, firms can reduce their costs through the discovery and implementation of new technology the general view of economists is that a pure monopolist will not be technologically progressive -although its economic profits provide ample means to finance research and development, it has little incentive to implement the new techniques or products - the absence of competitors means that there is no external pressure for technological advance in a monopolized market -only time monopolies may consider being technologically progressive is when it benefits them to create another barrier to entry and prevent other firms from having an advantage -it is then used for potential competition, not the monopoly market structure that drives technological advances
x-inefficiency
occurs when a firm produces output at a higher cost than necessary to produce it (P >ATC curve) producing at any point above the ATC curve reflects inefficiency or "bad management" by the firm why is x-inefficiency allowed to occur then? -managers may have goals, such as expansion power, an easier work life, avoiding business risk, or giving jobs to incompetent relatives, that conduct with cost minimization -may rise because a firm's workers are poorly motivated or inefficiently supervised -a firm may become lethargic, and inert relying on rules of thumb in decision making as opposed to careful calculations of costs and revenues do monopolies tend more toward x-inefficiency than competitive producers do? -use -competitive firms are also under pressure from rivals, forcing them to be efficient in order to survive -monopolists are sheltered from such competitive forces because of the entry barriers -the lack of pressure leads to x-inefficiency
price, output, and efficiency
productive efficiency is achieved when average total cost is at a minimum (producing in the least costly way) allocative efficiency is achieved when P = MC (the measure of a product's value or MB to society = the value of the alternative products forgone by society) however, the monopolist finds it profitable to sell a smaller output at a higher price than in pure competition and so pure monopoly yields neither productive nor allocative efficiency the lack of productive efficiency can be understood by noting that the monopolist's output is not the output at which ATC is the lowest and price does not equal minimum ATC monopolist's underproduction also implies allocative inefficiency because at the point of production the monopoly price exceeds the MC of production because consumers value additional units of this product more highly than alternative products that could have been produced with the same resources also for every unit produced MB > MC because the demand curve lies a bounce the suppply curve
if the monopoly is achieved and sustained through anticompetitive actions, creates substantial economic inefficiency, and appears to be long-lasting...
the government can file charges against the monopoly under the antitrust laws if found guilty of monopoly abuse, the firm can either be expressly prohibited from engaging in certain business activities or be broken into two or more competing firms
monopoly power
the seller must be a monopolist or, at least, must posses some degree of monopoly power, that is, some ability to control output and price
market segregation
the seller must be able to segregate buyers into distinct classes, each of which has a different willingness or ability to pay for the product. this separation of buyers is usually based on different price elasticities of demand
fair-return price: P = ATC
the socially optimal price suffers because it may e so low that ATC is not covered -in that case, forcing the socially optimal price would result in losses in the short run and shutdown in the long run what can be done to solve this problem? 1. provide a subsidy to cover losses 2. condone price discrimination 3. regulatory commissions -guarantees that regulated monopolies can break even -regulators set a regulated price that is high enough for monopolists to break even and continue in operation -referred to as fair return price because of a ruling in the supreme court that stated regulatory agencies must permit regulated utility owners to enjoy a fair return on their investments - fair return = normal profit -where the ATC curve intersects the demand curve -economic profit = 0
the monopolist is a price taker
the total industry output is exactly equal to whatever the single monopoly firm chooses to produce in deciding the quantity of output to produce, the monopolist is also determining the price it will charge because the industry is the firm, the firm does not have to make decisions based on the overall industry
price discrimination
under certain conditions the monopolist can increase its profits by charging different prices to different buyers the practice of selling a specific product at more than one price when the price differences are not justified by cost differences
marginal revenue is less than price (MR < P)
with a fixed downward sloping demand curve, the monopolist can increase sales only by charging a lower price MR is less than price(average revenue) for unit of output except the first one. why? -the reason is that the lower price of the extra unit of output also applies to all prior units of output. -the monopolist could have sold these units at a higher price if it had not produced and sold the extra output -each additional unit of output sold increases total revenue by an amount equal to its own price less the sum the price cuts that apply to all prior units of output
