Chapter 15 Monopoly
A. Monopoly General Concepts
1. Def: A monopoly market is one with:
(a) One seller – there is only one seller in the market
(b) Unique product – there are no close substitutes that can be used in place of the product.
(c) No entry and exit – the admittance of new firms into the market is restricted by impossible barriers to entry. These barriers to entry include:
i) Ownership of vital resource
ii) Legal Barriers – when the government erects barriers that make entry impossible. This creates a legal monopoly. This is something like a public franchise like the US postal service.
iii) Economies of Scale – as production gets larger the cost decreases so much that it gives the company achieving these reductions a huge competitive advantage. This is called a natural monopoly because nothing was altered in the market to make it a monopoly. One company can supply the entire market and do it cheaper than 2 firms.
Rent seeking – when a firm, consumers, or some group seeks to get special treatment from government in order to get more CS or PS.
2. Concepts for a Monopoly
A monopolist also faces a downward sloping demand curve. It is the steepest of all the firms demand curves discussed.
Graphically:
a. Price Maker – it faces a downward sloping demand curve and can choose from among all the P,Q combos on the demand curve in which to supply. It chooses its own price (but keep in mind it is on the demand curve)
b. Important Relationships to Recall
i. Recall that a straight-line demand curve has elastic, inelastic, and unit elastic portions as shown below.
When we are in the elastic range P ↑ è TR ↓
When we are in the inelastic range P ↓è TR ↓
Graphically:
ii. Relationship between D, MR, TR
(1) Recall that to get MR we can take 1-unit increments on the horizontal axis and get MR. So the graphs must correspond to what we had discussed before.
Mathematically: MR = ∆ TR / ∆ Q
Finding MR with the Total Revenue:
Step 1: Draw and Label TR curve
Step 2: Label 1-unit increments on the horizontal axis
Step 3: Draw up to the curve and over to the R-axis
Step 4: Label MR’s on the vertical axis
Graph 1: Getting MR
Graph 2: Graph of MR’s
Note:
i-Q* is the same in both graphs;
ii-Total Revenue is maximized when ED=1 or is unit elastic. This is NOT necessarily profit max. To know that we need costs.
(2) Relationship between MR and TR from a straight-line demand curve – it can best be seen in the following chart
P / Q / TR / MR15 / 1 / 15 / 15
14 / 2 / 28 / 13
13 / 3 / 39 / 11
So as we can see the MR plotted with the demand curve gives us a MR that is below the demand curve. In fact if it is a straight-line we can show that it is directly half of the demand curve and can be drawn as shown below.
So the law of demand always gives us a MR curve that is below the D-curve.
d. How a Monopoly Sets Price
i-Single price monopoly – when a monopoly must sell its output at the same price to all consumers.
ii-price discriminating monopoly – when a monopoly can sell its G/S at different prices. It then has the ability to sell items at the price that a consumer is willing to pay. These price differences are not based on cost.
3. Profit Max: Price and Output Decisions for Monopoly
- Just as with all other markets we can have +,-, or zero profit. Most likely we have + profit in a monopoly market.
a. SR – we set price equal to MR and then go up to the demand curve to find the price we can change. We then compare it to cost on the ATC (just as before). Note that the total method for profit max is exactly the same as in chapter 13 notes…this time the monopolist is the entire market so simply use the market TR curve.
Graphically:
LR – in the long run firms are not allowed to enter. So as long as ATC or Demand does not change to erode profits we would expect positive profit in the LR as well.
*show how Price and Costs can change to make the market unprofitable.
Note:
(a) If no profits are being earned in the LR then we would expect the monopolist to transfer resources to another market/industry.
(b) A monopolist can further increase its monopoly in the LR by finding a more optimal K,L ratio in which to produce something (i.e. move lower on LRAC).
(c) In the SR if a monopoly is not making a profit it can still face the shutdown rule just as in other markets.
4. Price discrimination – when the seller charges higher prices to consumers when there is no justification based on costs. This is not necessarily a bad thing and occurs all the time.
-ex: individual sales, auction sites, paying on-line fares for tickets, etc…
The problem comes in when it becomes predatory is in more in-line with price gouging.
Conditions needed for this are:
a. Seller must be a price-maker
b. Seller must be able to identify/segment the market
c. Consumers cannot engage in arbitrage, in which they purchase low in one market and sell higher in another.
5. Comparison with PC in the LR: A Firm and Market Example
Graphically:
a. Monopoly à Both Firm & Mkt are the same since there is only 1 seller in a monopoly market. If there was no change in the LR we would expect the same results as the SR.
b. Perfect Competition
i. 1 Firm
ii. Market – If we consider the same market structure (i.e. same Demand Curve) for PC we see that the Quantity is more and the price is much less than a Monopolists in part (a). Recall that as profits are realized there are new market entrants in perfect competition.
-there is an underutilization of resources due the fact that:
(1) QMonoply < QPC and
(2) The prices that are charged in Monopoly is are higher è PMonopoly > PPC
(3) Price exceeds MC in the Monopoly market while in the PC we have price exactly equal to MC and at the minimum of ATC in the LR. So in a perfectly competitive market we have 0 economic profit in the LR while in a monopoly market we have (+) profits still realized.
B. Price Discrimination and Monopoly Regulation – Optional
1. Price Discrimination – as mentioned before it is selling G/S at different prices to different customers based on:
-groups of buyers
-different types of units of a G/S
Through identification of different types of customers (based on willingness to pay) monopolies are able to charge different rates and earn more profit. Below perfect price discrimination is shown. Now they supply out to where MC=D. So output increases and Producers capture all surplus (PS + CS)
Graphically:
2. Monopoly Regulation – So given that monopolies have an ability to charge a higher price and create more DWL in certain cases, generally regulations are put on them in order to prevent this from happening.
Terms:
i-regulation – when government sets price or quantity restrictions, controls entry, or controls other aspects of economic activity
ii-deregulation – the process of removing these restriction by government.
iii-social interest theory – theory that seeks to reduce inefficiency and eliminate DWL.
iv-capture theory – the process by which single entities interests are maximized. So there is inefficiency (DWL).
a. Marginal Cost Rule Pricing – a rule the sets price equal to MC in order to achieve efficiency. So you aren’t paying more than the units cost. In general you set MB =MC as before. So we can see that CS is large, but there is a loss that is created.
Graphically:
-generally to cover the increased cost a tiered system to pricing is used or the government subsidizes.
b. Average Cost Price Rule- now to regulate the monopoly find where ATC hits demand so all costs are covered.
Graphically:
Many times because costs are difficult to determine a rate of return regulation which sets the profit/revenue at a specific rate based on total capital or price cap regulations are used which is simply a price ceiling. Both methods have issues in controlling them (see page 400-01)
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