Monopoly

1. Monopoly • Outline: • Characteristics of a monopoly • Why monopolies arise? • Production and pricing decision of monopolies • Monopoly and societal well- being • Government policy and monopolies • Price discrimination

2. What is a monopoly? • Monopoly is a firm that is the sole seller of a product without close substitutes • Monopoly has market power and this alters relationship between a monopoly firm’s price and its costs. • A monopoly is a price maker • Characteristics of a monopoly: • Product has no close substitutes • There are barriers to entry

3. Barriers to entry • Barriers to entry arise from three sources • Monopoly over key resources • Government gives a firm exclusive right to produce • Natural monopoly due to costs of production • Natural monopoly arises because a single firm can supply a good or service to an entire market at a smaller cost than could two firms (when a firm’s ATC continually declines)

4. Production and Pricing Decisions • Monopoly versus Competition: • Monopoly has market power and perfect competition has no market power • Monopoly is a price maker and competitive firm is a price taker • Demand curve faced by the competitive firm is perfectly elastic • Demand curve faced by the monopoly is downward sloping • Market demand curve is a constraint on the monopolist’s profit

5. Production and Pricing Decisions: Monopoly’s Revenue

6. Monopoly's Revenue • TR=PQ • AR=P • MR<P (demand curve is down-ward sloping) • There are two effects when a monopoly increases the amount it sells • Output effect: Q is higher • Price effect: P is lower • MR=0, positive, negative (depending on the price effect on TR)

7. Monopoly's Profit Maximization • A monopoly maximizes profit by producing output at the point where MR=MC • The price for the profit maximizing output is determined using the demand curve • For a monopoly firm: • P>MR=MC • For a competitive firm: • P=MR=MC

8. Monopoly's Supply Curve • Since a monopoly is a price maker, the monopolist’s decision to supply a particular quantity is linked to its demand curve • The demand curve determines MR, which in turn determines the profit maximizing quantity to be sold

9. Welfare Cost of Monopoly • P>MC and therefore this affects the well-being of the society by imposing a social cost on them • Socially efficient quantity maximizing total surplus occurs at the intersection of the demand and MC curves • Monopoly’s chosen level of output occurs at the intersection of the MC and MR curves

10. Welfare Cost of Monopoly • Monopolist produces less than the socially efficient quantity of output thus minimizing total surplus • P>MC implies that some potential consumers do not buy the good due to the deadweight loss imposed by the monopoly price (similar to a tax) • The welfare cost= cost of rent seeking activities+ deadweight loss

11. Public Policy Toward Monopolies • Policy makers respond to the problem of monopoly in 4 ways: • Competition law : problem of synergies • Regulation: problems with MC and ATC pricing • Public ownership: problem with bureaucratic methods • Leaving it to market forces

12. Price Discrimination • The practice of selling the same good at different prices to different consumers is known as price discrimination • Firms must have market power in order to price discriminate • Price discrimination is a rational strategy for a profit-maximizing monopolist • Price discrimination requires ability to distinguish consumers according to their willingness to pay

13. Price Discrimination • Certain market forces (arbitrage) can prevent firms from price discriminating • Price discrimination can eliminate the inefficiency inherent in monopoly pricing • Increase in welfare is reflected as an increase in producer surplus (profit) and there is no dead weight loss • Conclusion: monopoly power is a matter of degree and is usually limited