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Monopoly

Monopoly. By the end of this Section, you should be able to:. Define monopolies and discuss how they arise. Define and explain the types of monopolies Find monopolies profit maximizing output and price Evaluate the welfare cost of a monopoly

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Monopoly

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  1. Monopoly

  2. By the end of this Section, you should be able to: • Define monopolies and discuss how they arise. • Define and explain the types of monopolies • Find monopolies profit maximizing output and price • Evaluate the welfare cost of a monopoly • Define and discuss an example of price discrimination.

  3. Definition of a Monopoly • A monopolist is the single supplier of a good or service for which there is no close substitute. • The monopolist makes up the entire supply side of the economy. • Compare this to our definition of a competitive firm (infinite firms of perfect subsititutes)

  4. 2 Properties of a Monopoly • There exists a barrier for other firms to enter the market. • Natural Monopoly: A monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than two or more firms. • Ex. Water distillery. • Exclusive right: A monopoly arises when the government has given the exclusive right to sell some good to one firm • Ex. Patent, Licensing Fee • Ownership of resources: A monopoly arises when the monopolist has sole access to resources without a close substitute. • Ex. Lime Stone

  5. 2 Properties of a Monopoly 2. Monopolist is a price searcher. • Price and quantity changes by the monopolist has a big effect on the market. • The monopolist faces the entire industry’s demand. Monopolist Market Demand and Marginal Revenue Competitive Market Marginal Revenue Price Price MR Demand MR Quantity Quantity Marginal Revenue is horizontal because price is set by market forces. Because monopolist sets P and Q, demand and marginal revenue is the industry’s curve.

  6. Profit maximizing Q and P for a Monopolist: 2 approaches 1. TR – TC Approach • The Monopolist’s Profit Maximizing P and Q is where Profit = TR – TC is the highest. 2. MR = MC Approach • Note: Monopolist MR is ALWAYS < P • Here’s an example: Suppose a monopolist supplies 3 units of a good at a price of 8 and 4 units of a good at a price of 7. • P1=7, Q1=4 and P2=8, Q2=3 • MR = TR = P1*Q1 – P2*Q2 = 28 – 24 = 4 Q Q1 – Q2 1 • MR of the 4th unit=4<7=P of selling 4 units

  7. Profit maximizing Q and P for a Monopolist • MC = MR for a Monopolist graphically Price/Cost MC ATC Monopolist Profit = TR–TC = (Pm*)Qm*-(ATC at QM*)Qm* = (Pm*-ATC at Qm*)(Qm*) Pm* EconomicProfit ATC at Qm* MC=MR MR Demand Qm* Quantity

  8. Social Cost of a Monopoly as compared to a Competitive Market Competitive Market Monopoly Price/Costs Price/Costs MC=Supply MC ATC CS Pm* CS P* MR DWL ATC at Qm* PS PS Demand MR Demand Q* Quantity Qm* Quantity

  9. Price Discrimination • One way a monopolist causes a social cost is by price discrimination. For example: Movie Theatres • Price Discrimination is selling a given product at more than one price, with the price difference being unrelated to differences in cost. • A price discriminating monopolist charges some customers more than others based upon personal preferences of the monopolist. • Required Conditions for a Monopolist to charge different prices • Firm must face a downward sloping demand curve • Firm must be able to separate and identify buyers • Firm must be able to prevent resale of the product • In a competitive market, buyers are charged the same price for a couple of reasons: • Market sets the P • Goods are homogenous between all of the sellers • We assume buyers have full knowledge

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