Econ 200: Lecture 16
November 29, 2016
0. Learning Catalytics Session:
1. Monopolies
2. Monopoly Output and Prices
3. Comparing Monopoly to Perfect Competition
What is Monopoly and Why Do We Study It?
Monopoly is a market structure consisting of a firm that is the only
seller of a good or service that does not have a close substitute.
We study monopolies for two reasons:
1. Some firms truly are monopolists.
2. Firms might collude in order to act like a monopolist.
2
Are There Really Monopolies?
Suppose you live in a small town with only one pizzeria. Is that
pizzeria a monopoly?
1. It has competition from other fast-food restaurants.
2. It has competition from grocery stores that provide pizzas for you
to cook at home.
Note: The pizzeria’s unique position may afford it some monopoly
power to raise prices, and obtain positive economic profit, even if it is
not a true monopoly.
3
Reasons Why Monopolies Exist
For a firm to exist as a monopoly, there must be barriers to entry
preventing other firms coming in and competing with it.
The four main reasons for these barriers to entry are:
1. Government restrictions on entry
2. Control over a key resource
3. Network externalities
4. Natural monopoly
4
1. Government Restrictions on Entry
In the U.S., governments block entry in two main ways:
a. Patents, copyrights, and trademarks.
Patents and copyrights encourage innovation and creativity, since
without them, firms would not be able to substantially profit from their
endeavors.
b. Public franchises
A government designation that a firm is the only legal provider of a
good or service is known as a public franchise.
5
2. Control Over a Key Resource
For many years, the Aluminum Company of America (Alcoa) either
owned or had long-term contracts for almost all the world’s supply of
bauxite, the mineral from which we obtain aluminum.
6
3. Network Externalities
Economists refer to network externalities as a situation in which the
usefulness of a product increases with the number of consumers who
use it.
These network externalities can set off a virtuous cycle for a firm,
allowing the value of its product to continue to increase, along with
the price it can charge.
7
4. Natural Monopoly
Natural monopoly:
when economies of
scale are so large that
one firm can supply the
entire market at a lower
average total cost than
can two or more firms.
This is often because of high fixed costs; in this example, the cost of
erecting power lines and transformers.
8
Calculating a Monopoly’s Revenue
Comcast is a monopolist in
the market for cable
television services.
They must accommodate
downward sloping demand
when choosing Q.
9
Calculating a Monopoly’s Revenue—continued
As the monopolist seeks to expand its
output, two effects occur:
1. Revenue is up from additional
sales
2. Revenue is down due to lowered
prices.
So marginal revenue is always below
demand for a monopolist.
10
Profit-Maximizing Price and Output for a Monopoly
Just like the perfect competitor, MC = MR determines quantity for a
monopolist.
11
Price and Output for a Monopoly—continued
At this quantity,
• The demand curve determines price, and
• The average total cost (ATC) curve determines average cost.
Profit is the difference between these (P–ATC), times quantity (Q).
12
Long-Run Profits for a Monopoly
Since there are barriers to entry, additional firms cannot enter the
market.
• So there is no distinction between the short run and long run for a
monopoly (except lower costs due to flexible inputs).
We expect monopolists to continue to earn profits in the long run.
13
In this graph, which curve is conceptually the same as average revenue?
a.
b.
c.
d.
The demand curve.
The marginal revenue curve.
Both curves.
Neither curve.
14
In this graph, which curve is conceptually the same as average revenue?
a. The demand curve.
15
Which point shows the price and output for a monopoly?
a.
b.
c.
d.
A
B
C
None of the above.
16
Relative to the price and output produced by a perfectly competitive
industry, what price and output levels correspond to a monopoly in this
graph?
b. B
17
Comparing Monopoly and Perfect Competition
Suppose that a market could be characterized by either perfect
competition or monopoly. Which would be better?
Imagine a single firm buys up all of the smartphones in the country.
What would happen to:
• Price and quantity traded?
• Consumer surplus?
18
If a Perfect Competition Became a Monopoly…
Now the market is supplied by a single firm. Since the single firm is
made up of all of the smaller firms, the marginal cost curve for this
new firm is identical to the old supply curve.
19
… Quantity Will Fall and Price Will Rise
The new firm maximizes market profit, producing the quantity where
MC = MR.
This quantity (QM) is lower than the competitive quantity (QC)…
… and PM is higher than the competitive price, PC.
20
Measuring the Efficiency Losses from Monopoly
Fewer smartphones will be traded at a higher price.
• Consumer surplus will fall (with the higher price).
• Producer surplus must rise, otherwise the firm would have chosen
the perfectly competitive price and quantity.
Could the increase in producer surplus offset the decrease in
consumer surplus?
• No!
21
The Inefficiency of Monopoly
With the higher monopoly price, CS
decreases by A+B.
PS falls by C, but rises by A; an
overall increase.
Area A is a transfer of surplus.
But areas B and C are lost
surpluses: deadweight loss.
22
How Large Are the Efficiency Losses?
There are relatively few monopolies, so the loss of economic
efficiency due to monopolies must be relatively small.
But many firms have market power: the ability of a firm to charge a
price greater than marginal cost.
23
How Large Are the Efficiency Losses?
There are relatively few monopolies, so the loss of economic
efficiency due to monopolies must be relatively small.
But many firms have market power: the ability of a firm to charge a
price greater than marginal cost.
Still, economists estimate that overall, the loss of efficiency in the
United States due to market power is probably less than 1% of total
U.S. production—about $500 per person annually.
24
Calculate the profits of a monopoly facing demand
Qd=100-p (MR=100-2Q) and MC=AC=4 (TC=4Q).
P
100
52
4
MC
MR
48
Qd
50
100
Q
25
Calculate the profits of a monopoly facing demand
Qd=100-p (MR=100-2Q) and MC=AC=4 (TC=4Q).
P
100
52
4
MC
MR
48
Qd
50
100
Q
Profits = P*Q-AC*Q = 52*48 – 4*48 = 2304
26
Calculate the deadweight loss from the monopoly when
Qd=100-p (MR=100-2Q) and MC=4 (TC=4Q). (Hint:
Point A is the perfectly competitive equilibrium point)
P
100
52
A
4
MR
48
MC
Qd
50
100
Q
27
Calculate the deadweight loss from the monopoly. (Hint:
Point A is the perfectly competitive equilibrium point)
P
100
52
DWL
4
A
MR
48
MC
Qd
50
96
100
Q
DWL= ½ (52-4)*(96-48)=1152
28