LECTURE #13: MICROECONOMICS
CHAPTER 15
Monopolies
Production and Pricing Decisions
Public Policy
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Why Monopolies Arise
A. Competitive firms are price takers; a Monopoly
firm is a price maker
B. Monopoly: a firm that is the sole seller of a product
without close substitutes
C. The fundamental cause of monopoly is barriers to
entry.
1. Monopoly Resources
a.
b.
A monopoly can have sole ownership or control of a key resource
used in the production of the good.
A key example is DeBeers; it has at times controlled about 80%
of the diamonds in the world.
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Why Monopolies Arise
2. Government-Created Monopolies
a.
b.
c.
Monopolies can arise because the government grants one person
or one firm the exclusive right to sell some good or service.
Patents are issued by the government to give firms the exclusive
right to produce a product for 20 years.
Patents involve trade-offs; they restrict competition but
encourage research and development.
3. Natural Monopolies
a.
b.
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 could two or more firms.
A natural monopoly occurs when there are economies of scale,
implying that average total cost falls as the firm's scale becomes
larger.
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Why Monopolies Arise
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Monopoly Production and
Pricing Decisions
A. Monopoly versus Competition
1. The key difference between a competitive firm and a
monopoly is the monopoly's ability to influence the price
of its output.
2. The demand curves faced by each of these types of firms
are different as well.
a.
b.
A competitive firm faces a perfectly elastic demand at the market
price. The firm can sell all that it wants to at this price.
A monopoly faces the market demand curve because it is the only
seller in the market. If a monopoly wants to sell more output, it
must lower the price of its product.
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Monopoly Production and
Pricing Decisions
B. Monopoly's Revenue
2. A monopoly's marginal revenue will always be less than
the price of the good (other than at the first unit sold).
1.
2.
3.
If the monopolist sells one more unit, his total revenue (P x Q)
will rise because Q is getting larger. This is called the output
effect.
If the monopolist sells one more unit, he must lower price. This
means that his total revenue (P x Q) will fall because P is getting
smaller. This is called the price effect.
Note that, for a competitive firm, there is no price effect.
3. When graphing the firm's demand and marginal revenue
curve, they always start at the same point (because P =
MR for the first unit sold); for every other level of output,
marginal revenue lies below the demand curve (because
MR < P).
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Monopoly Production and
Pricing Decisions
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Monopoly Production and
Pricing Decisions
C. Profit Maximization
1. The monopolist's profit-maximizing occurs where MR =
MC.
a.
b.
If MR > MC, profit can be increased by raising output.
If MR < MC, profit can be increased by lowering output.
2. Even though MR = MC is the profit-maximizing rule for
both competitive firms and monopolies, there is one
important difference.
a.
b.
In competitive firms, P = MR; at the profit-maximizing level of
output, P = MC
In a monopoly, P > MR; at the profit-maximizing level of output,
P > MC
3. Monopolist's demand curve determines the price; how
much buyers are willing to pay for the product.
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Monopoly Production and
Pricing Decisions
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Monopoly Production and
Pricing Decisions
D. FYI: Why a Monopoly Does Not Have a Supply
Curve
1. A supply curve tells us the quantity that a firm chooses to
supply at any given price.
2. But a monopoly firm is a price maker; the firm sets the
price at the same time it chooses the quantity to supply.
3. The market demand curve that tells us how much the
monopolist will supply because the shape of the demand
curve determines the shape of the marginal revenue curve
(which in turn determines the profit-maximizing level of
output).
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Monopoly Production and
Pricing Decisions
A. A Monopoly's Profit
1. Monopolist’s profit: P = TR – TC.
2. Because TR = P x Q and TC = ATC x Q, we can rewrite
this equation: Profit = (P – ATC) x Q.
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Welfare Cost of Monopolies
A.
The Deadweight Loss
1.
2.
3.
4.
The demand curve represents the value that buyers place on each
additional unit of a good or service. The marginal-cost curve the
added cost of producing each unit of a good.
The socially efficient quantity of output is found where the demand
curve and the marginal cost curve intersect. This is where total
surplus is maximized.
Because the monopolist sets marginal revenue equal to marginal cost
to determine its output level, it will produce less than the socially
efficient quantity of output.
The price that a monopolist charges is also above marginal cost.
Although some potential customers value the good at more than its
marginal cost but less than the monopolist’s price, they do not
purchase the good even though that is inefficient because total
surplus is not maximized.
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Welfare Cost of Monopolies
The deadweight loss can be seen on the graph as the area between the demand
and marginal cost curves for the units between the monopoly quantity and the
efficient quantity.
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Welfare Cost of Monopolies
B. The Monopoly's Profit: A Social Cost?
1. Welfare in a market includes the welfare of both
consumers and producers.
2. The transfer of surplus from consumers to producers is
therefore not a social loss.
3. The deadweight loss from monopoly stems from the fact
that monopolies produce less than the socially efficient
level of output.
4. If the monopoly incurs costs to maintain (or create) its
monopoly power, those costs would also be included in
deadweight loss.
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Price Discrimination
A.
B.
Price Discrimination: the business practice of selling the
same good at different prices to different customers
The Analytics of Price Discrimination
1.
2.
3.
Perfect price discrimination describes a situation where a monopolist
knows exactly the willingness to pay of each customer and can
charge each customer a different price.
Without price discrimination, a firm produces an output level that is
lower than the socially efficient level.
If a firm perfectly price discriminates, each customer who values the
good at more than its marginal cost will purchase the good and be
charged his or her willingness to pay.
a.
b.
There is no deadweight loss in this situation.
Because consumers pay a price exactly equal to their willingness to pay,
all surplus in this market will be producer surplus.
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Price Discrimination
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Public Policy toward Monopolies
A. Increasing Competition with Antitrust Laws
1. Antitrust laws are a collection of statutes that give the
government the authority to control markets and promote
competition.
a.
b.
The Sherman Antitrust (1890) lowers the market power of the
large and powerful "trusts” that were viewed as dominating the
economy at that time.
The Clayton Act (1914) strengthened the government's ability to
curb monopoly power and authorized private lawsuits.
2. Antitrust laws allow the government to prevent mergers
and break up large, dominating companies.
3. Antitrust laws also impose costs on society. Some
mergers may provide synergies, which occur when the
costs of operations fall because of joint operations.
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Public Policy toward Monopolies
B.
Regulation
1.
2.
3.
Regulation is government's typical response in dealing with a natural
monopoly.
Most often, regulation involves government limits on the price of the
product.
It is possible that the government can eliminate monopoly
deadweight loss by setting the monopolist's price equal to its
marginal cost: However, this is often difficult to do.
a.
b.
c.
If the firm is a natural monopoly, its average total cost curve will be
declining because of its economies of scale.
When average total cost is falling, marginal cost must be lower than
average total cost.
Therefore, if the government sets price equal to marginal cost, the price
will be below average total cost and the firm will earn a loss, causing the
firm to eventually leave the market.
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Public Policy toward Monopolies
4.
Therefore, governments may choose to set the price of the
monopolist's product equal to its average total cost. This gives the
monopoly zero profit, but assures that it will remain in the market.
a.
b.
There is still a deadweight loss in this situation because the level of
output will be lower than the socially efficient level of output.
Average-cost pricing provides no incentive for the monopolist to reduce
costs.
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Public Policy toward Monopolies
C. Public Ownership
1. Rather run by a private firm, the government can run the
monopoly itself.
2. However, economists generally prefer private ownership
of natural monopolies.
a.
b.
Private owners have an incentive to keep costs down to earn
higher profits.
If government bureaucrats do a bad job running a monopoly, the
political system is the taxpayers’ only recourse.
3. Sometimes the costs of government regulation outweigh
the benefits.
4. Therefore, some economists believe that it is best for the
government to leave monopolies alone (do nothing)
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Homework
A. Questions for Review: 1, 2, 3, 6 (4th Ed: 1, 2,
3, 8)
B. Problems and Applications: 1, 8 (4th Ed: 1,
9)
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