ch16 monopoly

steps for solving monopoly problems

set MR = MC to find Q

plug into demand fxn to find P

Profit = TR - TC = (P-ATC)Q

To find socially optimal Q set demand equal to MC

Monopoly

A firm that is the sole seller of a product without close substitutes

in a monopoly relationship between P and MR and MC

P > MR = MC 

Why do monopolies arise

Fundamental cause of monopoly is barrier to entry ; A monopoly remains the only seller in its market because other firms can’t enter and compete with it. Barriers to entry in turn have 3 main sources

3 Barriers to entry

monopolized resources, government created (patent copyright) high fixed costs (natural monopoly)

2 ways a gov can create a monopoly

Patent or copyright laws -If the government gives one person or firm the exclusive right to sell a good or service

Why might being the sole seller of a product not mean that you have a monopoly

ex) writers who can barely support themselves - being sole seller does not guarantee large number of buyers

Effect of patent and copyright laws

Lead to higher prices and higher profits than would occur under competition ; laws can encourage research and creativity (incentive)

Natural monopoly

Arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms ; ex tap water or club goods

Example of a club good

Bridge that is used so rarely that is never congested. Excludable bc a toll collector can prevent someone from using it. Bridge isnt rival because one person’s use of the bridge does not hinder other’s use of it . ATC declines as the number of trips rises making the bridge a natural monopoly

Marginal revenue

Amount of revenue that the firm receives for each additional unit of output. Calculate by taking the change in total revenue when output increases by 1 unit

Marginal revenue in a monopoly

monopolist’s marginal revenue is less than the price of its good ; For a monopoly, marginal revenue is lower than price because a monopoly faces a downward sloping demand curve. ; To increase the amount sold, a monopoly firm must lower the price it chargers to all customers

Marginal revenue for monopolies vs marginal revenue for competitive firms

Marginal revenue for monopolies is very different from marginal revenue for competitive firms. (PxQ) - output and price effect

Output effect

The output effect: more output is sold so Q is higher which increases total revenue

Price effect

The price effect: the price falls so P is lower which decreases total revenue

Why is a monopoly’s marginal revenue (MR) less than its price (P)? Why doesn’t this happen in a competitive market?

Because to sell more, a monopoly must lower its price for all units. Competitive firms are price takers — they can sell as much as they want at the market price. The price doesn’t drop when they sell more.

Profit maximizing quantity

"For a competitive firm: P=MR=MC

Monopoly firm: P>MR = MC"

Why are monopolies inefficient

There is deadweight loss bc monopoly charges too much (above efficient and marginal cost) and produce too little (below efficient quantity)

Deadweight loss by monopoly

Area of triangle between demand curve (value of good to consumers) and marginal cost curve (costs of monopoly producer)

Price discrimination

The business practice of selling the same good at dif prices to diff customers - Price discrimination can raise welfare as measured by total surplus - minimizing deadweight loss

How can price discrimination maximize profit for a monopolist

By charging diff prizes to diff customers a monopolist can increase its profit. All consumers who value good at more than MC buys it and charged their willingness to pay. SO every mutually beneficial trade happens

Monopolist - how might they do price discrimination

Seller must be able to separate customers according to willingness to pay Certain market forces can prevent firms from price discriminating (arbitrage - buying a good in one market at a low price and selling it in another at higher price to profit from price differences)

Public policy towards monopolies

Increasing competition with antitrust laws

Antitrust laws - statutes aimed at curbing monopoly power - promotes competition. Prevents mergers and at times breaks up large companies ;; Prevents companies from colluding to reduce competition ;; Synergies?

Regulation (marginal cost pricing)

The government forces monopoly to set price = marginal cost (P = MC).total surplus is maximized → efficient allocation of resources.

Problem #1 with marginal cost pricing?

In natural monopolies, ATC keeps falling → MC < ATC → if P = MC, price is too low → firm loses money and exits.

How can the government fix marginal cost pricing problem 1?

"Option 1: Subsidize the monopolist (but that requires taxes = new deadweight loss).

Option 2: Let monopolist charge P = ATC → earns zero profit but still some inefficiency (since P > MC)."

Problem with marginal cost pricing as regulatory - no incentive to reduce cost

No incentive to cut costs — if costs fall, regulators lower prices, so the monopolist gains nothing from being efficient.

Public ownership

Government unit can run the monopoly itself; ex) european countries - telephone water and electric companies ; US postal service; However economists prefer private ownership bc costs of production - private has incentive to minimize costs as long as they reap part of the benefit in form of higher profits; Public → losers are customers and taxpayers

Above all do no harm