BUSS1040 Lecture 6 - Monopoly

Characteristics of Monopoly

• single seller (high concen)

• no close substitutes

• unique product

• barriers to entry

  • legal barriers

    • exclusive rights over a goods prod (patent, copyright)

    • public franchise (aus post), govt licenses (taxis, practice of med)

Why do monopolies exist?

natural barriers to entry

• control over essential input not available to other firms 

  • e.g Esso and gas fields in Victoria 

• monopolist might have lower COP that effectively allows them to prevent other firms entering 

  • favourable access to raw materials, geographic location, learning curve advantages 

• Tech/level of d make one producer more efficient than a no. of producers — natural monopoly

Natural monopoly

• single firm can supply an entire market at lower cost than 2/more firms could supply

  • e.g. telecomms, electricity, tap water

  • declining LR ATC implies natural monopoly 

    • substantial EOS (natural barrier to entry) 

    • often larger capital costs (infra) but low marginal cost of supply 

      

Price taker/maker

• since only one single seller — monopolist can decide p of their product to max profit

• d curve for monopoly same as market curve as only 1 seller

• monopolist is the price maker hence d curve for monopolist is downward sloping

  

Monopoly market power

• firm that has low PED for output can raise p and not lose customers

Monopolist’s output and pricing decision

• single price monopolist — charges same p to all its consumers 

• will choose output to max total profits = TR - TC

• can alter p in the market by changing q

  • downward sloping d curve 

  • if increase output by one unit — p will fall by some amt 

  • if prod more — p falls 

  • if prod less — p rises

  • causes trade off 

    • sell less q for higher p or sell more q for lower p

Monopoly MR

MR — additional rev from one extra unit of g sold

for monopolist — MR has 2 effects 

• output effect

  • as sell more units, extra rev obtained from add units sold

• price effect

  • sell more units, p fall and rev lost on existing units sold

MR is not the same as market P (always below p) 

Elasticity for MR and D curve 

• slope of MR curve is x2 value of D curve and has same intercept 

• when d is elastic — small decr in p leads to large incr in qd 

  • TR increase — MR is positive 

• when d is inelastic — small decr in p leads to small incr in qd 

  • TR decrease — MR is negative 

profit max monopolist would never prod at output in inelastic region of d curve 

TR and TC curve

• profit max is at QB where diff between TR and TC is greatest

• TR is concave and upward sloping from 0 to Qc and downward sloping from Q onwards

Profit max MR = MC

if MR>MC — monopolists can increase profits by selling 1 extra unit

if MR<MC — profit fall from selling last unit so better off not selling 

for a competitive firm — P = MR = MC 

for a monopolist — P > MR = MC

• for a single price monopoly P > MC at optimal qty supplies 

Economic Profits 

SR loss minimisation

Economic effects of monopoly

If perfect comp industry becomes a monopoly (assuming same cost curve and no EOS)

• monopolist charges higher p (pm) and produces smaller qty (qm) compared to competitive indus (pc,qc) 

Welfare Analysis of monopoly on graph

Welfare w monopoly

• at competitive qty — all gains from trade exhausted 

  • all potential trades where MB>=MC occur

• However monopolist restricts output to Qm<Q*

  • between Qm and Q* MB>MC so total surplus will increase

• but monopolist interested in own profit which is determined by MR not MB

  • surplus lost from the restriction of output — DWL

  • occurs because restricted output below the competitive level

Rent seeking behaviour

activity of trying to obtain a monopoly to earn economic profits

• firm is willing to spend up the monopoly profit to obtain a monopoly

  • buying a monopoly — taxies, import quotas

  • creating a monopoly — lobbying

  • creating barriers to entry — advertising

Are monopolies that bad?

• EOS and scope

• may prod at lower avg cost

• incentives to innovate

• monopolies provided by IPRs may provide an incentive to engage in R&D activities — e.g patents & copyright