Chapter 10 Economics: Monopoly

Market Power

the ability to alter the market price of a good or service

Does a monopoly have total market power?

Yes!

What type of curve does a monopolist have?

confronts a downward sloping market demand curve for its output

Imperfect competition

a market structure that does not meet the conditions of perfect competition (MR no longer equals price)

How do I find Profit Maximization?

1. Find where the MR curve intersects the MC curve

2. Drop down to the output to find the PROFIT MAXIMIZING QUANTITY

3. Go up to the demand curve and then left to the price axis to find the PROFIR MAXIMIZING PRICE

What is compatible with profit maximizing output?

ONLY ONE PRICE

The monopolist will charge that price

If higher or lower price, profit falls!

If MR>MC

increase output and profit rise

If MR

decrease output and profit rise

MR=MC

this is the profit maximizing output

Charactristics of Monopoly

-must be total barrier to entry, if not another firm will enter and end the monopoly

-no close substitutes

-no competitive pressure (charge higher prices and produce smaller quantity)

-no profit squeeze

-no increased quantity even if consumer demand increases

Competitive Industry

-High profits attract more suppliers.

-Supply shifts right and price falls.

-Economic profits go to zero.

-P = MC.

-Profits are squeezed, so there is great pressure to reduce costs and improve quality.

Monopoly

-High profits, but barriers to entry exclude new suppliers

-Want high barriers ---> earns them market power

-no product change, so price does not fall

-P>MC

-No profit squeeze, no pressure to reduce cost or improve quality

Where does market power come from?

-high entry barriers --> keep competitors out

-patients

-exclusive franchises

-political appointment

-considerable market power ---> generate products used by the firm to exert political power

Does a monopoly have absolute power?

No! The customer does not have to buy from the monopolist

Monopolists in any event would not gouge the customer, it will set its prices in accordance with the profit maximizing rules

Price Discrimination

the business practice of selling the same good at different prices to different customers

pros of market power

-greater ability to pursue research and development

-tremendous incentive for invention and innovation

-large companies can produce more efficiently

-act accordingly to competition

Cons of Market Power

-R&D. No competition = little incentive to improve their product

-Invention and innovation --> new products come from entrepreneurs who weren't allowed to pursue their dreams so they break away from the firm.

Economies of Scale

When bigger means cheaper

-As production increases, the average cost per unit decreases

-increasing scale does not lower costs as economies of scale kick in. However, there is no incentive for the monopolist to expand to achieve this advantage

(creates natural monopolies)

Natural Monopoly

an industry in which one firm can achieve economies of scale over the entire range of the market

-economies of scale acts as a natural barrier to entry

-utilities have been examples of natural monopolies (cable, water, gas)

Government sets up natural monopolies

-describes the rate quality and area of service

-sets the rate(price) the natural monopoly can charge its customers

-the rate is set so there is no economic profit

-normal profit is allowed

Contestable Market

an imperfectly competitive industry subject to potential entry if prices or profits increase

-monopolies may be constrained by potential competition

-entry barriers become important

-one firm may seem to monopolize an industry, but if other firms can enter the monopoly must compete

Sherman Act of 1890

Makes trusts and conspiracies in restraint of trade illegal; makes monopolies and attempts to monopolize misdemeanors

Clayton Antitrust Act

prohibits price discrimination, exclusice dealing agreements, certain types of merger, and interlocking boards of directors among competing firms

FTC (Federal Trade Commission)

studies industry structures and behaviors to identify anti competitive practices