AP Microeconomics Unit 4

5 Characteristics of a Monopoly

1) Single Seller

2) Unique good with no close substitute

3) "Price Maker"

4) High Barriers to Entry

5) Some "Nonprice" Competition

Single Seller (1)

-one firm controls the vast majority of a market

-firm=industry

"Price Maker" (3)

-firm can manipulate price by changing the quantity produced (ie. shifting supply to the left)

High Barriers to Entry (4)

-new firms CANNOT enter market

-no immediate competitors

-firms can make profit in the long-run

Some "Nonprice" Competition (5)

-monopolies still advertise their products in an effort to increase demand

Four Origins of Monopolies (Barriers to Entry)

1) Geography

2) Government

3) Technology or Common Use

4)Mass Production and Low Costs

Main difference between Monopolies and Perfect Competition

MARGINAL REVENUE DOES NOT EQUAL PRICE (MR LESS THAN PRICE)

-monopolies (and all imperfectly competitive firms) have downward sloping demand curve

How does a firm sell more in a monopoly?

A firm must lower its price

Total Revenue Test

If price falls and TR increases, then demand is elastic;

If price falls and TR falls, then demand is inelastic

(A monopoly will only produce in the elastic range)

Where do monopolists produce?

Where MR=MC, but it charges the price consumers are willing to pay identified by the demand curve

Are monopolies efficient?

No, monopolies under-produce and overcharge

What happens to CS and PS for a monopoly?

CS decreases

PS increases

Total Surplus decreases

There is now DWL

Are monopolies productively efficient?

No, they are not producing at the lowest cost (minimum ATC). Instead, they will maximize profit by finding MR=MC

Are monopolies allocatively efficient?

No, price is greater and the monopoly is under producing

Why are monopolies inefficient?

1) Charge a higher price

2) Don't produce enough (Not allocatively efficient)

3) Produce at higher costs (Not productively efficient)

4) Have little incentive to innovate (little external pressure to be efficient)

Natural Monopoly

One firm can produce the socially optimal quantity at the lowest cost due to economies of scale

-It is better to have only one firm because ATC is falling at socially optimal quantity

socially optimal quantity

What society wants, or where supply (MC) meets demand

Lump Sum

Does not change output, does not change MC

Why would the government regulate a monopoly?

1) To keep prices low

2) To make monopolies efficient

How does the government regulate monopolies?

Use Price Controls: Price Ceilings

Why don't taxes work for regulating monopolies?

Taxes reduce supply and that is the problem-monopolies are already unde-rproducing to begin with

Socially Optimal Price

P=MC (Allocative Efficiency)

Fair-Return Price (Break-Even)

P=ATC (Normal Profit, no economic profit)

Where should the government place the price ceiling in a monopoly?

Socially Optimal Price

-what society wants-using all resources

What happens if the government sets a price ceiling to get the socially optimal quantity in a natural monopoly?

The firm would make a loss and would require a subsidy

Price Discrimination (definition)

Practice of selling the same product to different buyers at different prices

Ex: Airline Tickets, Movie Theaters, Coupons, GBHS Football Games

Price Discrimination (concept)

-Seeks to charge each consumer what they are willing to pay in an effort to increase profits

-Those with inelastic demand are charges more than those with elastic

-Socially optimal quantity is higher

WHEN PRICE DISCRIMINATION, MR=D

Requirements for Price Discrimination

1) Must have monopoly power

2) Must be able to segregate the market

3) Consumer must NOT be able to resell product

Price for Discriminating Monopoly

range, no set price; monopolies will still accept the price until it hits minimum ATC because there is still a profit

What happens to profit, CS, and DWL in a price discriminating monopoly?

-more profit

-no CS; everyone is paying what they are willing to pay

-DWL is gone

What happens if the government sets a price ceiling to get the socially optimal quantity in a natural monopoly?

The firm would make a loss and would require a subsidy

Monopolistic Qualities

-control over price of own good due to differentiated product

-D greater than MR

-plenty of advertising

-not efficient

Perfect Competition Qualities

-large number of smaller firms

-relatively easy entry and exit

-zero economic profit in long-run since firms can enter

Monopolistic Competition Characteristics

-relatively large number of sellers

-differentiated products

-some control over price

-easy of entry and exit (low barriers)

-a lot of non-price competition (advertising)

Differentiated Products

-goods are NOT identical

-firms seek to capture a piece of the market by making unique goods

-firms use NON-PRICE Competition because these products have substitutes

Non-Price Competition

-brand names and packaging

-product attributes

-service

-location

-advertising

Two Goals to Advertising

1. Increase Demand

2. Make demand more INELASTIC

What does the short-run in monopolistic competition look like?

Monopolistic Competition is made up of price makers, so MR is less than demand and it is the same graph as a monopoly making profit

What happens to monopolistic competition in the long-run?

New firms will enter, driving down the DEMAND for firms already in the market until there is no economic profit; price and quantity falls and TR=TC

Long-run Equilibrium for Monopolistic Competition

Quantity where MR=MC up to Price=ATC

What happens when short-run profits are made in monopolistic competition?

-new firms enter

-more close substitutes and less market share for each existing firm

-demand for each firm falls

What happens when short-run losses are made in monopolistic competition?

-firms exit

-less substitutes and more market shares for remaining firms

-demand for each firm rises

What happens when there is a loss in monopolistic competition?

In the short-run, the graph is the same as a monopoly making a loss; in the long-run, firms will leave, driving up the DEMAND for firms already in the market

Are monopolistically competitive firms efficient?

No; not allocatively efficient because P≠MC and not productively efficient because it isn't producing at minimum ATC

Excess Capacity

-given current resources, the firm CAN produce at the lowest costs (minimum ATC) but they decide not to

-it is the gap between the minimum ATC output and the profit maximizing output, not the amount underproduced

Excess Capacity (reason)

The firm can produce at a lower cost but it holds back production to maximize profit

Advantages of Monopolistic Competition

-large number of firms and product variation meets society's needs

-Non-price Competition (product differentiation and advertising) may result in sustained profits for some firms

Ex: Nike, Apple might continue to make above normal profit because they are well-known