Pure Monopoly - AP Microeconomics

Pure Monopoly

Pure Monopoly exists when a single firm is the sole producer of a product and there are no close substitutes

Pure Monopoly Characteristics

single seller, no close substitutes, price maker, blocked entry

Single seller

In a pure monopoly single firm is the sole producer of a product for which there are no close substitutes
Firm = Industry

Price Maker

Monopolist controls total quantity of supplied therefore also being able to control price

No Close Substitutes

The product is unique. A consumer who chooses to not to buy the monopolized product has to go without it

Blocked Entry

No immediate competitors because of the high barriers to entry

Nonprice Competition

Product is standardized (engage in public relations advertising) or differentiated (advertise their products attributes)

imperfect competition

a market structure that does not meet the conditions of perfect competition

imperfect competition characteristics

- Firms must lower prices to sell more output
- MR is lower than Demand curve
- Produce where MR=MC

Near Monopolies

There are multiple firms but 1 firm holds more than 80% of the market share

Pure Monopoly Barriers to Entry

Economies of Scale, Patents and Licenses, Ownership of Resources, Pricing and Strategic Barriers

Economies of Scale

As you increase firm size there is a decline in the average total cost

Only few very large firms are able to achieve this low cost

When long run ATC is declining, only a monopolist can produce any amount of output at minimum total cost

Natural Monopoly

Industry in which economies of scale are so great that a single firm can produce the product at a lower average total cost than would be possible if more than one firm produced the same product

When do Natural Monopolies Occur

It occurs when market demand intersects long run ATC at any point where average total costs are declining

It will set price far above ATC to gain a large economic profit

The government regulates natural monopolies specifying what price they may charge

Patents and Licenses

The government can create legal barriers to entry by awarding patents and licences

Patents

It is an exclusive right of an inventor to use their invention

These aim to protect the inverter from rivals how use the invention without getting permission

Patents provide the inventor with a monopoly position for life of patent

Firm gain monopoly power through their own research can use patents to strengthen their market position

Licences

Government may limit entry to an industry through licensing

The government give licenses to only so many firms creating a monopoly

A public monopoly is when the government licenses itself to provide a product

Ownership or Control of Essential Resources

A monopolist can use private property as an obstacle to potential rivals

Pricing and other Strategic Barriers to Entry

A monopolist can create an entry barrier by slashing its price, increasing advertising, or doing other things to make it difficult for entry

Marginal Revenue is Less than Price

With the downward sloping demand curve the monopolist can increase sales by charging less

Because of this the marginal revenue curve is less than price for every unit sold except for the first one

Monopolist is a Price Maker

Firms with downward sloping demand curves are price makers

Because they control the output, they can make the price

Monopolist Sets Prices in the Elastic Region of Demand

When demand is elastic a price decline will increase total revenue

When demand is inelastic a decline in price will reduce total revenue

Once marginal revenue is negative, total revenue starts to decline

This is why the inelastic part of the monopolist demand curve comes when MR is zero

Pure Competion Demand Curve

Perfectly elastic Dem. at price determined by market

MR is constant and equal to price

Market determines price and firm accepts it

Monopoly Demand Curve

A pure monopolist is the industry.

This means that its Demand curve = the industry D curve.

Neither the industry Demand or the firms Demand is perfectly elastic

Demand curve is down-sloping
Qty demanded increases as price decreases

Down sloping Demand curve means 3 things:

1) To increase sales they must lower prices

2) They influence total supply through their decisions
they are price makers

3) They will set price in elastic region of D curve

In elastic region, a decline in P will increase TR

Monopolists will
never set price in inelastic region.

MC=MR Rule

A pure monopolist will use the same rules as pure competition to maximize profit

If producing is preferable to shutting down then the firm will produce where MR=MC

This means different demand conditions can bring about different price for same output.

Fallacy #1: Monopolist will charge highest price possible.

Want to maximize total profit, not maximum price.

Some high prices can reduce sales dramatically, reducing profits.

Fallacy #2: Total profit, not unit profit.

Monopoly wants to maximize total profit, not unit profit.

Ex: Would rather sell 5 units at $28 than 4 at $32.

Monopoly Price Output

For a monopolist Price is greater than MC and min ATC

They find it more profitable to sell a smaller output at a higher price

Because of this monopoly yields neither productive nor allocative efficiency

Monopoly Efficiency

Because monopoly price exceeds minimum average total cost it will not be productively efficient

Because of the monopolists underproduction they are also not allocatively efficient

In the deadweight loss area marginal benefit exceeds marginal cost because the demand curve lies above the supply curve

Economic profits

Likeliness of economic profit greater for monopoly than PC

Barriers to entry sustain economic profits but don't guarantee profits

Monopolists are not immune to:

Change in taste

Change in demand

Increase in resource prices

Usually realize at least normal profits or better in LR

If not then they will leave the industry.
(Price

What can the government do about a monopoly?

1) File charges under anti trust laws

2) If natural monopoly, let it expand
if no competition emerges use price/size regulations

3) Ignore it, if it wont last

Price Discrimination

The practice a product at more than once price to different buyers (No consumer surplus, Total Revenue is maxed)

This can take place in 3 different forms...

Charging each customer at the maximum price that they are willing to pay

Charging each consumer one price for the first unit purchased and then a lower price for other units bought

Charging some customers one price and other customers another price

Price discrimination can occur when the following conditions are met...

Monopoly Power: Seller must be able to control output and price

Market Segregation: Seller must be able to segregate buyers into different classes
This segregation is based on different price elasticities of demand

No Resale: The original purchaser

Regulated Monopoly

Natural monopolies are usually subject to price regulation

Socially Optimal Price: P=MC

Establish a price ceiling where P=MC

Pro: Removes incentive to restrict Qty to control price.

Con: It may be so low that monopolist does not cover min ATC, resulting in loss or bankruptcy.

Fair Return Price: P=ATC

The socially optimal price may be so low that the average total costs are not covered

To fix this problem the regulator can offer a subsidy to cover the total costs

P is set at ATC, keeping it lower than monopoly

Provides normal profit to monopolist

Dilemma of Regulation

When price is set to achieve the most efficient allocation of resources (P=MC) the regulated monopoly is likely to suffer losses

The firm's survival would depend on subsidies

Fair return price only partially resolves underallocation of resources

Most monopolies have little incentive to minimize average total costs