25.1 The Monopolist’s Output Decision

• A monopoly is a market in which a single firm sells a product that does not have any close substitutes.

• Market power is the ability of a firm to affect the price of its product.

• A barrier to entry is something that prevents firms from entering a profitable market.

• A patent is an exclusive right to sell a new good for some period of time.

• A network externality is the value of a product to the consumer increases with. The number of other consumers who use it.

• A natural monopoly is a market in which the economies of scale in production are so large that only a single large firm can earn a profit.

• At a price of $16, the firm doesn’t sell anything so its total even use is zero.

  • To sell the first unit, the firm must cut its price to $14, so its total revenue is $14.

  • To get consumers to buy two units instead of just one, the firm must cut its price to $12, so the total revenue for selling two units is $24.

  • As the price continues to drop and the quantity sold increases, total revenue increases for a while but then starts falling.

  • To sell five units instead of four, the firm cuts its price from $8 to $6, and total revenue decreases from $32 to $30.

  • The total revenue for selling six units is even lower, only $24.

• When the firm cuts its price from $12 to $10, there is good news and babe news:

  • The good news is that the firm collects $10 from the new customers, so the revenue increases by $10.

  • The bad news is that the firm cuts the price for all its customers,so it gets less revenue from the customers who would have been willing to pay the higher price of $12. Specifically, the firm collects $2 less from each of the two original customers, so revenue from the original customers decreases by $4.

• We can use a simple formula to compute marginal revenue.

Marginal revenue = new price + (slope of demand curve X old quantity)

• The marginal principle is to increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.

25.2 The Social Cost of Monopoly

• The switch to monopoly increases the price and decreases the quantity demanded because consumers obey the law of demand.

• The deadweight loss from monopoly is a measure of the inefficiency from monopoly; equal to the decrease in market surplus.

• Rent-seeking is a process of using public policy to gain economic profit.

  • Rent-seeking is inefficient because it uses resources that could be used in other ways.

25.3 Patents and Monopoly Power

• Suppose a firm called Flexjoint hasn’t yet developed the drug but believes the potential benefits and costs of doing so are as follows:

  • The economic cost of research and development will be $14 million, including all the opportunity costs of the project.

  • The estimated annual economic profit from a monopoly will be $2 million.

  • Flexjoint’s competitors will need 3 years to develop and produce their own versions of the drug, so if Flexjoint isn’t protected by a patent, its monopoly will last only 3 years.

25.4 Price Discrimination

• Price discrimination is the practice of selling a good at different prices to different consumers

• A firm has an opportunity for price discrimination if three conditions are met:

  • A market power where the firm must have some control over its price, facing a negatively sloped demand curve for its product.

  • Different consumer groups where consumers must differ in their willingness to pay for the product or their responsiveness to changes in prices, as measured by the price elasticity of demand. In addition, the firm must be able to identify different groups of consumers.

  • Resale is not possible. It must be impractical for one consumer to resell the product to another consumer.