L15 monopoly

Introduction to Monopoly

Microeconomics Topic 4: Monopoly

This lecture delves into the foundational concepts related to monopoly within the broader field of microeconomics, discussing how monopolistic practices contrast sharply with those observed in perfect competition.

Lecture Overview

Students will gain insights into the mechanisms of production and pricing within monopolized markets. We will explore how monopolists exercise their market power and its ensuing implications on consumer welfare and market efficiency.

Aims of the Lecture

• Definition of Monopoly: A monopoly is characterized as a market structure where one large firm dominates the market, often leading to the absence of competition. The monopolist has significant control over price and supply.

• Monopolist vs. Competitive Fringe: The lecture will highlight the strategic advantages and disadvantages of being a monopolist, contrasting it with firms operating in a competitive fringe.

Key Questions

• How does monopoly affect pricing and output? This question will guide our exploration into the pricing strategies employed by monopolists and the resultant impact on overall market output.

Lecture Outline

• Monopoly Assumptions

• Appropriate Market Structure

• Equilibrium under Monopoly

• Comparing Monopoly with Perfect Competition

Monopoly Assumptions

Assumptions Retained

• Buyers are price takers, operating under the assumption of complete information among buyers and sellers concerning market conditions. However, in a monopoly, this changes dramatically as the seller can dictate prices.

Key Assumptions

• Price Maker: The monopolist has the ability to set the price for its products; thus, the demand curve it faces slopes downward, indicating that higher prices lead to lower quantities demanded.

• Blocked Entry: Significant barriers prevent other firms from entering the market. These barriers can be legal (patents), structural (control over raw materials), or strategic (aggressive pricing tactics to deter potential entrants).

Appropriate Market Structure

• Market Structure Characteristics:

  • Number of Sellers: Dominated by a single, large seller, though small rivals may exist under certain circumstances.

  • Barriers to Entry: Barriers are typically high, which fosters the monopolist’s control over the market and prevents new competitors from entering.

  • Product Substitutability: The monopolist offers a unique product that lacks close substitutes, which allows price manipulation without significant loss of demand.

Equilibrium under Monopoly

Profit Maximization Rules

• Marginal Output Rule: The monopolist’s demand curve acts as the entire market demand curve, dictating prices across all units sold.

• Shut Down Rule: Monopolists must evaluate whether to continue production based on comparing marginal costs and marginal revenue to decide the viability of sustaining production.

• Marginal Revenue (MR): The MR is typically less than the price due to the necessity of lowering the overall price to sell additional units, which reflects the downward slope of the demand curve.

Revenue Curves and Elasticity of Demand

• Total Revenue Effects: Understanding how marginal revenue influences total revenue is crucial;

  • MR > 0: Indicates that total revenue (TR) is increasing as additional units are sold;

  • MR < 0: Represents a decrease in total revenue when attempting to sell additional units, illustrating the impact of price reductions on revenue.

Comparing Monopoly to Perfect Competition

• Pricing and Production Disparities: Monopolists tend to set higher prices and produce lower quantities compared to firms in a competitive market. This dynamic results in a deadweight welfare loss, illustrating inefficiencies in resource allocation when monopoly is present.

• Total Welfare Considerations: Total welfare is defined as the aggregate of consumer surplus (CS) and producer surplus (PS), both of which are adversely affected by monopolistic pricing strategies.

Consumer Surplus and Producer Surplus

• Consumer Surplus: Represents the difference between what consumers are willing to pay and what they actually pay. In monopolistic settings, CS typically decreases due to higher prices.

• Producer Surplus: Reflects the difference between the price received by the producer and the minimum price the producer would be willing to accept. Monopolists often enjoy higher PS at the expense of consumer surplus.

Total Welfare under Different Structures

• Perfect Competition: Characterized by higher total welfare owing to efficient resource allocation and equilibrium pricing where marginal cost equals marginal revenue.

• Monopoly: Results in lower overall welfare as monopolistic pricing leads to higher prices and reduced quantities traded, detracting from economic efficiency.

Summary of Key Points

• In conclusion, a monopolist operates as a price maker within a market structure characterized by significant barriers to entry. In the short run, monopolists may achieve supernormal profits when price exceeds short-run marginal costs (P > (SR)MC). Comparisons with perfect competition reveal that monopolists produce a lesser quantity of goods at inflated prices, resulting in marked market inefficiencies and economic welfare loss.