Chapter 16 Flashcards
What is a monopoly?
A firm that is the sole seller of a product without close substitutes
characteristics of a monopoly?
- Has market power: Price maker
- The ability to influence the market price of the product it sells
- A competitive firm has no market power
- Arise due to barriers to entry
- Other firms cannot enter the market and compete with it
How do monopolies arise?
Due to barriers to entry
Other firms cannot enter the market and compete with it
Main sources of barriers to entry
- Monopoly resources
- Government regulation
- The production process
Monopoly Resources
A single firm owns a key resource required for production
(Although exclusive ownership of a key resource is a potential cause of monopoly, in practice monopolies rarely arise for this reason.
Economies are large, and resources are owned by many people.)
Government-Created Monopolies
Government gives a single firm the exclusive right to sell a good or service
Patent and copyright laws: Have both benefits and costs.
Lead to higher prices and higher profits
Encourage some desirable behavior (provides incentives for creative activity)
When a pharmaceutical company discovers a new drug, it can apply to the government for a patent for 20 years.
Natural Monopolies (The production process)
A type of monopoly that arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms
There are economies of scale over the relevant range of output
Distribution of water, electricity, etc.
Club goods (excludable, not rival in consumption)
When a firm’s average-total-cost curve continually declines…
the firm has what is called a natural monopoly
Monopoly versus Competition
(monopoly)
Sole producer
Price maker, market power
Faces the entire market demand: Downward sloping demand
Monopoly versus Competition
(competitive firm)
Small, one of many
Price taker
Faces individual demand at P: Perfectly elastic demand
Increasing quantity has two effects on revenue: TR= P*Q
Output effect: Higher output increases revenue
Price effect: Lower price decreases revenue
Marginal revenue < Price (MR< P)
To sell a larger Q…
the monopolist must reduce the price on all the units it sells
Marginal revenue < Price (MR< P)
Is negative if …
price effect > output effect
Like a competitive firm, a monopolist maximizes profit by
producing the quantity where MR = MC
If MR > MC:
Increase production
If MC > MR:
Produce less
Maximize profit
-Produce quantity where MR = MC
-Price is found on the demand curve
For a monopoly firm:
P > MR = MC
As with a competitive firm, the monopolist’s profit equals
(P – ATC) x Q
Profit-Maximizing Rules for a Monopoly Firm
- Derive the MR curve from the demand curve
- Find Q at which MR = MC
- On the demand curve, find P at which consumers will buy Q
- If P > ATC, the monopoly earns a profit
A competitive firm takes P as given
Has a supply curve that shows how its Q depends on P
A monopoly firm is a “price-maker” where…
- Q does not depend on P
- Q and P are jointly determined by MC, MR, and the demand curve
- Hence, no supply curve for monopoly
The socially efficient quantity is found where
the demand curve and the marginal-cost curve intersect
The monopolist chooses to produce and sell the quantity of output at which
MR=MC
Produces less than the socially efficient quantity of output
Charges P > MR = MC
The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC)
Deadweight loss
Triangle between the demand curve and MC curve
Price discrimination
- Sell the same good at different prices to different buyers
- A firm can increase profit by charging a higher price to buyers with higher willingness to pay
- Rational strategy to increase profit
- Requires the ability to separate customers according to their willingness to pay
- Can raise economic welfare
Lessons About Price Discrimination
- Price discrimination is a rational strategy for a profit-maximizing monopolist
- Seller must be able to separate customers according to their willingness to pay
- Price discrimination can raise welfare as measured by total surplus
Perfect price discrimination
- Charge each customer a different price
- Exactly his or her willingness to pay
- Monopoly firm gets the entire surplus (Profit)
- No deadweight loss
- a price-discriminating monopolist charges each customer a price closer to her willingness to pay than is possible with a single price.
arbitrage..
the process of buying a good in one market at a low price and selling it in another market at a higher price to profit from the price difference.
Can price discrimination raise economic welfare?
yes
Government policymakers can deal with the problem of monopoly in several ways:
- By trying to make monopolized industries more competitive
- By regulating the behavior of the monopolies
- By turning some private monopolies into public enterprises
- By doing nothing at all
Antitrust laws:
- Promote competition
- Prevent mergers
- Break up companies
- Prevent companies from colluding to reduce competition
Regulating the behavior of monopolists
regulates the price
Problems arise with marginal-cost pricing
- When ATC is declining, MC < ATC
- No incentive to reduce costs
Public Ownership
Government unit can run the monopoly
Ownership of firm affects costs of production
Private owners have an incentive to minimize costs
Public employees may become a special-interest group and bend political system to their advantage
