econ 101 chp 12: monopoly Flashcards
define a monopoly
a market with a single firm that produces a good/service with no close substitutes and that is protected by a barrier that prevents other firms from entering that market
what are the 2 key reasons for the arising of a monopoly
- no close substitutes
- barriers to entry
how does technological change affect a monopoly
technological change can create substitutes and weaken a monopoly
can the arrival of a new product create a monopoly?
yes
define a barrier of entry
a constraint that protect a firm from potential competitors
what are the types of barriers to entry?
- natural
- ownership
- legal
fill in the blanks: a natural barrier to entry creates a
natural monopoly
define a natural monopoly
a market in which economies of scale enable 1 firm to supply the entire market at the lowest possible cost
define a ownership monopoly
a market in which competition and entry are restricted by a concentration of ownership
define a legal monopoly
a market in which competition and entry are restricted by the granting of a public franchise, government licence, patent, or copyright
define a public franchise
an exclusive right granted to a firm to supply a good or service
define a government licence
controls entry into particular occupations, professions, and industries
define a patent
an exclusive right granted to the inventor of a product
define a copyright
an exclusive right granted to the author or composer
what do patents encourage?
the invention of new products and production methods and innovation by encouraging inventors to publicize and license their discoveries
monopoly vs perfect competition
monopoly sets its own price
for a competitive firm, price = MR, so price = MC
for a monopoly, price > MR, and price > MC
what are the 2 pricing strategies of monopoly
- single price
- price discrimination
define a single-price monopoly
firm that must sell each unit of its output for the same price to all its customers
define price discrimination
firm that sells different units of a good or service for different prices
why does a firm price discriminate
it charges the highest possible price for each unit sold and make the largest possible profit
why is marginal revenue less than price?
the price is lowered to sell 1 more unit, 2 opposing forces affect total revenue - the lower price results in a revenue loss on the original units sold and a revenue gain on the additional quantity sold.
what is marginal revenue?
the change in total revenue and relates to the change in the quantity sold
marginal revenue lies ____ the demand curve
below
is a single-price monopoly’s marginal revenue related to the elasticity of demand?
yes
if demand is elastic, marginal revenue is ___. why?
marginal revenue is positive - a fall in price brings an increase in total revenue, the revenue gain from the increase in quantity sold outweighs the revenue loss from the lower price.
if demand is inelastic, marginal revenue is _____. why?
marginal revenue is negative - a fall in price brings a decrease in total revenue, the revenue gain from the increase in quantity would is outweighed by the revenue loss from the lower price
if demand is unit elastic, marginal revenue is ______
marginal revenue is zero, total revenue does not change, the revenue gain from the increase in the quantity sold offsets the revenue loss from the lower price
in a monopoly, demand is always ____. why?
elastic - a profit-maximizing monopoly never produces an output in the inelastic range of the market demand curve
a monopoly set its price + output at the levels that _____
maximize economic profit
what’s the relationship between the marginal revenue and marginal cost:
(1) when MR > MC
(2) when MR < MC
(3) when MR = MC
- profit increases if output increases
- profit decreases if output increases
- profit is maximized
in a monopoly, why does the firm not sell at the maximum possible price? what price do they sell at instead?
bc they can only sell 1 unit of output.
the firm produces at the profit-maximizing quantity and sells that quantity for the highest price it can get
can new firms enter the monopoly when there’s positive economic profit
no, barriers to entry prevent new firm from entering the market, so a monopoly can make a positive economic profit and might continue to do so.
compared to a perfectly competitive market, a single-price monopoly produce a
smaller output and charges a higher price
what happens when a perfectly competitive market becomes a monopoly
the demand curve of the perfect competitive market becomes the constraint for the monopoly’s marginal revenue
the market supply curve from the perfectly competitive market becomes the monopoly’s marginal cost curve
are monopolies inefficient? why?
yes, they create a deadweight loss
the smaller output and higher price drive a wedge between MSB and MSC cost (deadweight loss)
why does the consumers surplus shrink in monopolies?
- consumers lose by having to pay more for the good - this loss to consumers is a gain for the monopoly and increases the product surplus
- consumers lose by getting less of the good (loss is part of the deadweight loss)
why does the producer surplus shrink in the monopoly
the producer produces a smaller output - loss is part of deadweight loss
does a monopoly produce at he lowest possible long-run average cost?
no, because they produce a smaller output than perfect competition and faces no competition
how does the monopoly damage the consumer interest?
- monopoly produces less
- increase cost of production
- raises the price by more than the increase cost of production
does a monopoly bring a redistribution of surpluses?
yes - some of the lost consumer surplus goes tot he monopoly
this portion of loss of consumer surplus is not a loss to society - it’s a redistribution from consumers to the monopoly producer
how can the social cost of monopoly exceed teh deadweight loss
due to rent seeking
define economic rent
any surplus (producer or consumer)
define rent seeking
pursuit of wealth by capturing economic rent
how do rent seekers pursue their goals?
- buy a monopoly
- create a monopoly
what’s the rent seeking of a monopoly
to capture consumer surplus
how does a rent seeker buy a monopoly
a person searches for a monopoly that is for sale at a lower price than the monopoly’s economic profit
what’s the social cost of a monopoly?
time + effort to seeking out profitable monopoly business to buy
use of scarce resources that could otherwise have been used to produce goods + services
why is the amount paid for a monopoly not a social cost?
because the payment transfers an existing producer surplus from the buyer to the seller
how does a rent seeker create a monopoly
mainly a political activity - takes the form of lobbying and trying to influence the political process (campaign contribution in exchange for legislative support or by indirectly seeking to influence political outcomes through publicity in the media or more direct contact with politicians + bureaucrats
this is a costly activity that uses up scarce resources - firms spend billions of dollars lobbying politicians and bureaucrats in the pursuit of licenses + laws that create barriers to entry + establish a monopoly
are there barriers to entry into rent seeking?
no - it’s like a perfect comopetition
what does competition among rent seekers create?
and how does it affect the economic profit
competition creates a higher price to the point where the rent seeker makes zero economic profit
what type of cost is rent seeking to a monopoly’s cost
a fixed cost
how does rent seeking affect the cost of the monopoly
the average total cost curve includes the fixed cost of rent seeking - the ATC shifts upward until it touches the demand curve
what happens to economic profit, consumer surplus, and deadweight loss when the ATC touches the demand curve?
economic profit is zero, the profit is lost in rent seeking
consumer surplus is unaffected
deadweight loss from monopoly increases to include the original deadweight loss triangle plus the lost producer surplus
are all price differences, price discrimination? why?
not all price difference are price discrimination - many reflect difference in production costs
if price discrimination profitable? why?
it is profitable because it can increase economic profit
how do firms price discriminate
- among groups of buyers
- among units of a good
how does a firm price discriminate among groups of buyers
firms use the value (marginal benefit and willingness to pay) difference people place on a good
such differences can be correlated to age, employment status, etc
how does a firm price discriminate amount units of a good
firms’ discriminate among units of a good due to diminishing marginal benefit
a firm price discriminates among units of a good by charging a buyer 1 price for a single item and a lower price for a 2nd or 3rd item to capture some of the consumer surplus
how does a monopoly convert consumer surplus into producers surplus?
by getting buyers to pay a price as close as possible to their maximum willingness to pay
why does more producer surplus mean more economic profit
economic profit = TR - TC
producer surplus = TR - TVC
economic profit = producer surplus - TFC
producer surplus = TR - area under marginal cost curve
fill in the blanks: for a given level of total fixed cost, anything that increases producer surplus also _____ economic profit
increases
fill in the blank: the more consumer surplus a firm is able to capture, the closer it gets to the extreme case called ___
perfect price discrimination
define perfect price discrimination
occurs if a firm can sell each unit of output for the highest price someone is willing to pay for it
in this case, consumer surplus is eliminated and captured as producers surplus
what happens to the marginal revenue and market demand curve in perfect price discrimination? why?
the market demand curve becomes the marginal revenue curve
this happens because when the monopoly cuts the price to sell a larger quantity, it sells only the marginal unit at the lower price, all other units continue to be sold for the highest price that each buyer is willing to pay - for the perfect price discriminator, marginal revenue = price and the market demand curve becomes the monopoly’s marginal revenue curve - with marginal revneue = price, the firm can obtain even greater producer surplus by increasing output up to the point at which price (aka MR) = MC
how is producer surplus maximized in perfect price discrimination
when the lowest price = MC
what’s the effect on output in a perfect price discrimination
output increases to the point at which price = MC - this output is identical to that of perfect competition
what’s the effect of perfect price discrimination on consumers surplus, monopoly’s producer surplus and deadweight loss?
perfect price discrimination pushes consumer surplus to zero and increases the monopoly’s producer surplus equal to the total surplus in perfect competition, and no deadweight loss is created
is perfect price discrimination efficient?
yes bc no deadweight loss is created
what’s the relationship between perfect price discrimination and monopoly’s efficiency
the more perfectly the monopoly can price discriminate, the closer its output is to the competitive output and the more efficient is the outcome
what are the differences in the outcomes of perfect competition and perfect price discrimination
- difference in total surplus distribution - in perfect competition, total surplus is shared by consumers and producers, in perfect price discrimination the monopoly takes it all
- rent seeking is profitable in a monopoly bc it takes the total surplus, it’s not profitable in perfect competition bc with free entry into rent seeking, the long0run equilibrium outcome is that rent seekers use up the entire producer surplus
what’s the dilemma in natural monopoly
with economies of scale, it producers at the lowest possible cost, but with market power it has an incentive to raise the price above the competitive price and produce too little - to operate in self-interest of the monopolist and not in the social interest
define regulation
rules administered by a government agency to influence prices, quantities, entry, and other aspects of economic activity inn a firm/industry
how does the government implement regulation
government establishes agencies to oversee and enforce the rules
define deregulation
process of removing regulation of prices, quantities, entry and other aspects of economic activity in a firm or industry
fill in the blanks: regulation is a _____ solution to the dilemma presented by natural monopoly but not a ____ solution
possible, guaranteed
what are the 2 theories about how regulation actually works
- social interest theory
- capture theory
define the social interest theory
political and regulatory process relentlessly seeks out inefficiency and introduces regulation that eliminates deadweight loss and allocates resources efficiently
define capture theory
regulation serves the self-interest of the producer who captures the regulator and maximizes economic profit. Regulation that benefits the producer but creates a deadweight loss gets adopted because of the producer’s gain is large and visible while each individual consumer’s loss is small and invisible - no individual consumer has an incentive to oppose the regulation, but the producers has a big incentive to lobby for it
how can a natural monopoly be regulated to produce the efficient quantity of the good
marginal cost pricing rule - as the quantity demanded at this price is the efficient quantity
define marginal cost pricing rule
regulating a natural monopoly to set its price equal to marginal cost
what’s the problem with the marginal cost pricing rule?
the natural monopoly firm will incur an economic loss and will not stay in the business for long
how can the firm in a natural monopoly cover its costs and obey marginal cost pricing rule?
- price discrimination
- 2-part price (2-part tariff)
what’s an example of a 2-part price
wireless providers offer plans at a fixed monthly price that five access to the cellphone network with unlimited calls
the price of a call (0) = MC of a call
the cable TV operator can charge a 1-time connection fee that covers its fixed cost and then charge a monthly fee equal to its marginal cost
what are the 2 possible ways of enabling a regulated monopoly to avoid an economic loss - when a natural monopoly cannot always be regulated to achieve an efficient outcome and which is better?
- average cost pricing
- government subsidy
answer depends on the relative magnitudes of the 2 deadweight losses - average cost pricing generates a deadweight loss in the market served by the natural monopoly, a subsidy generates deadweight losses in the markets for the items that are taxed to pay for the subsidy
the smaller deadweight loss is the second-best solution to regulating a natural monopoly
generally, average cost pricing is preferred to a subsidy
define the average cost pricing rule
sets price equal to average total cost - firm produces the quantity at which the ATC cure cuts the demand curve - results in the firm making zero economic profit
but for a natural monopoly, ATC exceeds MC, the quantity produced is less than the efficient quantity and a deadweight loss arises
average cost price regulation creates a deadweight loss, but it is less than with unregulated profit-maximization
define a government subsidy + effects on the monopoly quantity + pricing
government subsidy = direct payment to the firm, which is equal to its economic loss
what challenge does the average cost pricing present to a regulator
it’s not possible to be sure what a firm’s costs are
what practical rules are available for regulators use
- rate of return regulation
- price cap regulation
define rate of return regulation
a firm must justify its price by showing that its return on capital doesn’t exceed a specified target rate
what are some characteristics to know about the rate of return regulation
this type of regulation can end up serving the self-interest of the firm rather than the social interest - the firm’s managers have an incentive to inflate costs by spending on items + to use more than the efficient amount of capital
the rate of return on capital is regulated but not the total return on capital, so as the amount of capital used increases the total return on capital increases
define a price cap regulation
a price ceiling - a rule that specifies the highest price the firm is permitted to set
what are the characteristics of the price cap regulation
this type of regulation gives a firm an incentive to operate efficiently and keeps costs under control
lowers the price and increases output in a monopoly (sharp contrast to the effect of a price ceiling in a competitive market)
why does a price cap regulation lower price and increase output in a monopoly?
in a monopoly, the unregulated equilibrium output is less than the competitive equilibrium output an the price cap regulation replicates the conditions of a competitive market
define an earnings sharing regulation
a regulation that requires firms to make refunds to customers when profits rise above a target level
price cap regulations are often combined with _____, why?
combined with a earnings sharing regulation to achieve a more efficient than the rate of return regulation
this is because the price cap regulation may set the cap too high (price cap delivers average cost pricing)
