Monopoly Flashcards
What is a Monopoly?
is a market structure in which a single firm makes up the entire supply side of the market.
Monopoly is the polar opposite of perfect competition.
Monopolies exist because of barriers to entry into a market that prevent entry by new firms.
How a Monopoly arises:
- no substitutes
- Barriers to entry
What are the barriers to entry with a monopoly?
- Economies of scale
- set up costs
- legislation
- Network externalities
- Control over a scarce resources
Why is economies of scale a barrier to entry?
When production is characterized by increasing returns to scale, the larger the firm becomes, the lower its per unit costs become.
A natural monopoly exists when increasing returns to scale (economies of scale) provide a large cost advantage to a single firm.
If significant economies of scale are possible, it is inefficient to have two producers because if each produced half of the output, neither could take advantage of economies of scale.
Key difference between monopoly and perfect competition
A competitive firm is too small to affect the price.
A competitive firm’s marginal revenue is the market price.
Monopolist as the only supplier faces the entire market demand curve.
Therefore, monopoly demand is downward sloping, and to increase output the firm must decrease its price.
What are the two types of monopoly price setting strategies?
- A single price monopoly (is a firm that must sell each unit of its output for the same price to all its customers )
- Price discrimination (is the practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms )
For single price monopoly, marginal revenue is —- then price
less
What is the relation between marginal Revenue and Elasticity in a single price monopoly?
A single-price monopoly’s marginal revenue is related to the elasticity of demand for the good.
If demand is elastic, a fall in the price brings an increase in total revenue.
MR is positive.
If demand is inelastic, a fall in the price brings a decrease in total revenue.
The rise in revenue from the increase in quantity sold is outweighed by the fall in revenue from the lower price per unit.
So MR is negative.
If demand is unit elastic, a fall in the price does not change total revenue.
The rise in revenue from the greater quantity sold equals the fall in revenue from the lower price per unit.
MR = 0.
Total revenue is maximized when MR = 0.
The monopolist employs a two-step profit maximizing process;
Choosing quantity and price
To determine the profit-maximizing price and quantity:
one first finds output (where MC = MR), and then
extends a vertical line for that output, up to the demand curve to find the price.
Determine the average cost at the profit-maximizing level of output.
Determine the monopolist’s profit (loss) by subtracting average total cost from average revenue (P) at that level of output and multiply by the chosen output.
A single price monopoly creates welfare losses.( What is a welfare loss)
Welfare losses can be illustrated by the area of consumer and producer surplus that is lost due to smaller output produced, compared to output produced in perfect competition.
The monopolist’s MR is below its price, thus its equilibrium output is different from a competitive market.
How to be a price discriminatory monopoly?
Identify groups of customers who have different elasticities of demand;
Separate them in some way; and
Limit their ability to resell its product between groups.
When will a price discriminating monopoly stop expanding and what will this cause?
A perfect price discriminating monopoly will stop expanding its output when MR = MC, which corresponds to the perfectly competitive output.
The deadweight loss is therefore eliminated under perfect price discrimination.
