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Principles of Economics, Ninth Edition N. Gregory Mankiw

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V. Andreea CHIRITESCU

Eastern Illinois University

N. Gregory Mankiw Principles Of Economics Ninth Edition

Chapter 15

Monopoly

Why Monopolies Arise Part 1

Market power

Alters the relationship between a firm’s costs and the selling price

Monopoly

Charges a price that exceeds marginal cost

A high price reduces the quantity purchased

Outcome: often not the best for society

Why Monopolies Arise Part 2

Governments

Can sometimes improve market outcome

Monopoly

Firm that is the sole seller of a product without close substitutes

Price maker

Cause: barriers to entry

Why Monopolies Arise Part 3

Barriers to entry

A monopoly remains the only seller in the market

Because other firms cannot enter the market and compete with it

Monopoly resources

Government regulation

The production process

Why Monopolies Arise Part 4

Monopoly resources

A key resource required for production is owned by a single firm

Higher price

“Rather than a monopoly, we like to consider ourselves ‘the only game in town.’”

Why Monopolies Arise Part 5

Government regulation

Government gives a single firm the exclusive right to produce some good or service

Government-created monopolies

Patent and copyright laws

Higher prices

Higher profits

Why Monopolies Arise Part 6

Natural monopoly

A single firm can supply a good or service to an entire market

At a smaller cost than could two or more firms

Economies of scale over the relevant range of output

Club goods

Excludable but not rival in consumption

Figure 1 Economies of Scale as a Cause of Monopoly

When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the lowest cost.

Production and Pricing Decisions Part 1

Monopoly

Price maker

Sole producer

Downward sloping demand: the market demand curve

Competitive firm

Price taker

One producer of many

Demand is a horizontal line (Price)

Figure 2 Demand Curves for Competitive and Monopoly Firms

Because competitive firms are price takers, they face horizontal demand curves, as in panel (a).

Because a monopoly firm is the sole producer in its market, it faces the downward-sloping market demand curve, as in panel (b). As a result, the monopoly has to accept a lower price if it wants to sell more output.

Production and Pricing Decisions Part 2

A monopoly’s total revenue

Total revenue = price times quantity

A monopoly’s average revenue

Revenue per unit sold

Total revenue divided by quantity

Always equals the price

Production and Pricing Decisions Part 3

A monopoly’s marginal revenue

Revenue per each additional unit of output

Change in total revenue when output increases by 1 unit

MR < P

Downward-sloping demand

To increase the amount sold, a monopoly firm must lower the price it charges to all customers

Can be negative

Table 1 A Monopoly’s Total, Average, and Marginal Revenue

(1) Quantity of Water (Q)	(2) Price (P)	(3) Total Revenue (TR = P x Q)	(4) Average Revenue (AR = TR/Q)	(5) Marginal Revenue (MR= (∆TR/AQ)
0 gallons	$11	$0	-
1	10	10	$10	$10
2	9	18	9	8
3	8	24	8	6
4	7	28	7	4
5	6	30	6	2
6	5	30	5	0 -2
7	4	28	4	-4
8	3	24	3

Production and Pricing Decisions Part 4

Increase in quantity sold

Output effect

Q is higher: increase total revenue

Price effect

P is lower: decrease total revenue

Because MR < P

Marginal-revenue curve is below the demand curve

Figure 3 Demand and Marginal-Revenue Curves for a Monopoly

The demand curve shows how the quantity sold affects the price of the good.

The marginal-revenue curve shows how the firm’s revenue changes when the quantity increases by 1 unit.

Because the price on all units sold must fall if the monopoly increases production, marginal revenue is less than the price.

Production and Pricing Decisions Part 5

Profit maximization

If MR > MC: increase production

If MC > MR: produce less

Maximize profit

Produce quantity where MR=MC

Intersection of the marginal-revenue curve and the marginal-cost curve

Price: on the demand curve

Figure 4 Profit Maximization for a Monopoly

Production and Pricing Decisions Part 6

Profit maximization

Perfect competition: P=MR=MC

Price equals marginal cost

Monopoly: P>MR=MC

Price exceeds marginal cost

A monopoly’s profit

Profit = TR – TC = (P – ATC) ˣ Q

Figure 5 The Monopolist’s Profit

Monopoly Drugs versus Generic Drugs

Market for pharmaceutical drugs

New drug, patent laws, monopoly

Produce Q where MR=MC

P>MC

Generic drugs: competitive market

Produce Q where MR=MC

And P=MC

Price of the competitively produced generic drug

Below the monopolist’s price

Figure 6 The Market for Drugs

The Welfare Cost of Monopolies Part 1

Total surplus

Economic well-being of buyers and sellers in a market

Sum of consumer surplus and producer surplus

Consumer surplus

Consumers’ willingness to pay for a good

Minus the amount they actually pay for it

The Welfare Cost of Monopolies Part 2

Producer surplus

Amount producers receive for a good

Minus their costs of producing it

Benevolent planner: maximize total surplus

Socially efficient outcome

Produce quantity where

Marginal cost curve intersects demand curve

Charge P=MC

Figure 7 The Efficient Level of Output

The Welfare Cost of Monopolies Part 3

Monopoly

Produce quantity where MC = MR

Produces less than the socially efficient quantity of output

Charge P > MC

Deadweight loss

Triangle between the demand curve and MC curve

Figure 8 The Inefficiency of Monopoly

The Welfare Cost of Monopolies Part 4

The monopoly’s profit: a social cost?

Monopoly - higher profit

Not a reduction of economic welfare

Bigger producer surplus

Smaller consumer surplus

Not a social problem

Social loss = Deadweight loss

From the inefficiently low quantity of output

Price Discrimination Part 1

Price discrimination

Business practice

Sell the same good at different prices to different customers

Rational strategy to increase profit

Requires the ability to separate customers according to their willingness to pay

Can raise economic welfare

Price Discrimination Part 2

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

Price Discrimination Part 3

Without price discrimination

Single price > MC

Consumer surplus

Producer surplus (Profit)

Deadweight loss

Figure 9 Welfare with and without Price Discrimination

Price Discrimination Part 4

Examples of price discrimination

Movie tickets

Lower price for children and seniors

Airline prices

Lower price for round-trip with Saturday night stay

“Would it bother you to hear how little I paid for this flight?”

Price Discrimination Part 5

Examples of price discrimination

Discount coupons

Not all customers are willing to spend time to clip coupons

Financial aid

High tuition and need-based financial aid

Willingness to pay

Quantity discounts

Customer pays a higher price for the first unit bought than for the last unit bought

Public Policy Toward Monopolies Part 1

Increasing competition with antitrust laws

Sherman Antitrust Act, 1890

Clayton Antitrust Act, 1914

Prevent mergers

Break up companies

Prevent companies from

coordinating their activities

to make markets less competitive

“But if we do merge with Amalgamated, we’ll have enough resources to fight the anti-trust violation caused by the merger.”

ASK THE EXPERTS

Airline Mergers

“If regulators had not approved mergers in the past decade between major networked airlines, travelers would be better off today.”

Public Policy Toward Monopolies Part 2

Regulation

Regulate the behavior of monopolists

Price

Common in case of natural monopolies

Marginal-cost pricing

May be less than ATC

No incentive to reduce costs

Figure 10 Marginal-Cost Pricing for a Natural Monopoly

Public Policy Toward Monopolies Part 3

Public ownership

How the ownership of the firm affects the costs of production

Private owners

Incentive to minimize costs

Public owners (government)

If it does a bad job, losers are the customers and taxpayers

Public Policy Toward Monopolies Part 4

Do nothing

Some economists argue that it is often best for the government not to try to remedy the inefficiencies of monopoly pricing

Determining the proper role of the government in the economy requires judgments about politics as well as economics

Table 3 Competition versus Monopoly: A Summary Comparison