sss/Principles of Microeconomics

Spring 2019 Prin iples of Mi roe onomi s T. Tung

Part XV

Monopoly

Monopoly is the opposite situation than perfe t ompetition. Due to the market stru ture, monopolists are pri e

makers. Mi rosoft and Bill Gates are an example of the high pro�ts that an ome with monopoly power.

� Monopoly: Firm that is the sole seller of a produ t without lose substitutes.

� Monopolies exhibit high barriers of entry (other �rms are kept from joining the market)

There are three main sour es for this:

1. Monopoly Resour e:

(a) When 1 �rm ontrols/owns an entire resour e. This o urs most often with natural resour es (Su h as

DeBeers/diamonds). In real life, this type of monopoly o urs infrequently as many �rms onstantly vie

for advantageous market positions.

2. Government Regulation:

(a) Governments sometimes grant monopoly power and give the ex lusive right to produ e a good/servi e

to one �rm.

i. Example: Patents and Copyrights. Sin e information is a publi good, the government provides

monopoly power as an in entive to undertake the resear h/information gathering pro ess.

3. The Produ tion Pro ess:

(a) A single �rm an produ t a good at a lower ost than a large number of produ ers. Natural monopolies

are the ommon root for this barrier and are hara terized by:

i. Very high initial osts ( an also be viewed as �xed osts)

A. Examples; Cable ompanies, PG & E, water

B. Natural Monopolies fa e a ost urve that demonstrates e onomies of s ale:

How Monopolies Make Produ tion and Pri ing De isions:

� Monopoly vs. Competition:

� The key di�eren e between a monopoly and a ompetitive �rm is the monopolist's ability to in�uen e

the pri e of its output.

62

Spring 2019 Prin iples of Mi roe onomi s T. Tung

� A ompetitive �rm is a pri e taker and pri es are determines by market intera tions. Thus, the demand

urve fa ing the ompetitive �rm is a horizontal pri e line that also represents MR and AR.

� On the other hand, monopolists (as the only �rm in the market) fa e the market demand urve. Market

demand is downward sloping due to the Law of Demand.

� The market demand urve represents a onstraint on the pro�ts that monopoly power grants �> It is

not possible for the monopolist to harge a high pri e and sell a high quantity of output.

* The monopolist an produ e a quantity (or harge a pri e) at any point on the demand urve but

not above it:

� The monopolist will hoose a produ tion point that maximizes pro�ts �

Monopolist's Revenue:

� The following table represents the relevant revenue data for a monopolist:

� The last olumn of data demonstrates the marginal revenue from di�erent points of produ tion and illustrates

a lear point: A Monopolist's marginal revenue is always less than the pri e.

63

Spring 2019 Prin iples of Mi roe onomi s T. Tung

� If the �rm raises produ tion of water from 3 to 4 gallons, it will in rease total revenue by only $4, even

though it will be able to sell ea h gallon for $7. To in rease the amount sold, a monopoly �rm

must lower the pri e it harges to all ustomers.

� The output e�e t: More output is sold, so Q is higher whi h tends to in rease total revenue.

� The pri e e�e t: The pri e falls, so P is lower, whi h tends to de rease total revenue.

� Monopolist fa es the market demand urve whereas a ompetitive �rm (small relative to the market)

an sell as mu h as it wants at the market pri e:

� Demand urve and marginal-revenue urve always start at the same point but the MR urve has a steeper

slope.

� Marginal revenue an be negative � This o urs when the pri e e�e t on revenue is greater than the

output e�e t.

Pro�t Maximization:

� The following graph demonstrates the demand urve, the MR urve, and the ost urves for a monopolist.

(These urves have the standard shapes established in previous se tions):

64

Spring 2019 Prin iples of Mi roe onomi s T. Tung

� The monopolist's pro�t-maximizing quantity of output is determined by the interse tion of the marginal-revenue

urve and the marginal- ost urve.

� A ompetitive �rm and a monopolist's marginal revenue di�er:

For a ompetitive �rm: P = MR = MC

For a monopolist: P > MR = MC

� Both types of �rms hoose the quantity where MR = MC. However, the relationship between the pri e and

MR/MC that di�ers for a monopolist ompared to a ompetitive �rm.

� Monopolies use the demand urve to determine the maximize pri e that ustomers are willing to pay at the

pro�t-maximizing quantity level.

� In ompetitive markets, pri e equals marginal ost. In monopolized markets, pri e ex eeds marginal ost.

A Monopoly's Pro�t:

Pro�t = TR - TC

� We an rewrite this as

Pro�t = (TR/Q - TC/Q) * Q

� TR/Q is average revenue, whi h equals the pri e, P, and TC/Q is average ost, ATC �

Pro�t = (P - ATC) * Q

� Graphi ally, we an measure the pro�t like so:

The Welfare Cost of Monopolies:

� We an use welfare analysis to analyze the market impa t of the high pri e monopolists harge as well as the

bene�ts monopolists re eive.

� The Deadweight Loss

� A benevolent so ial planner determines that the so ially e� ient quantity is found where the demand

urve and the marginal- ost urve interse t.

65

Spring 2019 Prin iples of Mi roe onomi s T. Tung

* This is in line with previous welfare analysis.

� The monopolist produ es less than the so ially e� ient quantity of output.

* The monopolist harges a pro�t-maximizing pri e that orresponds to a quantity that is ine� iently

low. Thus, this pri e is ine� ient as well.

* At the high monopolist pri e, some potential onsumers value the good at more than its marginal

ost but less than the monopolist's pri e � ine� ien y is introdu ed as mutually bene� ial trades

are lost.

* Thus, there is a deadweight loss:

� The type of DWL aused by a monopolist is similar to the DWL aused by a tax.

Pri e Dis rimination:

� Pri e Dis rimination: The business pra ti e of selling the same good at di�erent pri es to di�erent ustomers.

(not viable for a ompetitive �rm)

� Di�erent onsumers value goods at di�erent levels. If the monopolist harges ea h ustomer their maxi-

mum willingness to pay, a higher level of pro�ts (and a possible in rease in welfare) an o ur.

� There are three primary lessons from a pri e dis rimination parable/example:

1. Pri e dis rimination is a rational strategy for a pro�t-maximizing monopolist. Pro�ts an be in reased

by harging di�erent pri es to di�erent ustomers.

2. Pri e dis rimination requires the ability to separate ustomers a ording to their willingness to pay.

(a) Corollary: arbitrage an prevent pri e dis rimination. Arbitrage is the pro ess of buying a good in

one market at a low pri e and selling it in another market at a higher pri e to pro�t from the pri e

di�eren e. For pri e dis rimination to work, arbitrage opportunities an not be available.

3. Surprisingly, pri e dis rimination an raise e onomi welfare. In ertain situations, onsumers an be

enti ed into buying a produ t when the monopolist knows and harges the appropriate pri e for them.

(a) In reases in overall welfare are to produ er surplus not onsumer surplus.

Perfe t Pri e Dis rimination vs. Monopolist Pri ing:

� Graphi ally, the di�erent in pro�ts that pri e dis rimination represents an be demonstrated as so:

66

Spring 2019 Prin iples of Mi roe onomi s T. Tung

....

� Perfe t pri e dis rimination allows a monopolist to harge every onsumer in the market the maximum will-

ingness to pay. This is preferable to the standard monopolist pri ing de ision.

Examples of Pri e Dis rimination:

1. Movie Ti kets

(a) Student vs. Elderly vs. Matinee Pri es

2. Airline Pri es

3. Dis ount Coupons

(a) Only those willing to ut out the oupons and put in the e�ort will bene�t from the lower pri e.

4. Finan ial Aid

(a) Based on need/merit.

5. Quantity Dis ounts

Publi Poli y Towards Monopolies:

� In reasing ompetition with Antitrust Laws

� The government monitors how �dense� market ompetition is. If monopoly power will highly negatively

impa t a market, the government will blo k ompanies from merging.

� Regulation

� The government often regulates natural monopolies to maintain reasonable pri es for onsumers. Though

it may seem logi al for the monopolist to harge a pri e that equals MC, the monopolist will make a loss

� Publi Ownership

� The government may de ide to take over ownership of a private �rm altogether (Example: The USPS)

� Doing Nothing

Con lusion:

67

Spring 2019 Prin iples of Mi roe onomi s T. Tung

68