Econ - monopoly (18) PDF

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Monopoly Price Takers Vs. Price Searchers - Price Takers - Individual firms that have no impact on market price - Face horizontal, perfectly elastic demand curve - Perfect Competition - Price Searcher - Firms that have at least some influence on market price - Face downward sloping demand curve - Monopoly, Oligopoly - Market Power: The ability of a firm to raise its price above the perfectly competitive level

Monopoly - Monopoly - Market with a single supplier of a good - Monopolists know their actions influence market price - Take this into account when deciding how much to produce - Choose price and quantity to maximize profits - Constrained by the Demand Curve - Face downward sloping market demand curve Profit Maximizing Condition - In order to maximize profits, a firm should continue to produce as long as the additional revenue from an additional unit of output is greater than the additional cost from an additional unit of output - Keep producing as long as MR > MC - Profits are maximized by producing the quantity at which the marginal cost of the last unit produced is equal to its marginal revenue

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Profit Maximizing Condition: Stop producing where MR = MC(Or last unit for which MR > MC; Do not produce if MR < MC)

Monopoly and Marginal Revenue - For price takers (Perfect Competition) marginal revenue equals price - Firm faces a horizontal demand curve - Can sell all they want at the market price - Each additional unit sold provides additional revenue (marginal revenue) equal to the market price - No individual firm large enough to influence market price (price taker) - Monopolist is the market - Firm faces downward sloping, market demand curve - If the monopolist alters their quantity produced, the market price will change - As a result: Marginal revenue will not equal price - Has important implications for which price they charge and how many units they sell

Price and Quantity Effects - Key Point: In order to attract new customers, the monopolist must lower price - Due to fact that the monopolist faces the downward sloping market demand curve - An increase in production by a monopolist has two opposing effects on revenue: - A quantity effect: one more unit is sold, increasing total revenue by the price at which the unit is sold (demand curve) - If only the quantity effect existed, then Marginal Revenue = Price and the marginal revenue curve would be the same as the demand curve - A price effect: in order to sell the last unit, the monopolist must reduce the market price on all units sold. This decreases total revenue. (change in price*existing consumers)

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Price Effect: - Increase in Price: 𝑃𝐸 = (𝑃2 − 𝑃1) * 𝑄2 - Decrease in Price: 𝑃𝐸 = (𝑃2 − 𝑃1) * 𝑄1 Quantity Effect - When price decreases : QE = (Q2-Q1)*P2 - When price increases : QE = (Q2-Q1)*P1

Marginal Revenue Curve - For a Monopolist, at any given quantity, marginal revenue will be less than price - Due to Price Effect - The Marginal Revenue Curve then will be below the Demand curve at any given quantity produced

Marginal Revenue Curve - If Demand Curve is Linear, then Marginal Revenue Curve will be linear - Marginal Revenue Curve will intersect horizontal axis exactly halfway between the origin and where the Demand Curve intersects the horizontal axis. - Accident?No! Elasticity! Elasticity, Total Revenue, and Marginal Revenue - If demand for a good is elastic - The quantity effect will dominate the price effect - A decrease in price will increase total revenue - If total revenue is increasing, marginal revenue must be positive - As the price continues to be lowered, the good becomes less elastic and marginal revenue becomes smaller. - If demand for a good is inelastic - The price effect will dominate the quantity effect - A decrease in price will decrease total revenue - If total revenue is decreasing, marginal revenue must be Negative - If demand for a good is unit elastic - The price and quantity effects will offset - Marginal revenue will be zero - Marginal revenue curve crosses the horizontal axis at this point

Monopolist’s Production DecisionI - in order to maximize profit, the monopolist (like all firms) will continue to produce more units of a good until the additional revenue from the last unit produced equals the additional cost - MR = MC - At that level of output profits are maximized

Monopoly Versus Perfect Competition - Perfectly Competitive Firms produce where P = MC - Monopolies produce where P > MR = MC - Compared with a competitive industry (the entire market, not individual firms), a monopolist: - Produces a smaller quantity: Qm< Qc - Charges a higher price: Pm> Pc - Likely earns a profit in both short-run and long-run.

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Highest profit possible

Shutdown Decision - Shutdown if: - Short-Run: P < AVC - Long-Run: P < ATC - Monopolist can charge higher price than perfectly competitive firm Welfare Effects

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Monopolist charges a price higher than marginal cost and produces output at a level lower than the efficient, perfectly competitive output level As a result, monopolies cause deadweight loss to society (Market Failure)

Reason Monopolies Exist - A monopolist has market power - Charges a higher price than perfectly competitive outcome - Produces a lower quantity than the perfectly competitive outcome - Creates deadweight loss - Generates economic profits for the firm - In order for profits to persist in the long-run, some form of barrier to entry must be in place. - Otherwise, other firms will enter Barriers to Entry - Control of scarce resource or input - Cost advantage - Large set-up costs - High initial set-up costs - A given quantity of output produced at a lower ATC by one large firm than by two or more smaller firms - Natural monopoly - Local utilities: water, gas, electricity - Strategic behavior to prevent entry of other firms - Government Created Monopoly - Government License - Government grants firm exclusive right to serve given area - Patents and Copyrights - Patents: 20 years from date of filing - Copyrights: 70 years post-death

Regulation - Break-up Monopoly - Anti-trust legislation - Price Regulation (Price Ceiling) - If set at proper amount can get rid of welfare losses - Increase Competition - Grant more licenses - Reduce trade barriers for foreign firms - Alter patent laws - Subsidize competing firms (offer tax breaks)

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A single-price monopolist will produce less output than would occur if the same market were perfectly competitive....