Monopoly and Market Regulation

Monopoly

• A monopoly firm charges a price where marginal revenue equals marginal cost (MR=MC)
• Monopoly profit equals total revenue minus total cost
• The fair-return price for a monopoly is the break-even price, where price equals average total cost
• The socially optimum price for a monopoly is where price equals marginal cost, leading to allocative efficiency

Welfare Cost of Monopoly

• Monopolist charges a higher price and sells less than a perfectly competitive industry
• The welfare loss is the sum of consumer surplus lost (B + D) and producer surplus gained (C)
• The welfare loss created by a monopoly is the "deadweight loss"
• Opportunity cost of resources not used is not a loss to society (A)

Public Policy Toward Monopolies

• Antitrust laws break up monopolies
• Regulation sets prices and quantities
• Public ownership creates state-run enterprises
• Doing nothing allows markets to address monopolies naturally

Regulation Pricing Choices

• Setting a price for a natural monopoly at marginal cost leads to allocative efficiency, but may incur losses for the firm
• A fair-return price breaks even for the firm, which is socially acceptable
• A natural monopolist cannot always achieve productive efficiency

Measuring Industry Concentration

• Concentration ratio reveals the percentage of sales held by the four largest firms in an industry
• Herfindahl index sums the squared values of individual market shares of firms within an industry

Demand and Marginal Revenue

• Monopolistic firms face a downward sloping demand curve
• This means that price is greater than marginal revenue (P > MR = MC)

Marginal Approach

• Find profit maximizing output by locating where MR=MC
• The price is determined by where the demand curve intersects the profit maximizing output

Possible Outcomes

• In the short run, firms can make profits, break even, sustain losses, or shut down
• In the long run, firms tend to break even (zero economic profit) due to entry and exit of firms

Efficiency

• Monopolies are not productively efficient because price is greater than the minimum average total cost
• Monopolies are not allocatively efficient because price is greater than marginal cost

Kinked Demand Curve Model

• A gap in the marginal revenue curve exists due to the assumption that firms will match price decreases, but not increases
• This means firms will not immediately change their price or output for small changes in marginal cost
• The demand curve is elastic if prices increase and inelastic if prices decrease

Collusive Pricing Model

• Oligopolies act like a monopoly and set a price to maximize joint profits
• Output quotas are assigned to individual firms to maximize total output

Price Leadership Model

• An implicit form of collusion occurs where a dominant firm initiates price changes
• Other firms follow the leader and may use limit pricing to prevent entry of new firms
• This is an informal form of collusion

Oligopoly Inefficiency

• Oligopolies lack productive and allocative efficiency
• Oligopolies lack allocative efficiency because price is greater than marginal cost

Price Discrimination Conditions

• Price discrimination requires monopoly power, market segregation, and prevention of resale

Price Discrimination Example (Local-Daily Newspaper)

• Local-Daily can charge different prices to business employees and students
• By charging higher prices to business employees and lower prices to students, Local-Daily can maximize its profits
• The obstacle for Local-Daily is preventing resale of newspapers between the two groups

Explore the concepts of monopolies, including their pricing strategies, welfare costs, and the implications of public policy. This quiz covers essential economic principles related to monopolistic practices and regulatory frameworks. Test your understanding of how monopolies differ from competitive markets and analyze the welfare losses involved.