Chapter 15 Monopoly Principles of Economics 2024 PDF

Chapter 15 Monopoly Principles of Economics 2024 Fall Soo Kyung Woo Monopoly Firm that is the only seller of a product without close substitutes “Price maker” Can influence the market price of its product Has the market power Because of barriers to entry Other firms cannot...

Chapter 15 Monopoly Principles of Economics 2024 Fall Soo Kyung Woo Monopoly Firm that is the only seller of a product without close substitutes “Price maker” Can influence the market price of its product Has the market power Because of barriers to entry Other firms cannot enter the market to compete with it 2 Barriers to Entry 1. Monopoly resources A single firm owns a key resource 2. Government regulation Government gives a single firm the exclusive right to produce some good/service Patent and copyright laws 3. The production process (natural monopoly) A single firm can supply a good or service to an entire market at lower cost Economies of scale 3 Natural Monopoly Cost ATC Q When a firm’s ATC continually declines Cheaper to be produced by a single firm than many EXAMPLE: Electricity Cost $80 $50 ATC 500 1000 Q Consider a small town where 1,000 homes need electricity Electricity: huge FC and small MC At which point is the ATC lower? One firm services all 1,000 homes Two firms each service 500 homes 5 Demand that a Firm Faces Competitive Firms Monopoly Sell to 1/very many Whole market Price setting Price takers Price maker Demand P P P = MR D D Q Q 6  Monopoly’s Revenue Total revenue TR = P × Q Average revenue AR = TR / Q = P Marginal revenue MR = ΔTR / ΔQ MR ≠ P Downward-sloping demand: to increase Q, need to lower P Demand and MP Curves Think about the meaning of each curve D curve: how the quantity sold is related to the price of the good MR curve: 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, MR < P MR curve is below the demand curve EXAMPLE: You own the only hair salon in town. Q P TR AR MR $0 - P, MR 0 $60 55 $60 1 55 55 55 50 45 40 2 50 100 50 35 30 3 45 135 45 20 25 10 D 4 40 160 40 15 0 Q 5 35 175 35 -10 5 -20 6 30 180 30 MR -5 -30 7 25 175 25 0 1 2 3 4 5 6 7 8 9 10 -15 8 20 160 20 What is the relation between P and AR? P = AR Between P and MR? P > MR 9  Profit-maximization for a Monopoly Costs and Revenue MC The profit-maximizing Q ATC P is where MR = MC. At this Q, find P on the demand curve. D Profit MR = TR – TC = (P – ATC) x Q Q Quantity Profit-maximizing output 10 Monopoly Profit Maximization To maximize profit, produce Q where MR=MC Set the highest price consumers are willing to pay for that quantity Shown on the D curve As a result, earn the profit = (P−ATC) ×Q 11 Monopoly Does Not Have a S Curve A competitive firm is a “price taker” Has a supply curve that shows how its Q depends on P A monopoly firm is a “price maker” Q does not depend on P Q and P are jointly determined by MC, MR, and the demand curve Hence, no supply curve for monopoly 12  Monopoly vs. Generic Drugs Price The market for a typical drug PM (Assume MC is PC = MC constant over Q) D MR QM QC Quantity Drug with patent: a temporary monopoly (PM, QM ) Drug after the patent expires: the market becomes competitive (PC, QC) 13 The Welfare Cost of Monopolies Efficient quantity: P = MC Value to buyers = Cost to monopoly Monopoly’s quantity: MR = MC Thus, monopoly’s quantity is inefficient: P > MC Value to buyers > Cost to monopoly The monopoly quantity is too low 14 Source of the Deadweight Loss Because the monopoly makes a lot of profit? Bigger producer surplus Smaller consumer surplus Profit itself does not reduce the total surplus The inefficiency: Monopoly Q < Efficient Q Deadweight loss 17 Price Discrimination Price discrimination Sell the same good at different prices to different customers Charge a higher price to buyers with higher willingness to pay Can raise economic welfare Perfect price discrimination Charge each customer at exactly their willingness to pay Monopoly gets the entire surplus 18 Welfare with and without Price Discrimination Price Discrimination in the Real World Perfect price discrimination: Not possible No firm knows every buyer’s WTP Firms divide customers into groups based on some trait that is likely related to willingness to pay, such as age Examples Movie tickets: Lower price for students Airline: Higher price for Sunday return tickets Discount coupons: People who have time to clip and organize coupons are more likely to have lower income and lower WTP than others Quantity discounts: Customer pays a higher price for the first unit bought than for the last unit bought Competition vs. Monopoly: Summary