Lecture Outlines

Overview:

• The Monopoly Market Structure
• Price and Output Decisions
• Price Discrimination
• Comparing Monopoly and Perfect Competition
• The Case Against and For Monopoly

The Monopoly Market Structure

Monopoly: A market structure characterized by a single seller, a unique product, and impossible entry into the market. Monopoly is the polar opposite of perfect competition.

1. Single Seller. One firm provides the total supply of a product in a given market. Local market monopolies are more common than national or international market monopolies.

 

2. Unique Product. There are no close substitutes for the monopolists product.

 

3. Impossible Entry. Extremely high barriers make it very difficult or impossible for new firms to enter an industry. There are three types of barriers:

1. Ownership of a Vital Resource. The monopolist has sole control of the entire supply of a strategic input.
2. Legal Barriers. Government franchises and licenses permit a single firm to provide a certain product and exclude competing firms by law. Patents and copyrights are other legal barriers to market entry.
3. Economies of Scale. Results in a Natural Monopoly: An industry in which the long-run average cost of production declines throughout the entire market. As a result, a single firm can supply the entire market demand at a lower cost than two or more smaller firms.

Price and Output Decisions for a Monopolist

The major difference between perfect competition and monopoly is the shape of the demand curve -- not the shape of the cost curves.

Recall that a perfectly competitive firm is called a "price taker." Monopolists, on the other hand, are called "price makers."

Price Maker: A firm that faces a downward-sloping demand curve and therefore it can choose among price and output combinations along the demand curve.

Marginal Revenue, Total Revenue, and Price Elasticity of Demand

Straight line demand curves have an elastic upper half (E_d > 1), a unit elastic midpoint (E_d = 1) and an inelastic lower half (E_d < 1).

Total revenue for a monopolist is related to Marginal Revenue (MR).

• When E_d > 1, total revenue rises as the price drops. The MR curve is above the quantity axis.
• When E_d = 1, total revenue reaches a maximum. The MR curve intersects the quantity axis.
• When E_d < 1, total revenue falls as the price falls. The MR curve is below the quantity axis.

Rule to help locate where E_d = 1 and where MR = 0: The marginal revenue curve for a straight-line demand curve intersects the quantity axis halfway between the origin and the quantity axis intercept of the demand curve.

Monopoly in the Short-Run

Monopolists maximize profit by producing the quantity of output where MR = MC.

Monopolists charge neither the highest possible price nor the revenue-maximizing price. The price charged to maximize profit is higher on the demand curve than the price that maximizes total revenue.

The monopolist always maximizes profit by producing at a price on the elastic segment of its demand curve.

The fact that a firm has a monopoly does not guarantee profits.

• If the price at the MR = MC output is greater than the ATC, the monopolist earns a profit.
• If the price at the MR = MC output is greater than the AVC, but less than the ATC, the monopolist minimizes losses.
• If the price at the MR = MC output is less than the AVC, the monopolist will shut down.

Monopoly in the Long-Run

In perfect competition, economic profits are zero in the long-run.

In monopoly, if the positions of a monopolist's demand and cost curves give it a profit and nothing disturbs these curves, the monopolist will earn profit in the long-run.

• In reality, however, no monopolist can depend on barriers to protect it fully from competition in the long-run.

Price Discrimination

Price discrimination: The practice of a seller charging different prices for the same product not justified by cost differences.

• Is sometimes practiced by monopolists in order to maximize profit.

Conditions for price discrimination:

Is price discrimination unfair?

Some arguments for price discrimination:

1. Price discrimination allows the seller to increase profits.

2. Many buyers benefit form price discrimination by not being excluded from buying the product.

Arguments against price discrimination:

1. It offers monopolists a way to exercise market power and exploit consumers. 

Comparing Monopoly and Perfect Competition

A monopolist is characterized by inefficiency because resources are underallocated to the production of its products.

• Efficient allocation of resources is achieved when a firm produces the quantity of output at which P = MC.
• Perfectly competitive firms produce the quantity of output where P=MC.
• Monopolists produce output where P > MC. Consumers are shortchanged because the marginal benefit of the last unit produced exceeds the marginal cost of producing it.

Monopoly harms consumers by charging a higher price and producing a lower output than would result under a perfectly competitive market structure.

• In order to maximize profit, the monopolist sets MR = MC by restricting the output and raising the price.

The Case Against and For Monopoly

The economists case against monopoly:

1. Monopolists "gouge" consumers by charging a higher price than would be the case under perfect competition.
2. Because a monopolist restricts output in order to maximize profit, too few resources are used to produce the product -- resources are misallocated.
3. Long-run economic profit for a monopolist exceeds the zero economic profit in the long run for a perfectly competitive firm.
4. Monopoly may alter the distribution of income in favor of the monopolist.
5. Monopolies are slow to innovate because there is no competition and little motivation to change.