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ECN 104 (447)
Lecture

Chapter 15

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Department
Economics
Course
ECN 104
Professor
Tsogbadral Galaabaatar
Semester
Fall

Description
ECN104 – Chapter 15 Notes Chapter 15 • Questions o Why do monopolies arise? o Why is MR < P for a monopolist? o How do monopolies choose their P and Q? o How do monopolies affect society’s well-being? o What can the government do about monopolies? o What is price discrimination • Introduction o A monopoly is a firm that is the sole seller of a product without close substitutes o In this chapter, we study monopoly and contrast it with perfect competition o The key difference:  A monopoly firm has market power, the ability to influence the market price of the produce it sells  A competitive firm has no market power • Why Monopolies Arise o The main cause of monopolies is barriers to entry – other firms cannot enter the market o Three sources of barriers to entry:  1. A single firm owns a key resource (e.g., DeBeers owns most of the world’s diamond mines)  2. The government gives a single firm the exclusive right to produce the good. (e.g., patents, copyright laws)  3. Natural monopoly: a single firm can produce the entire market Q at lower cost than could several firms • Example: 1000 homes need electricity • ATC is lower if one firm services all 1000 homes than if two firms each service 500 homes • Monopoly vs. Competition: Demand Curves o In a competitive market, the market demand curve slopes downward o But the demand curve for any individual firm’s produce is horizontal at the market price o The firm can increase Q without lowering P o So, MR = P for the competitive firm o A monopolist is the only seller, so it faces the market demand curve o To sell a larger Q, the firm must reduce P o Thus, MR doesn’t equal P • Understanding the Monopolist’s MR o Increasing Q has two effects on revenue:  Output effect: higher output raises revenue  Price effect: lower price reduces revenue o To sell a larger Q, the monopolist must reduce the price on all the units it sells o Hence, MR < P o MR could even be negative if the price effect exceeds the output effect (e.g., when Common Grounds increases Q from 5 to 6) • Profit-Maximization o Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC o Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity o It finds this price from the D curve. o 1. The profit-maximizing Q is where MR = MC o 2. Find P from the demand curve at this Q • The Monopolist’s Profit o As with a competitive firm, the monopolist’s profit equals (P – ATC) x Q • A Monopoly Does Not Have A Supply Curve o A competitive firm  Takes P as given  Has a supply curve that shows how its Q depends on P o A monopoly firm  Is a “price-maker,” not a “price-taker”  Q does not depend on P, rather Q and P are jointly determined by MC, MR, and the demand curve  So there is no supply curve for monopoly • CASE STUDY: Monopoly vs. Generic Drugs o Patents on new drugs give a temporary monopoly to the seller o When the patent expires, the market becomes competitive, generics appear • The Welfare Cost of Monopoly o Recall: In a competitive market equilibrium, P = MC and total surplus is maximized o In the monopoly equilibrium, P > MR = MC  The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC)  The monopoly Q is too low – could increase total surplus with a larger Q  Thus, monopoly results in a deadweight loss o Competitive equilibrium quantity = Qc, P = MC, total surplus is maximized o Monopoly equilibrium quantity = Qm, P > MC, deadweight loss • Price Discrimination o Discrimination: treating people differently based on some characteristic (e.g., age or gender) o Price Discrimination: selling the same good at different prices to different buyers o The characteristic used in price discrimination is willingness
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