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Chapter 13- Monopoly

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University of Waterloo
ECON 101
Emanuel Carvalho

CHAPTER 13: Monopoly  Monopoly: A market with a single firm that produces a good or service for which no close substitute exists and that is protected by a barrier that prevents other firms from selling that good or service How Monopoly Arises  Monopoly arises for two key reasons:  No close substitute  Barrier to entry No Close Substitute  If a good has a close substitute, even though only one firm produces it, that firm effectively faces competition from the producers of the substitute  A monopoly sells a good or service that has no good substitute Barrier to Entry  A constraint that protects a firm from potential competitors is called a barrier to entry  The three types of barrier to entry are: 1. Natural 2. Ownership 3. Legal Natural Barrier to Entry  A natural barrier to entry creates a natural monopoly: an industry in which economies of scale enable one firm to supply the entire market at the lowest possible cost. The firms that deliver gas, water, and electricity to our homes are examples of natural monopoly Ownership Barrier to Entry  An ownership barrier to entry occurs if one firm owns a significant portion of a key resource Legal Barrier to Entry  A legal barrier to entry creates a legal monopoly: a market in which competition and entry are restricted by the granting of a public franchise, government licence, patent, or copyright  A public franchise is an exclusive right granted to a firm to supply a good or service  A government licence controls entry into particular occupations, profession, and industries  Licensing does not always create a monopoly, but it does restrict competition  A patent is an exclusive right granted to the inventor of a product or service  A copyright is an exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work  Patents encourage the invention of new products and production methods  They also stimulate innovation-the use of new inventions-but encouraging inventors to publicize their discoveries and offer them for use under licence Monopoly Price-Setting Strategies  A major difference between monopoly and competition is that a monopoly sets its own price  In doing so, the monopoly aces a market constraint: To sell a larger quantity, the monopoly must set a lower price  There are two monopoly situations that create two pricing strategies: 1. Single price 2. Price discrimination Single Price  Single-price monopoly: a firm that must sell each unit of its output for the same price to all its customers Price Discrimination  When a firm practises price discrimination, it sells different units of a good or service for different prices  When a firm price discriminates, it looks as though it is doing its customers a favour  In fact, it is charging the highest possible price for each unit sold and making the largest possible profit A Single-Price Monopoly`s Output and Price Decision Price and Marginal Revenue  In a monopoly there is only one firm, so the demand curve facing the firm is the market demand curve  Total revenue is the price multiplied by the quantity sold  Marginal revenue is the change in total revenue resulting from a one-unit increase in the quantity sold Marginal Revenue and Elasticity  A single-price monopoly`s marginal revenue is related to the elasticity of demand for its good  The demand for a good can be elastic, inelastic, or unit elastic  Demand is elastic if a 1 percent fall in price brings a greater than 1 percent increase in the quantity demanded  Demand is inelastic if a 1 percent fall in price brings a less than 1 percent increase in the quantity demanded  Demand is unit elastic if a 1 percent fall in price brings a 1 p
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