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Lecture

Chapter 13 Lecture Notes.doc

18 Pages
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Department
Economics
Course Code
ECON 101
Professor
Corey Van De Waal

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CHAPTER 13: MONOPOLY 1. What is Monopoly? 2. How Monopoly arises? --No close substitute & ownership, legal and natural barrier to entry 3. Monopoly Price-Setting Strategies  Single price monopoly  Price discriminating monopoly 4. A Single-Price Monopoly’s Output and Price Decision  Price and Marginal Revenue  Marginal Revenue and Elasticity  In Monopoly, Demand Is Always Elastic  Price and Output Decision  Comparing monopoly Price & Output with competitive price & output  Efficiency Comparison  Redistribution of Surpluses  Rent Seeking, Rent-Seeking Equilibrium 5. Price Discrimination  Capturing Consumer Surplus  Profiting by Price Discriminating  Perfect Price Discrimination  Efficiency and Rent Seeking with Price Discrimination 5. Monopoly Regulation 6. Efficient Regulation of a Natural Monopoly  Marginal cost pricing rule  Second-Best Regulation of a Natural Monopoly 1  average cost pricing rule 1.What is Monopoly? A monopoly is a market:  That produces a good or service for which no close substitute exists  In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. 2. How Monopoly arises? --No close substitute & ownership, legal and natural barrier to entry A monopoly has two key features: a) No close substitutes. The absence of any firms making close substitutes allows the monopolist to avoid competition in the market. b) Barriers to entry. Legal or natural constraints that protect a firm from potential competitors are called barriers to entry. Three types of barriers to entry are legal barriers, natural barriers & ownership barriers a) Legal barriers to entry create a legal monopoly, a market in which competition and entry are restricted by the granting of: i) Public franchise. The exclusive right granted to a firm to supply a good or service is called a public franchise. For example, Canada Post has a public franchise to deliver first-class mail. ii) Government license. The government controls entry into particular occupations, professions and industries by requiring a government license. For example, a license is required to 2 practice law. Licensing doesn’t always create a monopoly, but it does restrict competition. iii) Patent and copyright. 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. Because these rights can be sold, patents and copyrights don’t always create a monopoly, but they do restrict competition. b) Natural barriers to entry create a natural monopoly, which is an industry in which one firm can supply the entire market at a lower price than two or more firms can. Figure 12.1 shows the average total cost curve for an electrical power company that is a natural monopoly. In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the entire market demand is met. The LRAC curve is still sloping downward when it meets the demand curve. 3 c) An ownership barrier to entry occurs if one firm owns a significant portion of a key resource. During the last century, De Beers owned 90 percent of the world’s diamonds 4 3. Monopoly Price-Setting Strategies  For a monopoly firm to determine the quantity it sells, it must choose the appropriate price.  There are two types of monopoly price-setting strategies: a) A single-price monopoly is a firm that must sell each unit of its output for the same price to all its customers b) Price discrimination is the practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms. 1. A Single-Price Monopoly’s Output and Price Decision a. Price and Marginal Revenue  A monopoly is a price setter, not a price taker like a firm in perfect competition.  The reason is that the demand for the monopoly’s output is the market demand.  To sell a larger output, a monopoly must set a lower price. TR = P x Q and MR = Δ TR/ ΔQ  For a single-price monopoly, marginal revenue is less than price at each level of output. That is, MR < P 5 b. Marginal Revenue and Elasticity  A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good: 6 • If demand is elastic, a fall in price brings an increase in total revenue. The increase in revenue from the increase in quantity sold outweighs the decrease in revenue from the lower price per unit, and MR is positive. As the price falls, total revenue increases. • If demand is unit elastic, a fall in price does not change total revenue. The rise in revenue from the increase in quantity sold equals the fall in revenue from the lower price per unit, and MR = 0. Total revenue is maximized when MR = 0. • If demand is inelastic, a fall in price brings a decrease in total revenue. The rise in revenue from the increase in quantity sold is outweighed by the fall in revenue from the lower price per unit, and MR is negative. c. In Monopoly, Demand Is Always Elastic A single-price monopoly never produces an output at which demand is inelastic. If it did produce such an output, the firm could increase total revenue, decrease total cost, and increase economic profit by decreasing output. d. Price and Output Decision The monopoly faces the same types of technology constraints as the competitive firm, but the monopoly faces a different market constraint. a) The monopoly selects the profit-maximizing level of output in the same manner as a competitive firm, where MR = MC. b) The monopoly sets its price at the highest level at which it can sell the profit-maximizing quantity. Table 12. uses a numerical example to illustrate the profit-maximizing output and price decision. 7  Figure 13.4 illustrates the profit- maximizing choices of a single-price monopoly.  In part (a), the monopoly produces the quantity that maximizes total
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