Economics 1021A/B Lecture Notes - Marginal Cost, Deadweight Loss, Marginal Revenue

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24 Apr 2012
Economics Textbook Notes
Monopoly and How is Arises
A monopoly is a market with a single firm that produces a good or service for which no
close substitutes exist 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
o A monopoly sells a good or service that has no good substitute
Tap water for washing a car or having a shower
Barrier to Entry
o A constraint that protects a firm from potential competitors is called a
barrier to entry
o Types:
Natural Monopoly: an industry in which economies of scale
enable one firm to supply the entire market at the lowest
possible price
o The firms that deliver gas, water, and electricity to
our homes
Economies of scale prevail over the entire length of the
LRAC curve
One firm can supply the entire market at a lower cost than
two or more firms can
An ownership barrier to entry occurs if one firm owns a
significant portion of a key resource
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 license, patent,
or copyright
o A public franchise is an exclusive right granted to a
firm to supply a good or service
o A government licence controls entry into particular
occupations, professions, and industries
o A patent is an exclusive right granted to the
inventor of a product or service
o A copyright is an exclusive right granted to the
author of composer of a literary, musical, dramatic,
or artistic work.
Patents and copyrights are valid for a limited
time period that varies from country to
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Monopoly Price-Setting Strategies
A monopoly sets its own price. In doing so, the monopoly faces 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:
Single Price
o A single price monopoly is a firm that must sell each unit of its output for
the same price to all its customers
Price Discrimination
o Price discrimination is when a firm 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
The marginal revenue curve lies below the demand curve. When the price is lowered to
sell one more unit, two opposing forces affect total revenue. The lower price results in a
revenue loss, and the increased quantity sold results in a revenue gain.
Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity of demand for its
If demand is elastic, a fall in price brings an increase in total revenue
If demand is inelastic, a fall in price brings a decrease in total revenue
If demand is unit elastic, total revenue does not change
In Monopoly, Demand is Always Elastic
o A profit maximizing monopoly never produces an output in the inelastic
range of the market demand curve
Price and Output Decision
A monopoly sets its price and output at the levels that maximize economic profit.
A monopoly faces the same types of technology and cost constraints as a competitive
firm, so its costs behave just like those of a firm in perfect competition
Maximizing Economic Profit
o Total cost (TC) and the total revenue (TR) both rise as output increases,
but TC raises at an increasing rate and TR rises at a decreasing rate
Marginal Revenue Equals Marginal Cost
o The greatest economic profit is made at the quantity when MR=MC
Maximum Price the Market Will Bear
o A monopoly influences the price of what it sells. But a monopoly doesn’t
set the price at the maximum possible price
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