Economics 1021A/B Lecture Notes - Deutscher Motor Sport Bund, Marginal Revenue, Deadweight Loss

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Nicole Wallenburg
Economics
Parkin
Nov 21, 2011
Economics Lecture #18
Monopoly and How It Arises
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.
How Monopoly Arises
A monopoly has two key features:
No close substitutes
o If a good has a close substitute, even if it is produced by only one firm,
that firm effectively faces competition from the producers of the
substitute.
o A monopoly sells a good that has no close substitutes.
Barriers to entry
o A constraint that protects a firm from potential competitors are called
barriers to entry.
o Three types of barriers to entry are
Natural
Ownership
Legal
Natural Barriers to Entry
o Natural barriers to entry create natural
monopoly.
o A natural monopoly is an industry in
which economies of scale enable one
firm to supply the entire market at the
lowest possible cost.
o Figure 13.1 illustrates a natural
monopoly.
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 single-price monopoly is a firm that must sell each unit of its output for the
same price to all its customers.
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Nicole Wallenburg
Economics
Parkin
Nov 21, 2011
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.
A Single-Price Monopoly’s Output and Price Decision
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.
Total revenue, TR, is the price, P, multiplied
by the quantity sold, Q.
Marginal revenue, MR, is the change in total
revenue that results from a one-unit increase
in the quantity sold.
For a single-price monopoly, marginal
revenue is less than price at each level of
output. That is,
o MR < P.
TR gain TR loss = Marginal Revenue
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.
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.
The monopoly selects the profit-maximizing
quantity in the same manner as a competitive
firm, where MR = MC.
The monopoly sets its price at the highest level at
which it can sell the profit-maximizing quantity.
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