2 - Monopoly

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Gustavo Indart

MONOPOLY A monopoly is the sole producer in an industry. This means industry demand is demand for the monopoly and that the marginal cost and average cost functions of the monopoly are the marginal cost and average cost functions for the industry. Since price is not constant, marginal revenue is not equal to price for a monopolist. Also, since P is not constant and price is dependent upon the output of the monopoly, a monopoly can determine commodity price by restricting output. The marginal cost function of the monopoly is not the supply function for the industry because quantity supplied is not simply determined by the marginal cost in response to a price but depends upon the monopolist’s determination of price to maximize profit. Profit Maximization for a Monopolist: MR = MC Slope = 2*Slope for Linear Demand MR D MR for linear demand has the same intercept as the Demand function and twice the slope Elasticity is unit elastic at the midpoint of a Demand function, which means that MR is 0 at the midpoint because Total Revenue doesn’t change. A monopoly will not produce in the inelastic portion of a Demand function since a decrease in quantity will a) increase Total Revenue and b) reduce Variable Costs. The monopolist reduces quantity in the elastic portion of the Demand function so long as the decreased Variable Cost of one less unit is greater than the decreased revenue from one less unit, i.e., until MR = MC. Monopoly Equilibrium and Economic Profit Monopoly Equilibrium = monopoly output (Q ) wherM MR = MC Monopoly Price (P ) Mrom Demand at Q M Average Cost (AC ) fMom Average Cost at Q M Economic Profit = (P - MC )*QMor M *Q -MTotMl Cost M Types of Monopoly 1) Government Monopolies: governments perform functions that otherwise might be monopolized, establish public corporations with monopoly power in an industry, or grant monopoly power to private firms. The rationale for government monopolies is to prevent private exploitation of a natural monopoly for revenue purposes. 2) Control of an Essential Input (‘Normal’ monopoly): control over an essential resource, technolog
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