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ECON 1000 Quiz: Micro4th ppt notes ch15

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York University
ECON 1000
Avi Cohen

A monopoly is a firm that is the sole seller of a product without close substitutes. In this chapter, we study monopoly and contrast it with perfect competition. The key difference: A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market power. Why Monopolies Arise The main cause of monopolies is barriers to entry – other firms cannot enter the market. Three sources of barriers to entry: 1. A single firm owns a key resource. E.g., DeBeers owns most of the world’s diamond mines 2. The gov’t gives a single firm the exclusive right to produce the good. E.g., patents, copyright laws Why Monopolies Arise 3. Natural monopoly: a single firm can produce the entire market Q at lower ATC than could several firms. Monopoly vs. Competition: Demand Curves In a competitive market, the market demand curve slopes downward. but the demand curve for any individual firm’s product is horizontal at the market price. The firm can increase Q without lowering P, so MR = P for the competitive firm. Monopoly vs. Competition: Demand Curves A monopolist is the only seller, so it faces the market demand curve. To sell a larger Q, the firm must reduce P. Thus, MR ≠ P. A monopoly’s revenue the only seller of cappuccinos in town. The table shows the market demand for cappuccinos. Fill in the missing spaces of the table. What is the relation between P and AR? Between P and MR? Here, P = AR, same as for a competitive firm. Here, MR < P, whereas MR = P for a competitive firm. Moonbuck’s D and MR Curves Understanding the Monopolist’s MR Increasing Q has two effects on revenue: The output effect: More output is sold, which raises revenue The price effect: The price falls, which lowers revenue To sell a larger Q, the monopolist must reduce the price on all the units it sells. Hence, MR < P MR could even be negative if the price effect exceeds the output effect (e.g., when Moonbucks increases Q from 5 to 6). Profit-Maximization Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC. Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity. It finds this price from the D curve. Profit-Maximization 1. The profit-maximizing Q is where MR = MC. 2. Find P from the demand curve at this Q. The Monopolist’s Profit As with a competitive firm, the monopolist’s profit equals (P – ATC) x Q A Monopoly Does Not Have an S Curve A competitive firm ▪ takes P as given ▪ has a supply curve that shows how its Q depends on P A monopoly firm ▪ is a “price-maker,” not a “price-taker” ▪ Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand curve. So there is no supply curve for monopoly. Case Study: Monopoly vs. Generic Drugs Patents on new drugs give a temporary monopoly to the seller. When the patent expires, the market becomes competitive, generics appear. The Welfare Cost of Monopoly Recall: In a competitive market equilibrium, P = MC and total surplus is maximized. In the monopoly eq’m, P > MR = MC The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC). The monopoly Q is too low – could increase total surplus with a larger Q. Thus, monopoly results in a deadweight loss. The Welfare Cost of Monopoly Competitive eq’m: quantity = Q E P = MC total surplus is maximized Monopoly eq’m: quantity = QM P > MC deadweight loss Public Policy Toward Monopolies Increasing competition with antitrust laws Examples: Act for the Prevention and Suppression of Combinations Formed in Restraint of Trade (1889), Combines Investigation Act (1910). Competition Act and Competition Tribunal Act (1986) Competition law in Canada is enforced by the Competition Bureau which is a unit of Industry Canada. Competition laws prohibit certain anticompetitive practices, allow gov’t to break up monopolies. Public Policy Toward Monopolies Governments can also deal with the problem of monopoly is through regulation. Common
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