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ECON 1B03 (302)
Chapter 15

Chapter 15

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McMaster University
Usman Hannan

CHAPTER 15: MONOPOLY - a monopoly firm is a price maker and has market power - price charged by a monopoly exceeds marginal cost - charge high prices, but their profits are not unlimited - governments can restrict moves made by monopolies to reduce their power and better the economy Why Monopolies Arise -monopoly: a firm that is the sole seller of a product without close substitutes - fundamental cause are the barriers to enter - barriers to enter: 1) monopoly resources – a key resource is owned by a single firm 2) government- created monopolies – the government gives a single firm the exclusive right to produce some good or service 3) natural monopolies – a single firm can produce output at a lower cost than can a larger number of producers Monopoly Resources - not as common, the economy is so large a complete resource is rarely controlled by one firm - example: De Beers controls 80% of diamond production in the world Government-Created Monopolies - patents and copyrights are examples of how the government creates monopolies out of public interest - encourages research and creativity to develop an original idea or product Natural Monopoly - examples include public goods and common resources - less concerned about new entrants eroding its power - sometimes dependent on market size How Monopolies Make Production and Pricing Decisions Monopoly vs. Competition - key difference is that a monopoly can influence the price of its output - monopoly demand curve = the market demand curve (slopes downwards) - demand curve provides a constraint on the monopolies power - competitive market, P = MR A Monopoly’s Revenue - average revenue = price of the good - monopoly’s marginal revenue is always less than the price of its good (downward slope) - when a monopoly increases the amount it sells: 1)the output effect – more output sold, higher Q, increase in total revenue 2) price effect – price falls, lower P, decrease total revenue - competitive firm has no price effect - P > MR - monopoly’s marginal-revenue curve lies below its demand curve (starts at the same point) - marginal revenue is negative when the price effect on revenue is greater than the output effect Profit Maximization - when the MC > MR the firm can produce more units to increase profit - maximum profit when MC = MR - main difference between competitive firm and monopolistic firm is that for a competitive firm the price = MR = MC and for a monopoly firm price > MR = MC - demand curve gives the firm what the price will be A Monopoly’s Profit - profit = (P – ATC) x Q (since P is much larger than ATC, the profit is much higher) - there is no supply curve for a monopoly The Welfare Cost of Monopoly The Deadweight Loss - the socially efficient quantity is found where the demand curve and the marginal cost curve intersect - monopolist chooses to produce less than the socially efficient quantity of output - inefficiency can be measured with a deadweight loss triangle between the demand curve and the marginal cost curve - ineffici
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