ECON 1B03 Chapter Notes - Chapter 15: Deadweight Loss, Marginal Revenue, Imperfect Competition

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29 Jul 2016
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15. monopoly
Why Monopolies Arise
monopoly = imperfect competition: a firm that is the
sole seller of a product without close substitutes
Market power: the ability to increase prices without losing
customers
Monopolies arise because of barriers that prevent firms from
entering the market. Some sources of barriers are:
1. monopoly resources: a key resource is being owned
by a single firm. The resource may also have no close
substitutes
blood diamond
2. government-created monopolies: when the
government gives a single firm the exclusive right to
produce some good or service. There are benefits
(incentive to produce original goods/services) and
costs (monopoly pricings)
patent and copyright laws
3. natural monopolies: a single firm can produce output
at a substantially lower cost than could 2 or more
firms together
water infrastructure: a firm wants to supply
water to a town, as more firms want to do the
same thing, the average total cost of the water
increases because each firm would have to pay
the fixed cost of building a network. The average
total cost is less if a single firm serves the entire
market
bridges: if a bridge is uncongested, it can serve as
many vehicles as it allows, but it is excludable.
The more vehicles, the lower the average total
cost. If the bridge becomes more congested, then
firms can enter the market and so the monopoly
evolves into a competitive market
How Monopolies Make Production and Pricing Decisions
Monopoly vs. Competition
The demand curve for a:
a. competitive firm: is perfectly inelastic because it has
many substitutes
b. monopoly: is a linear downward sloping curve; thus a
monopoly has to accept a lower price if it wants to
sell more output
A Monopoly’s Revenue
The rule is: a monopoly’s marginal revenue is always less
than the price of its good
There are 2 effects on the total revenue as the quantity of
output increase:
1. the output effect: more output is sold, which tends to
increase total revenue
2. the price effect: the price falls, which tends to
decrease total revenue
Profit Maximization
A monopoly’s profit-maximizing quantity of output is
determined by the intersection of the marginal-revenue
curve and the marginal-cost curve
a. in a competitive firm: price = MC = MR
b. in a monopoly firm: price > MC = MR
A monopoly will always make its price greater than its
marginal cost
A Monopoly’s Profit
It maximizes profit by producing Q where MR = MC. It then
uses the demand curve to find the price that will induce
consumers to buy at that quantity
- positive
economic profit because price > ATC
The Welfare Cost of Monopoly
The Deadweight Loss
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