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Chapter 10

Chapter 10 notes.docx

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Department
Economics
Course Code
ECON 110
Professor
Ian James Cromb

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Chapter 10: Monopoly, Cartels, and Price Discrimination A Single-Price Monopolist Revenue Concepts for a Monopolist  The same forces that lead to perfectly competitive firms to have U-shaped costs curves equally applies to a monopolist  Because a monopolist is the sole producer of the product that it sells, the demand curve it faces is simply the market demand curve for the product o Therefore, the firm faces a negatively sloped demand curve unlike those individual firms in a perfectly competitive market  Sales can only be increased if price is reduced - price can only go up if sales reduce Average Revenue  A monopolist charges one price for all units, total revenue equals price x the quantity sold  Since average revenue is total revenue divided by the quantity sold, therefore average revenue is just equal to the sale price of the product  Since the demand curve shows the price of the product, it follows that the demand curve is also the monopolist`s average revenue curve Marginal Revenue  Because its demand curve is negatively sloped, the monopolist must reduce the price it charges on every product it sells to sell one extra unit o Implies that the price received from the one extra unit sold it not the firm`s marginal revenue because, by reducing the price on all previous units, the firm loses some revenue  Marginal revenue is equal to the sale price minus this lost revenue o Marginal revenue will be less than the price at which it sells out put – therefore the MR curve is below its demand curve Short-Run Profit Maximization  Output should be based on equating its marginal cost with its marginal revenue o The interception between these curves determines the firm’s quantity produced, but here the priced charged is determined by the demand curve  A profit-maximizing monopolist may not be making profits o Even when the firm is choosing its quantity to maximize its profits, the size of those profits depends on the position of the ATC curve No Supply Curve for Monopolist  A monopolist does not have a supply curve because it is not a price taker – it chooses its profit maximizing price-quantity combination from among the possible combinations on the market demand curve – this level of output is where MC and MR intersect Firm and Industry  Only one producer, there is no need to discuss firm vs. industry – short run position of the firm is also the short-run equilibrium of the industry Competition and Monopoly Compared  For a perfectly competitive industry, the equilibrium is determined by the intersection of the industry demand and supply curves o Since the industry supply curve is determined by the sum of all of the individual firm’s marginal cost curves, the equilibrium output in a perfectly competitive industry is such that price = marginal cost  In contrast, for the monopolist equilibrium output is such that price is greater than marginal cost – they produce a lower level of output compared to perfectly competitive  Since price exceeds marginal cost, society would benefit if more units of output were produced – because marginal value exceeds the marginal cost o More economic surplus would be generated for society o The monopoly’s profit-maximizing decision to restrict output below the competitive level creates a loss of economic surplus for society – deadweight loss o This leads to market inefficiency Entry Barriers and Long-Run Equilibrium  As in perfectly competitive markets, profits and losses lead to market entry and exit  If the monopoly is suffering losses in the short-run, it will continue to operate as long as it can cover its variable costs o In the long-run, it will leave the industry unless it can find a scale of operations at which its full opportunity costs can be covered  If the monopoly is making profits, other firms will want to enter the industry o As such entry occurs, the firm will cease to be a monopoly and will have to compete with new firms and thus capture only part of the overall market demand  If monopoly profits are to persist in the long run, there must be barriers to entry Natural Entry Barriers  Most commonly arise as a result of economies of scale o When the long run average cost curve is negatively sloped over a large range of output, big firms have significantly lower average total costs than small firms  A natural monopoly occurs when the industry’s demand conditions allow no more than one firm to cover its costs while producing at its minimum efficient scale  One type of natural entry barriers is a setup cost – the cost to a new firm of entering the market, developing its brand image and its dealer network may be so large that entry would be unprofitable Created Entry Barriers  Many of these are created by government actions o Patent laws, for example, prevent entry by giving the patent holder the sole right to produce a particular product for a specific period of time o Regulation and/or licensing of firms can also restrict entry The Significance of Entry Barriers  Because of the freedom to enter an exit markets, perfectly competitive industries cannot have profits that persist in the long run  In monopolized industries, profits can persist in the long run whenever there are effective barriers to entry The Very Long Run and Creative Destruction  In the very long run, technology changes – new ways of producing old products, new products created to satisfy the same needs o Monopolists that try to prevent market entry will sooner or later find these barriers circumvented due to innovation o Patents can be circumvented by using slightly different production processes o May produce a slightly different product to satisfy the same needs o Inventing a tech that produces at a low minimum efficient scale which allows it to enter the industry and still cover its costs  Such innovations explain why monopolies rarely persist over a long period of time  Creative Destruction: The replacement of one product by another o The development of similar products against which the monopolist will not have entry protection o Reflects new firms’ abilities to circumvent a monopolists entry barriers Cartels as Monopolies  Cartel: An organization of producers who agree to act as a single seller in order to max
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