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Chapter 10

ECO100Y1 Chapter 10 Notes

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University of Toronto St. George
Robert Gazzale

ECO100Y1 Textbook Notes Chapter 10  Monopoly: a market containing a single firm.  Monopolist: a firm that is the only seller in a market. 10.1 A Single-Price Monopolist  Unlike a perfectly competitive firm, a monopolist faces a negatively sloped demand curve.  Since the demand curve shows the price of the product, D curve = AR curve.  The monopolist’s MR is less than the price at which it sells its output. Thus the monopolist’s MR curve is below its demand curve.  Two forces act on TR when decreasing price to sell more units: o The loss in revenue resulting from the decrease in price on the initial units (amount of the price reduction X number of initial units). o The added revenue resulting from increased sales (current price X change in quantity).  When MR > 0, η > 1.  When MR < 0, η < 1.  A profit-maximizing firm will always produce on the elastic portion of its demand curve (more precisely where MR = MC).  Nothing guarantees that a monopolist will make positive profits in the short run, but if it suffers persistent losses, it will eventually go out of business.  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.  The level of output in a monopolized industry is less than the level of output that would be produced if the industry were instead made up of many price- taking firms.  A monopolist restricts output below the competitive level and thus reduces the amount of economic surplus generated in the market. The monopolist therefore creates an inefficient market outcome.  If monopoly profits are to persist in the long run, the entry of new firms into the industry must be prevented.  Entry barrier: any barrier to the entry of new firms into an industry. An entry barrier may be natural or created.  Minimum efficient scale (MES): the smallest-size firm that can reap all the economies of large-scale production (LRAC minimum).  Natural entry barriers: o Natural monopoly: an industry characterized by economies of scale sufficiently large that only one firm can cover its costs while producing at its MES. o Setup cost: costs faced by a new firm are so large that entry would be unprofitable.  Created entry barriers: o Patents: prevent entry by conferring on the patent holder the sole legal right to produce a particular product for a specific period of time. o A charter or a franchise that prohibits competition by law (i.e. Canada Post has a government-sanctioned monopoly on the delivery of first- class mail). o Threat or sabotage (i.e. setting unsustainably low prices on new entrants).  In competitive industries, profits attract entry, and entry erodes profits. In monopolized industries, positive profits can persist as long as there are effective entry barriers.  A monopolist’s entry barriers are often circumvented by the innovation of production processes and the development of new goods and services. Such innovation explains why monopolies rarely persist over long periods, except those that are protected through government charter or regulation.  Creative destruction: coined by Joseph Schumpeter referring to the process by which a new product replaces an old product.  Since creative destruction thrives on innovation, the existence of monopoly profits is a major incentive to economic growth. 10.2 Cartels as Monopolies  Cartel: an organization of producers who agree to act as a single seller in order to maximize joint profits.  The members agree among themselves to restrict their total output to the level that maximizes their joint profits.  Does not necessarily mean that ALL firms within an industry will be members.  The profit-maximizing cartelization of a competitive industry will reduce output and raise price from the perfectly competitive levels.  Cartels tend to be unstable because of the incentive for individual firms to violate the output restrictions needed to sustain the joint-profit-maximizing (monopoly) price.  Cartels must also be able to limit the entry of new firms if their cartels are to be successful. o Some cartels are able to issue licences and thus can choose to allow new firms into the market. o Certain industries have government imposed quotas and if the quotas are allocated among existing producers, new firms cannot enter. 10.3 Price Discrimination  Price discrimination: the sale by one firm of different units of a commodity at two or more different prices for reasons not associated with dif
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