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Chapter 13

Chapter 13 Textbook Notes

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Department
Economics
Course
Economics 1021A/B
Professor
Michael Parkin
Semester
Fall

Description
Economics Chapter 13 Notes Nov. 20 Monopoly and How it Arises • Monopoly: a market with a single firm that produces a good or service for which no close substitute exists and that is protected by a barrier that prevents other firms from selling that good or service • Arises for two key reasons: ○ No close substitute ○ Barrier to entry No close substitute  Monopoly sells a good or service that has no good substitute ○ Barrier to entry Barrier to Entry  Barrier to entry: a constraint that protects a firm from potential competitors  Three types: ○ Natural  natural barrier to entry creates a natural monopoly  natural monopoly: an industry in which economies of scale enable one firm to supply the entire market at the lowest possible cost  e.g. firms that deliver gas, water, electricity ○ Ownership  Occurs if one firm owns a significant portion of a key resource ○ Legal  Creates a legal monopoly  Legal monopoly: a market in which competition and entry are restricted by granting of a public franchise, government licence, patent, or copyright  Public franchise: an exclusive right granted to a firm to supply a good or service  E.g. Canada Post  Government licence: controls entry into particular occupations, professions, and industries  E.g. medicine, law, dentistry  Patent: exclusive right granted to the inventor of a product or service  Copyright: an exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work Natural Monopoly Monopoly Price-Setting Strategies  Monopoly sets its own price  To sell a larger quantity, the monopoly must set a lower price  Two monopoly situations that create two price strategies: ○ Single price  Single-price monopoly: a firm that must sell each unit of its output for the same price to all its customers ○ Price discrimination  Price discrimination: when a firm sells different units of a good or service for different prices  When a firm discriminates, it looks as though it is doing its customers a favour  It is charging the highest possible price for each unit sold and making the largest possible profit A Single-Price Monopoly’s Output and Price Decision Price and Marginal Revenue  In a monopoly there’s only one firm, so the demand curve facing the firm is the market demand curve  Total revenue (TR) is the price (P) multiplied by the quantity sold (Q)  Marginal revenue (MR) is the change in total revenue (TR) resulting from a one-unit increase in the quantity sold Marginal Revenue and Elasticity  A single-rpice monopoly’s marginal revenue is related to the elasticity of demand for its good  Demand is elastic if a 1% fall in price brings a greater 1% increase in the quantity demanded ○ If demand is elastic, a fall in price brings a increase in total revenue  The marginal revenue is positive because the revenue gain from the increase in quantity sold outweighs the revenue loss from the lower price  Demand is inelastic if a 1% fall in the price brings a less than a 1% increase in the quantity demanded ○ If demand is inelastic, a fall in price brings an increase in total revenue  The marginal revenue is negative because the revenue gain from the increase in quantity sold is outweighed by the revenue loss from the lower price  Demand is unit elastic if a 1% fall in price brings a 1% increase in the quantity demanded ○ If demand is unit elastic, total revenue doesn’t change  The revenue gain from the increase in the quantity sold offsets the revenue loss from the lower price to marginal revenue is zero  in monopoly, demand is always elastic Price and Output Decision  a monopoly sets its price and output at the levels that maximize economic profit  a monopoly faces the same types of technology and cost constraints as a competitive firm, so its costs behave like those of a firm in perfect competition  a monopoly’s revenues behave the same also Maximizing Economic Profit  total cost and total revenue both rise as output increases, but TC rises at an increasing rate and TR rises at a decreasing rate  economic profit (TR minus TC) increases as small output levels, reaches a minimum and then decreases Marginal Revenue Equals Marginal Cost  the profit maximizing price Maximum Price the Market Will Bear  a monopoly influences the price of what it sells  doesn’t set the price at a maximum possible price ○ at this price the firm would be able to sell only one unit of output, which in general is less than the profit maximizing quantity  a monopoly produces the profit-maximizing quantity and sells that quantity for the highest price it can get  all firms maximize profit by producing the output at which marginal revenue equals marginal cost  for a monopoly, price exceeds marginal revenue, so price exceeds marginal cost  barriers to entry prevent new firms from entering the market, so a monopoly can make a positive economic profit and might continue to do so indefinitely Single-Price Monopoly and Competition Compared Comparing Price and Output  perfect competition ○ with small perfectly competitive firms in the market, the market supply curve is S ○ in perfect competition, equilibrium occurs where the supply curve and the demand curve intersect ○ the price is c and the quantity produced by the industry is c ○ because each firm is a small part of the total industry, there is no incentive for any firm to try and manipulate the price by varying its output  monopoly ○ if the industry is taken over by a single firm, consumers don’t change so the market demand curve remains the same but now the monopoly recognizes this demand curve as constraint on the price at which it can sell its output ○ the monopoly’s marginal revenue curve is MR ○ to find the monopoly’ marginal cost curve, the competitive industry’s supply curve becomes the monopoly’s marginal cost curve (MC) ○ compared to a perfectly competitive industry, a single-price monopoly produces a smaller output and charges a higher price Efficiency Comparison  consumer surplus shrinks for two reasons ○ consumers lose by having to pay more for the good ○ consumers lose by getting less of the good  although the monopoly gains from a higher price, it loses some producer surplus because it produces a smaller output  a monopoly produces a smaller output than perfect competition and faces no competition, so it doesn’t produce at the minimum possible long-run average cost  monopoly damages the consumer interest in three ways ○ produces less ○ increases the cost of production ○ raises the price by more than the increased cost of production Redistribution of Surpluses  monopoly also brings a redistribution of surpluses  the monopoly takes the difference between the higher price, and the competitive price on the quantity sold Rent Seeking  the social cost of monopoly can exceed the deadweight loss because of an activity called rent seeking  economic rent: any surplus – consumer surplus, producer surplus or economic profit  rent seeking: the pursuit of wealth by capturing economic rent  the pursuit of economic profit by a monopoly is rent seeking
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