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Chapter 15

Chapter 15 EC120.docx

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Department
Economics
Course
EC120
Professor
Peter Sinclair
Semester
Fall

Description
EC120 Chapter 15-Monopoly Week 9 -While a competitive firm is a price taker, a monopoly firm is a price maker -The market price of Windows is many times the marginal cost -Customers of monopolies might seem to have little choice but to pay whatever the monopoly charges -Monopolies cannot achieve any level of profit they want, because high prices reduce the amount that their customers buy. Although monopolies can control the price of their goods, their profits are not unlimited. -Monopoly firms, like competitive firms aim to maximize profit -The government keeps a close eye on Microsoft’s business decisions Why Monopolies Arise -A firm is a monopoly if it is the sole seller of its product and if its product does not have close substitutes. -The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it. Barriers to entry, in turn, have three main sources: 1. Monopoly Resources -The simplest way for a monopoly to arise is for a single firm to own a key resource. -If there is a town with water wells, then there is a competitive model. However, if there is one town with only one water well, they the owner of the well has a monopoly on water. -The monopolist has much greater market power than any single firm in a competitive market. 2. Government Created Monopolies -In many cases monopolies arise because the government has given one person or firm the exclusive right to sell some good or service. -The government grants a monopoly because doing so is viewed to be in the public interest -The patent and copyright laws are two important examples of how the government creates a monopoly to serve the public interest. -For example, pharmaceutical companies -Because these laws give one producer a monopoly, they lead to higher prices than would occur under competition. -A benefit of these laws is that the pharmaceutical companies charge high prices but encourage research and copyright on books encourages authors to write. 3. Natural Monopolies -An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms -An example of a natural monopoly is the distribution of water. To provide water to residents of a town, a firm must build a network of pipes throughout the town. If two or more firms were to compete in the provision of this service, each firm would have to pay the fixed cost of building a network. Thus, the average total cost of water is lowest is a single firm serves the entire market. -When a firm is a natural monopoly, it is less concerned about new entrants eroding its monopoly power. -Entering a market in which another firm has a natural monopoly is unattractive -If the natural monopoly is on a bridge in a town, then as the population of a town grows a natural EC120 Chapter 15-Monopoly Week 9 monopoly can evolve into a competitive market. How Monopolies make Production and Pricing Decisions Monopoly vs. Competition -The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price of its output -Because a monopoly is the sole producer in its market, it can alter the price of its good by adjusting the quantity it supplies to the market -Because a monopoly is the sole producer in its market, its demand curve is the market demand curve, thus it slopes downward A Monopoly’s Revenue -Consider a town with a single producer of water EC120 Chapter 15-Monopoly Week 9 -A monopolist’s marginal revenue is always less than the price of its good -For a monopoly, marginal revenue is lower than price because a monopoly faces a downward-sloping demand curve -When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q): 1. The output effect: More output is sold, so Q is higher which tends to increase total revenue 2. The price effect The price falls, so P is lower, which tends to decrease total revenue -When a monopoly increases production by 1 unit, it must reduce the price it charges for every unit it sells, and this cut in price reduces revenue on the units it was already selling. As a result, a monopoly’s marginal revenue is less than its price -In this case, when the firm produces an extra unit of output, the price falls by enough to cause the firm’s total revenue to decline, even though the firm is selling more units Profit Maximization -If the firm is producing at a low level of output, marginal cost is less than marginal revenue. -At a high level of output, marginal cost is greater than marginal revenue. If the firm reduced production by 1 unit, the costs saved would exceed the revenue lost. -The monopolist’s profit-maximizing quantity of output is determined by the intersection of the marginal-revenue curve and the marginal cost curve For a competitive firm: P=MR=MC For a monopoly firm: P>MR=MC -In competitive markets, price equals marginal cost. In monopolized markets, price exceeds marginal cost. EC120 Chapter 15-Monopoly Week 9 A Monopoly’s Profit -To see the monopoly’s profit: Profit = TR-TC -Rewritten as: Profit = (TR/Q – TC/Q) x Q -TR/Q is average revenue, which equals the price P, and TC/Q is average total cost ATC. Therefore, Profit=(P-ATC) x Q le The Welfare Cost of Monopoly -A monopoly, in con
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