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CAS EC 101 (177)
Todd Idson (13)
Chapter 15

Chapter 15 Monopoly

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CAS EC 101
Todd Idson

Chapter 15: Monopoly Friday, December 6, 2013 11:12 AM I. Why Monopolies Rise ○ Monopoly: A firm that is the sole seller of a product without close substitute  Barrier to entry: Monopolies can remain the sole seller because other firms cannot enter the market □ Monopoly resources: A key resource required for production is owned by a single firm □ Government regulation: Gives single firm the exclusive right to produce some good or service □ Production process: Single firm can produce output at a lower cost than can a larger number of producers A. Monopoly Resources ○ DeBeers controls 80% of the diamond mines in South Africa B. Government Created Monopolies ○ Pharmaceutical companies can apply for patents C. Natural Monopolies ○ Natural monopoly: Monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms  Occurs when there are economies of scale over the relevant range of output  Larger number of firms leads to less output per firm and higher average total cost □ Example: Distribution of water  Firm must build a network of pipes throughout the town, each competing firm would have to build separate pipe systems, thus cheaper if only one firm supplies □ Example: Bridge (club good)  One car's use of the bridge would not diminish another's, the more that crosses the bridge, the cost divided by number of trips becomes smaller  Firms in natural monopolies do not worry about others entering □ Monopolist's profit makes the market more attractive to enter but entering a natural monopoly is unattractive  Each entrant would have a smaller piece of the market because on the firm with the natural monopoly can achieve the low cost II. How Monopolies Make Production and Pricing Decisions A. Monopoly versus Competition ○ Monopoly has the ability to influence the price of its output  Demand curve is the market demand curve  Demand curve slopes downward □ If the price of its good is raised, consumers buy less of it □ If the quantity is reduced, the price increases  Market demand curve makes high production at high price impossible because of the downward slope ○ Competitive firms are small in the market so they are price takers of the market conditions  Horizontal demand curve because the competitive firm can control the quantity sold but not price  Demand curve is perfectly elastic because of the many perfect substitutes B. A Monopoly's Revenue ○ Monopolist's marginal value is always less than the price of its good  The output effect: More output is sold, so Q is higher, which tends to increase total revenue  The price effect: Price falls, so P is lower, which leads to decrease total revenue ○ A competition can sell all its wants as long as it is at the market ○ A monopoly must reduce the price of the good for every extra unit produced ○ Demand curve is also the average revenue curve, always start at the same point ○ Monopolist marginal revenue lies below the demand curve  Marginal revenue could even be negative C. Profit Maximization Deadweight Loss Marginal Cost ○ When marginal cost is less than marginal revenue, the firm can increase profit by producing more units ○ Profit maximizing quantity is the intersection of the marginal revenue curve and the marginal cost curve  For a competitive firm: P=MR=MC Price Monopoly  For a monopoly firm: P>MR=MC ○ Demand curve relates the amount that customers are willing to pay to the quantity sold Profit Avg Total Cost D. A Monopoly's Profit
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