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Chapter 15

Chapter 15 Economics.docx

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Economics 10a
Gregory Mankiw

Chapter 15 Economics: Monopoly • Monopoly: a firm that is the sole seller of a product without close substitutes o Cause: high barriers to entryother firms cannot enter the market and compete with it  Monopoly resources: a key resource for production is owned by a single firm • If there is only one well in a town, then the owner of the well has significant market power • If the resource were a necessity like water, the monopolist could obtain a high price even if the marginal cost of water is low • Example: DeBeers’diamond mines • This is rare because the economy is so large and resources are owned by many people  Government regulation: the government gives a single firm the exclusive right to produce some good or service • Monopolies could be granted to friends and allies of a government • Sometimes governments grant monopolies because they are viewed to be in the public interest (i.e. patent and copyright laws) • Because copyright and patent laws give exclusive rights to one producer, it leads to higher prices than what would occur under competition • By allowing producers to charge higher prices and earn higher profits, the laws encourage desirable behavior like innovations (incentivizing creativity)  Natural monopoly: created by production process; a single firm can produce output at a lower cost than can a larger number of producers • Occurs when theATC curve continually declines • Arises when there are economies of scale over the relevant range of output • For any given amount of output, a larger number of firms leads to less output per firm and higher average total cost • Example: Water distributions o Multiple firms would each have to pay the fixed price of laying pipe, making the average total cost of water lower if a single firm ran the market • Club goods that are excludable but not rival in consumption: a bridge built and maintained by a firm is a natural monopoly o If more bridges were built because of congestion, then the natural monopoly would be abolished • The size of the market determines whether an industry is a natural monopoly in some casesas the market expands, a natural monopoly can evolve into a more competitive market • Firms typically have trouble maintaining a monopoly position without ownership of a key resource or protection from the government o Amonopolist’s profit attracts entrants into the market, which makes the market more competitive o Natural monopolies make entering a market unattractive because would-be entrants know that they cannot achieve the same low costs that the monopolist enjoys because, after entry, each firm would have a smaller piece of the market • Monopolies are price-makers: they charge prices that exceed the marginal cost o Amonopoly firm can control the price of the good it sells, but because a high price reduces the quantity that its customers buy, the monopoly’s profits are not unlimited o The outcome in such a market is not often in the best interest of society o 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 the market, its demand curve is the market demand curve (sloping downward) (demand curve=average revenue) o Because the firm’s price equals its average revenue, the demand curve is theAR curve o If the monopolists reduces the quantity of output that it produces and sells, the price of its output increases o If the monopolist raises the price of the good, consumers buy less of it o The market demand curve prevents the monopolist from charging a high price and selling large quantity at that high price by placing a constraint on the market o The market demand curve describes the combinations of price and quantity that are available to a monopoly firm (which can only choose quantities and prices along the curve) o The demand curve relates the amount customers are willing to pay with quantity sold • Average revenue always equals the price of the good (AR=TR/Q) • Total Revenue=P × Q • Marginal revenue: the amount of revenue that a firm receives for each additional unit of output o MR=Change in TR/Change in Q o Always less than the price of its good (MRMR, the firm should increase profit (reduce losses) by producing less units until MC=MR • The monopolist’s profit-maximizing quantity of output is determined by the intersection of the marginal revenue curve (which is less than the price curve) and the marginal-cost curve • P>MR=MC; Pr
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