Notes
AP Microeconomics: Monoply
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Overview
Introduction
Oligopoly and monopolistic competition have potential monopoly power
The Lerner Index
(P – MC) / P
used to ascertain the pricing power of potential monopolistic powers
the greater the value, the greater the power
The Herfindahl Index
the sum of the squares of the market shares of firms in a particular market or industry
purpose: to measure the concentrated power of power generated by shares of the market
Basic Concepts
The monopolist faces a downward sloping demand function
implies that price is greater than marginal revenue
which implies a pricing policythat could actually lead to a lowering of price by the monopolist in order to induce more sales in a relatively elastic demand market
The monopolist maximizes profits at the optimal level of output (MC = MR)
controls the supply of the product
can influence, but not control, the demand by changing the price relative to price elasticity of demand
Unregulated monopoly can lead to
higher than competitive prices
lower than competitive output
misallocation of resources, inefficiency, and dead-weight loss
rent seeking
Regulated monopoly can lead to
move towards outputs that are more efficient, through subsidies that rise as outputs rise
“fair” rate of returnP = ATC
a socially optimal price and output, P = MC, which would require subsidies
The Nature of Monopoly and It’s Types
Basics
Likely to show some inefficiency relative to the model of perfect competition
Dead-weight loss
a form of resource misallocation
resources could have been utilized to produce goods and services but are instead totally wasted
Higher prices, lower outputs → misallocation of resources
Monopolist receives a rentmore than he contributes to production at the margin of the effort of the monopolist
P > MC is symptomatic of monopoly pricing power
Definition of monopoly- both a firm and an industry
Price Discrimination
Works best if:
there are no opportunities for the resale of the product
the price differences are not based on cost differences
the firm is a price-makerhas a pricing strategy that looks to charge a higher price and realize more profits
separate markets for consumer based on different price elasticities of demand
those with high price elasticity of demand have more choices of substitute products
Monopolies want to charge each customer exactly the maximum price that each consumer would be willing to pay
Natural Monopoly
Original theory- certain industries could best operate as monopolies
competition would negate the major economies of scale inherent in the nature of these industries
smaller competitive firms would be less efficient and more costly
Originally for the electric industry
Regulated Monopoly
Prices and outputs in between those of perfect competition and unregulated monopoly
“Fair rate of return”
this price is approximately the price of the perfectly competitive firm
would cover average costsincludes implicit costs that represent what would have been earned elsewhere with the same resources
Unregulated Monopoly
A profit maximizer
Prices and determines output at the level of output where MC = MR
→ prices higher than the competitive price
→ outputs lower than the perfect competition output
Other Regulated Monopolies
Priced at the socially optimal price
May require government subsidies to survive
Monoply Explained