chapter 13 monopoly

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chapter 13

monopoly

markets dominated by one big firm

- no close substitutes

-barrier to entry

3types of barrier to entry:

1. natural-- economies of scale enables 1 firm to supply the enitre market at the lowest price possible

2. ownership--if a firm has a significant portion of a resource key

3. legal-- competetion and entry are restricted

*majpr difference between competetion and monoploy*

------monopoly sets its own price

to sell a larger quantity, the monopoly must set a lower price

2 pricing strategies :

1. single price-- a firm must sell each unit of its output fro the same price to all customers

2. price discrimination--sell units at different prices

PRICE AND MARGINAL REVENUE

-B/C in monopoly there is only one firm, the demand curve facing the firm is the market demand curve

at a price of $20, bobbie sells no haircuts.

the lower the price, the more haircuts per hour she can sell

for ex:at $12 consumers demand 4 haircuts per hr

total revenue(tr) is the price(p) multiplied by the quantity sold (q)

bobbie sells 3 haircuts at $14 each, so total revenue is $42

marginal revenue(mr) is the chsnge in total revenue resulting from a one unit increase in quantity sold

if the price falls from $16 to $14, the quantity sold increasses from 2 to 3 haircuts. total revenue increases from $32 to $4, so the change in total revenue is $10

at each levdel of output, marginal revenue is less than price- the marginal revenue is less than price.

the marginal revenue curve lies below the demand curve

when the price is lowered to sell one more unit, two opposing forces affect total revenue.

the lower pricdes resullts in a revenue loss

increases quantity sold results in a gain in revenue

MARGINAL REVENUE AND ELASTICITY

a single price monopoly's marginal revenue is realted to the elasticity of demand for it good

if demand is elatic, a fall in the price bring an increase in total revenue

the revenue gain from the increase in quantity sold outweighs the revenue loss from the lower price

the marginal revenue will be posittive

if demand is inelastic, a fall in the price bring a decrease in quantity sold is outweighed by the revenue loss from the lower price

the marginal revenue is negative

if demand is unit elastic, total revenue does not change

*in monopoly, demand is always elastic*

ex:

bobbie produces 3 haircuts an hour

her avg total is $10 an hr (on the ATC curve)

her price is $14 (on the D curve)

bobbie's economic profit is shown by the area of the blue rectangle, which equals the profit per haircut ($4) multiplied by the number of haircuts (3)for a total of $12

MONOPOLY

consumers do not change, so the market demand curve remains the same as in the case of perfect competetion

the monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost

-compared to a perfectly competitivr market, a single-price monopoly produces a smaller output and changes a higher price

a monopolu produces a smaller output than perfect competeion and faces no competition

it therefore does not produce at the lowest possible long run average cost

as a rsult, monopoly produce less, increase cost of production, and raise the price by more than the increased cost of production

REDISTRIBUTION OF SURPLUSE

monopoly is inefficient because marginal social benefit exceeds marginal social cost and there is deadweight loss- a social loss

but monopoly also brings a redistribution of surpluses

some of the lost consumer surpluses goes to the monopoly the monopoly takes the difference betweenthe higher price

the monolpoly takes that part of the consumer surplus

this portion of the loss of consumer surplus is not a loss to society

it is a redistribution

RENT SEEKING

monopoly creates a deadweight loss and is inefficient

the social cost of monopoly can exceed the deadweight loss b/c rent seeking

any surplus is called ECONOMIC RENT

the pursuit of wealth by capturing economic rent is called rent seeking

rent seekers pursue their goals in two main ways

1. buy a monopoly

2. create a monopoly

barriers to enetry create monopoly.

but there is no barrier to enter into rent seeking

rent seeking is like perfect competition

competeition among rent seekers pushes up the prices that must be paid for a monopoly

Firms that rice discriminate in two broad ways:

1. among groups of buyers

2 among units of a good

-buy one pizza and get the 2nd one for less is an ex of price discrimination

INCREASING PROFIT AND PRODUCER SURPLUS

by getting buyers to pay a price as close as possible to their maximum willingness to pay

a monopoly captures the consumer surplus and converts it into producer surplus

economic profit = TR -TC

producer surplus = TR-TVC

economic profit = producer surplus - TFC

PERFECT PRICE DISCRIMINATION

- occurs if a firm cansell each unit of output for the highest price someone is willing to pay for it

with this, output increaes to the point at which price equals marginal cost

output is identical to that of perfect competetion

no deadweight los is created

efficency is achieved

the more perfectly the monopoly can price discriminate, the closer its output is to the competitive output and the more efficient is the outcome

in perfect competeion, total surplus is shared by consumers and producers, while with perfect price discrimination, the monopoly takes it all

REGULATION

natural monpoly presents a dilemma

with economics of scale, it produces at the lowest possible cost

with market power it has an incentive tp raise the price above the competive price and produce too little

THE SOCIAL INTEREST THEORY --

that the political and regulatory process relentelessly seeks out inefficeincy and introduces regulation that eliminats deadweight loss and allocates resources efficiently

THE CAPTURE THEORY--

the regulation serves the self interest of the producer, who captures the regulator and maximizes economic profit

a natural monopoly cannot always be regulated to achieve the efficent outcome. there are two possible ways of enabling a regulated monopoly to avoid an economic loss are:

1.average cost pricing--sets price equal to average total cost. produces the quantity at which the average total cost curve cuts the demand curve. results in the break even point

2.government subsidy--a direct payment to the firm equal to its economic loss

regulators use two principal rukes:

1. rate of retuen regulation--firm must justify its price by showing that its return on caital doesnt exceed a specfic target rate

2. price cap regulation--a price ceiling, a rule that specfies the highest price the firm is permitted to set

*a price cap lowers the price and increase output

*in a monoply the uregulated equilibrium output is less than the competitive equilibrium output. the price cap regulation replicates the conditions of a competitive market.