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Monopoly. Eco 2023 Chapter 10 Fall 2007. Monopoly. A market with a single seller with a product that is differentiated from other products. Characteristics. Single seller Firm and industry are synonymous No close substitutes Price maker Blocked entry

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Monopoly l.jpg

Monopoly

Eco 2023

Chapter 10

Fall 2007


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Monopoly

  • A market with a single seller with a product that is differentiated from other products.


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Characteristics

  • Single seller

    • Firm and industry are synonymous

  • No close substitutes

  • Price maker

  • Blocked entry

    • Barriers to entry keep competitors out of the market

  • Standardized or differentiated


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Barriers to Entry

  • Any impediment that prevents new firms from entering an industry and competing on an equal basis with existing firms

  • Types

    • Economies of scale

    • Legal restrictions

    • Control over essential resource


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Economies of Scale

  • Declining average total cost with added firm size are extensive

  • Long run average total cost will decline over a wide range of output

  • Only a single large firm can achieve low average total costs

  • Protects the firm from competitors

  • Natural monopoly

    • the market demand curve cuts the long-run ATC curve where average total costs are still declining


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Legal Restrictions

  • Patent

    • A legal barriers to entry that grants its holder the exclusive right to sell a product for 20 years from the date the patent application is filed

    • Innovation

      • The process of turning an invention into a marketable product

  • Licenses

    • Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service


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Control over Essential Resource

  • Firms owns all sources of a resource

    • ALCOA – aluminum

    • DeBeers – diamonds


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Monopoly Demand

  • Three assumptions

    • Patents, economies of scale or resource ownership secure our monopolist’s status

    • No unit of government regulates the firm

    • Single price monopolist,

  • Demand curve

    • Downward sloping demand curve

    • Quantity demanded increases as price decreases


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Implications

  • Marginal revenue is less than price

    • The downward sloping demand curve means that it can increase sales by charging a lower price

    • Marginal revenue is less than price for every level of output

    • Marginal revenue curve is below the demand curve

    • Marginal revenue is positive while total revenue is increasing.

    • When total revenue is decreasing, marginal revenue is negative


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Price

Elastic

Unit Elastic

Inelastic

Demand = Average Revenue

Monopoly

Marginal Revee


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Monopoly

  • Where demand is price elastic, marginal revenue is positive

  • Therefore:

  • TR increasesas Price decreases

  • Where demand is price inelastic, marginal revenue is negative

  • TR decreasesas Price increases

  • Where demand is unit elastic, marginal revenue is zero,

    • TR is at a maximum, neither increasing nor decreasing


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Implications

  • Price Maker

    • When monopolist decides on output level, he determines price.

  • Elastic Region

    • Monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease

      • Marginal revenue is NEGATIVE


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Example


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Monopoly

  • Profit Maximization

    • A firm that must find the profit maximizing price when the demand curve for its output slopes downward

    • Monopolist produces the quantity at which total revenue > total cost by greatest amount

    • Marginal revenue = Marginal cost


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Price

Profit

Marginal Cost

Average Total Cost

P

Demand = Average Revenue

Monopoly – short run

Marginal Revenue

Q


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Monopoly

  • Short run

    • Economic profits can exist

    • Losses

      • Can exist

      • If the price covers average variable cost, the firm will produce

      • If not, the firm will shut down at least in the short run


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Long run Profit Maximization

  • Long run efficiency in pure competition is

    • P = MC = Minimum ATC

  • Monopoly

    • MR < P, monopolist will sell smaller output at a higher price than pure competition

    • An efficiency loss occurs because

      • P > MC

      • P > minimum ATC


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Long-Run Profit Maximization

  • If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run.


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Monopoly

  • Allocation of Resources

    • If monopolists are no greedier than perfect competitors because both maximize profit

    • What is the problem with monopoly?

      • Lower output

      • Higher price

        • Than perfect competition


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Monopoly

  • Price Discrimination

    • Increasing profits by charging different groups of consumers different prices when the price differences are not justified by differences in production costs


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Monopoly

  • Conditions

    • Demand must be downward sloping

    • At least to separate groups of consumers

      • Each with different price elasticity of demand

    • Firm must be able to charge each group a different price for essentially the same product

    • The firmmust be able to prevent those who pay the lower price from reselling the product to those who pay the higher price

    • Each market, the firms equates marginal revenue with marginal cost


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