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Chapter 12

Chapter 12. Monopoly. Basic Definitions. Imperfect Competition: Occurs when firms in a market or industry have some control over the price of their output. Monopoly, Oligopoly, and Monopolistic Competition

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Chapter 12

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  1. Chapter12 Monopoly

  2. Basic Definitions • Imperfect Competition: Occurs when firms in a market or industry have some control over the price of their output. • Monopoly, Oligopoly, and Monopolistic Competition • Pure Monopoly:An industry with a single firm that produces a product for which there are no close substitutes, and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

  3. Barriers to Entry • Government franchises • Patents • Economies of scale and other cost advantages • Ownership of a scarce factor of production

  4. There are now four firm decisions that must be characterized: • There are now four firm decisions that must be characterized: • How much output to produce • How to produce output • How much to demand in each input market • What price to charge for output

  5. Similarities and differences - Monopoly and Competition • Similarities: • Both know exactly what the demand curve and price will be • Differences: • Competitor has no control over price • Monopolist has total control over price

  6. Price and Output Decisions in Pure Monopoly Markets • Basic assumptions: • Entry to the market is strictly blocked. • Firms act to maximize profits. • The monopolistic firm cannot price discriminate. • The monopoly faces a known demand curve.

  7. Consider this hypothetical data for a monopolist’s demand curve

  8. Example-Demand/MR $$$ Quantity

  9. Example -Demand/MR/TR

  10. The monopolist’s profit-maximizing output and price: • Maximizing profit at MR=MC Profit = $1*4000 = $4000 $ MC ATC Pm=$4 ATC=$3 MC=$1.5 D Q 4000 MR

  11. Details... • The monopolist has no supply curve; there is no unique relationship between price and quantity supplied. • Since entry is blocked, the monopolist can earn economic profits in the long run. • Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high.

  12. Comparison of monopoly and perfectly competitive market solutions: $ Monopoly: MC=MR Pm=$4 Ppc=MCc=MCm=$2 MC=MR=P=ATC D 2000 4000 Q MR

  13. Comparison of monopoly and perfectly competitive market solutions: $ Monopoly Pm=$4 Perfectly competitive market Ppc=MCc=MCm=$2 MC=MR=P=ATC D 2000 4000 Q MR

  14. Losses from Monopoly • LESS output is produced than would be produced in a competitive industry. • If we look at the diagram, we see that output stops short of where Mgl. Benefits = Mgl. Costs. • Buyers must pay MORE than they would pay in a competitive market • Figure 13.6

  15. The Social Costs of Monopoly • Prices are higher when a market is monopolized than when it is perfectly competitive. • Output is lower when a market is monopolized than when it is perfectly competitive. • Some consumer surplus is reallocated to producers when a market is monopolized. • Some consumer surplus is lost when a market is monopolized.

  16. Consumer Surplus • The difference between the market price and what people are willing to pay for a unit of output

  17. Consumer Surplus Price ($) Price ($) Total consumer surplus A $5.00 B $5.00 C Demand Demand E E $2.50 $2.50 1 2 3 7 1 2 3 7 Millions of hamburgers per month

  18. Consumer surplus in a perfectly competitive market: Consumer surplus of PC $ Monopoly Pm=$4 Perfectly competitive market Ppc=MCc=MCm=$2 MC=MR=P=ATC D 2000 4000 Q MR

  19. Consumer surplus in a monopoly market Consumer surplus of Monopoly $ Monopoly Pm=$4 Perfectly competitive market Ppc=MCc=MCm=$2 MC=MR=P=ATC D 2000 4000 Q MR

  20. Consumer surplus in a monopoly market: Consumer surplus of Monopoly $ CS reallocated to producer Pm=$4 Net loss of social welfare Ppc=MCc=MCm=$2 MC=MR=P=ATC D 2000 4000 Q MR

  21. Rent-Seeking Behavior (1) • Rent-seeking behavior: Actions taken by households or firms to preserve positive profits. • Suppose someone is in a competitive market, but would like, somehow, to be a monopolist and earn monopoly rents.

  22. Rent-Seeking Behavior (2) • Actions taken by households or firms to acquire or preserve extra normal profits • Lobbying gov’t officials; asking for licensure. • Some argue that many medical professionals lobby for licensure in order to earn monopolistic rents.

  23. Natural Monopoly • An industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

  24. Natural Monopoly • Economies of scale must be realized at a scale that is close to total demand in the market. • Figure 13

  25. There are several ways to regulate natural monopoly • The government sets a monopoly’s price equal to marginal cost. • The government sets a monopoly’s price to cover average cost per unit.

  26. Summary • Monopolies exist when there is a single seller of a unique product and significant entry barriers. • The monopolist will produce where MR=MC and determine its price from demand.

  27. Review questions • Application • Decide the output level for monopoly • Calculate consumer surplus • Definitions: • Imperfect competition • Pure monopoly • Natural monopoly

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