MONOPOLY: THE FIRM AS INDUSTRY

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CHAPTER 9 MONOPOLY THE FIRM AS INDUSTRY
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ASSUMPTIONS OF MONOPOLY MODEL - Single seller
in the market - No close substitutes - High
barriers to entry EXAMPLES - Electricity -
Local phone service - First class mail - Cable
(in some areas)
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• DEFINITION BARRIERS TO ENTRY
• - Anything that prevents new firms from entering
  a market in which economic profits are being
  earned
• SOURCES OF ENTRY BARRIERS
• -Government
• ?franchise
• license
• ?patent
• -Other (debatable)
• economies of scale
• access to raw material
• advertising by incumbent

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Because a monopolist is the only firm in the
market, the monopolists demand curve is the
market demand. And, because market demand
slopes downward (the Law of Demand), the
monopolists demand curve slopes downward. This
means that, by selecting how much output to
produce, the monopolist determines the market
price.
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Figure 9.1a
Demand Curves for Competitive and Monopoly Firms
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Figure 9.1b
Demand Curves for Competitive and Monopoly Firms
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DEFINITION TOTAL REVENUE - The dollar receipts
received by the firm by selling its output. It
is equal to price times quantity. TR P x
Q DEFINITION MARGINAL REVENUE - The charge in
total revenue caused by a one-unit change in
output. Or the change in total revenue divided
by the change in output. MR ?TR/
?Q Because the monopolists demand curve slopes
downward, the marginal revenue curve will fall
below the demand curve for all Q 1.
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Figure 9.2
The Dual Effects of a Price Reduction on Total
Revenues
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Because Total Revenue (TR), Marginal Revenue
(MR), and Price Elasticity of Demand (E) all
depend upon the demand curve, they are all
related. If E 1 ? MR 0 TR
increasing E 1 ? MR 0 TR maximum E
? MR
profit-maximizing firms will operate in the
elastic (E 1) region of demand.
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Figure 9.3
Changes in Elasticity of Demand and Total
Revenue as Price Changes
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MONOPOLY EQUILIBRIUM To maximize its profit (?
PQ C), the monopolist 1) Selects the output
where MC MR 2) Charges what the market
will bear for that output i.e., the maximum
price consumers will pay for that output. Read
off the demand curve. Profits are shown as ?
(P - ATC)Q Profits may be positive or negative.
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Figure 9.4
Monopoly Profits
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Figure 9.5
An Unprofitable Monopoly
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PRICE DISCRIMINATION DEFINITION PRICE
DISCRIMINATION - Charging different prices to
different groups of buyers for a product that
costs the same to supply to both groups. Or
charging the same cost where costs
differ. Necessary conditions 1) Firm must have
same monopoly power (control over price). 2) Must
have identifiable groups of buyers with different
elasticities of demand. 3) Must be able to
prevent arbitrage. Where the above conditions
are satisfied, the monopolist can earn greater
profits by practicing price discrimination than
it can earn by charging everyone the same price.
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Figure 9.6
Price Discrimination
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RESULT The monopolist charges a higher price to
the group with the less elastic
demand. EXAMPLES - Coupons at Pizza Hut or the
grocery store - In-state tuition versus
out-of-state - Scholarships - Movie tickets
(adults versus children) - University bookstores
(faculty versus students)
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WELFARE LOSS DUE TO MONOPOLY Because a
monopolist sets price above marginal cost,
monopoly equilibrium is allocatively inefficient.
Social welfare is not maximized at PM,
QM. Because P MC, there is an underallocation
of resources to the industry from societys point
of view. Too little is produced. Transforming
an industry from competition to monopoly results
in a net loss in social welfare, called the
Welfare Triangle.
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Figure 9.7
Welfare Loss Due to Monopoly Power
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Welfare loss due to monopoly is a static concept
assumes a given production technology. If
monopoly leads to a greater rate of technological
advance (more R D), then society may be better
off with monopoly despite the static welfare
loss. Dynamic Efficiency pushes the production
possibilities curve outward over time. This is
the economic justification for the patent system.
Assigns property rights (for 20 years) to new
products or processes.