Single Seller - a One Producer of a Specific Product

Pure Monopoly

 exists when a single firm is the sole producer of a product for which there are no close substitutes

Characteristics

 Single Seller - a one producer of a specific product  No Close Substitutes - no reasonable alternative products  "Price Maker" - the firm exercises considerable control over price because it is responsible for the quantity supplied.  Totally Blocked Entry - no competitors because of economic, technological, legal obstacles  Advertising - monopolies may or may not advertise o monopolist selling luxury good can advertise to increase demand o monopolist selling utilities/necessities will not advertise

Examples

1. gas/electric companies 2. water company 3. cable TV 4. telephone company 5. professional sports leagues 6. monopoly caused by geographic isolation

Barriers to Entry

Economies of Scale

 natural monopoly - economies of scale that are so great that a good or service can be produced by one firm at an average total cost lower than if produced by more than one firm.  New firms attempting to enter the industry as small-scale producers will have little or no chance to survive and expand  New small-scale entrants cannot realize the cost of economies of scale of the monopolist and therefore cannot realize profits necessary for survival and growth  New large-scale producers find it extremely difficult to secure enough startup money and capital

Legal Barriers: Patent and Licenses

Patents

 Patents allow inventor from having the product usurped by rivals who have not shared in the time, effort, and money put into the products development  Patents give the inventor a monopoly position for the life of the patent  Profits gained from a patent can further finance research required to develop new patentable products. Therefore, tremendous monopoly power can be obtained. Licenses

 Entry into an industry or occupation may require a government license  Allows the government to create a public monopoly  Examples: radio/TV stations, taxi cabs  Ownership of Essential Resources  Example: De Beers owns most of the world's known diamond mines

Implications:

 Monopolies are relatively rare  Barriers to entry are rarely complete - meaning pure monopoly is relatively rare  Technology may undermine existing monopoly power (e.g. email and postal service)  Existing patent advantages can be circumvented by new and distinct, yet substitutable products  New resources can be found

Desirability

Comments on resource ownership, patents, and licensing imply undesirable connotations

Monopoly Demand Curve

The demand curve in a monopoly is down-sloping - This implies that the monopolist cannot sell more without lowering the price.

Price Exceeds Marginal Revenue

Marginal revenue is less than price for every level of output except for the first

1. Price cuts apply to both extra output sold as well as all other units of output, which could have been sold at a higher price 2. The monopolist must lower price to boost sales  When marginal revenue is positive - total revenue is increasing  When marginal revenue is negative - total revenue is decreasing

Price Elasticity

 When demand is elastic, a decline in price will increase total revenue  When demand is inelastic, a decline in price will reduce total revenue  The profit-maximizing monopolist will always want to avoid the inelastic segment of its demand curve  By lowering price into inelastic range, total revenue will decline

Monopoly Output and Price Determination

MR = MC Rule - this tells us that maximum profit/minimum loss will occur if we produce where MR = MC

How to determine economic profit:

 find quantity where MC = MR  find the corresponding quantity on the demand curve  draw a line down to the ATC curve  draw a rectangle to the y-axis  the area of this rectangle is economic profit Losses occur when ATC exceeds demand

There is no supply curve in a monopoly.

 There is no unique relationship between price and quantity supplied  There is only one producer

Misconceptions Concerning Monopoly Pricing

 The monopolist will not charge the highest price possible  The monopoly will charge the price where total profit is greatest  Monopolists want to maximize total profit, not unit profit

Economic Effects of Monopoly

Price, Output, and Efficiency

The monopolist will find it profitable to sell a smaller output and to charge a higher price than would a competitive producer

Competitive markets seek to optimize allocative and productive efficiency. Monopolistic markets seek to optimize profits

Therefore, monopolies never achieve allocative or productive efficiency

Income Distribution

Monopolists generally charge a higher price than a competitive firm with the same costs. Thus, monopolies earn much more economic profit

Thus, the owners of the monopolistic enterprise are enriched at the expense of society X-inefficiency

 Occurs when a firm's actual costs of producing any output are greater than the minimum possible costs. For example, at quantity Q1, a firm produces at ATCx when it could produce at ATCm.

 Monopolists are sheltered from competitive forces by entry barriers. Thus, this allows X- inefficiency to occur  In competitive markets, firms are continually under pressure from rivals. Thus, X- inefficiency does not occur

Rent-seeking Expenditures

 Rent seeking behavior refers to activities designed to transfer income or wealth to a particular firm or resource supplier at someone else's expense.  Example: Monopolies spend lots of money lobbying for legislation that allows monopolies to hold their privileged position. This increases costs, but not output. This is a rent- seeking expenditure.

Dynamic Efficiency

 Dynamic efficiency considers whether monopolists are more likely to develop more efficient techniques over time than competitive firms.

The Competitive Model

 There is little or no technological progress in a purely competitive market because there are no economic profits, which are a large incentive to produce new technology.

The Monopoly Model

 "Does not promote advancement" view o Because monopolies make a large economic profit, there is no incentive to change the status quo. As a result, firms do not develop new technology.  "Does promote advancement" view o Monopolies are more willing to develop new technology because doing so lowers costs and expands profits. Monopolies can develop new technology without the fear of competitors.

Price Discrimination

 Price discrimination occurs when a given product is sold at more than one price, and these price differences are not justified by cost differences  Price discrimination is workable under three conditions

1. The seller possesses some degree of monopoly power 2. The seller must be able to segregate buyers into separate classes 3. The original purchaser cannot resell product or service

Consequences

1. Monopolists that practice price discrimination get more profit

2. Price-discriminating Monopolists produce more output

When a monopolist lowers the price, the reduced price applies only to additional unit sold and not to prior units. Hence, price and marginal revenue are equal. Therefore, the demand curve and marginal revenue curves will coincide. This allows the monopolist to produce more output to receive maximum profit.

3. More allocative efficiency is attained

Regulated Monopoly

When the government regulates monopolies, there are two prices the government can choose from.

Socially Optimal Price: P = MC

 if government sets the price, the monopolist will choose its profit maximizing output  there is allocative efficiency

"Fair-Return" Price: P = ATC

 firm will only realize a normal profit

Notes from tutorials available on theshortrun http://www.theshortrun.com/main.html