MicroEconomics theory and application 12th by browning an zupan chapter 11

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MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

Chapter 11: Monopoly

Prepared by Dr Della Lee Sue, Marist College

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Learning Objectives

 Define monopoly and show what a monopolist’s demand and marginal revenue curves look like.

 Explain why a monopolist’s profit-maximizing

output is where marginal revenue equals marginal cost Describe why the extent to which a

monopolist’s price exceeds marginal cost is larger the more inelastic the demand faced by the

monopolist.

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Learning Objectives (continued)

 Explain several important implications of

monopoly analysis such as that the shutdown

condition applies to monopolies as well as to firms operating in perfectly competitive environments.

 Outline the potential sources of monopoly power: absolute cost advantages, economies of scale,

product differentiation, and regulatory barriers.

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Learning Objectives (continued)

 Explore the efficiency effects of monopoly from static and dynamic perspectives.

 Provide an overview of public policy toward

monopoly.

 Explain the mathematics behind monopoly.

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11.1 THE MONOPOLIST’S DEMAND AND MARGINAL REVENUE CURVES

Define monopoly and show what a monopolist’s demand and marginal revenue curves look like.

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 Monopoly – a market with a single seller

 Monopoly power – some ability to set price above

marginal cost

 Price maker – a monopoly that supplies the total

market and can choose any price along the market demand curve that it wants

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The Monopolist’s Demand and Marginal Revenue Curves

 Demand curve

 market demand

 average revenue

 Marginal revenue:

 effect on total revenue due to change in output

 decreases as output increases

 less than price when demand curve slopes downward

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Figure 11.1 - The Monopolist’s (Mad

Men co-stars) Demand Curve

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Table 11.1

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Profit-Maximizing Output of a

Monopoly

 Marginal revenue is always less than price when the demand curve slopes downward.

 Profit is maximized where MR=MC:

 If MR>MC, then profits will increase if output is increased.

 If MR<MC, then profits will increase if output is decreased.

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Table 11.2

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Figure 11.2 - Profit-Maximization: Total and Per-Unit Curves

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Figure 11.3 - Profit Maximization

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The Monopoly Price and Its Relationship

to Elasticity of Demand

The smaller the demand elasticity, the greater the

profit-maximizing price, relative to marginal cost.

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Derivation of Price Formula

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Figure 11.4 - The Inverse Elasticity

Pricing Rule

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Further Implications of Monopoly

Analysis

 A monopoly has no supply curve.

 A monopoly does not necessarily make positive

economic profit.

 A monopoly’s demand curve is elastic where

marginal revenue is positive.

 A profit-maximizing monopolist will always sell at

a price where demand is elastic.

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Figure 11.5 - Monopoly and the

Shutdown Condition

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Figure 11.6 - Monopoly Demand,

Marginal Revenue, and Total Revenue

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11.4 THE MEASUREMENT AND

SOURCES OF MONOPOLY POWER

Outline the potential sources of monopoly power: absolute cost

advantages, economies of scale, product differentiation, and regulatory barriers.

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Figure 11.7 - Monopoly Power When

There are Several Suppliers

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Measuring Monopoly Power

 Lerner Index – a means of measuring a firm’s

monopoly power that takes the markup of price over marginal cost expressed as a percentage of a product’s price:

Lerner Index = (P – MC)/P (3)

 The Lerner index varies between zero and one.

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Sources of Monopoly Power

What factors determine the extent to which a firm has monopoly power?

 The elasticity of the market demand curve

 If the market demand curve is perfectly elastic, any individual supplier has no monopoly power.

 The elasticity of supply by other firms

 The monopoly power of any one firm is more limited when there is a greater number of rival firms.

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Barriers to Entry

 Barrier to entry – any factor that limits the number of firms operating

in a market and thereby serves to promote monopoly power

 Categories:

 Absolute cost advantage

 A situation in which an incumbent firm’s production cost run average total cost) is lower than potential rivals’ production costs at all relevant output levels

(long- Economies of scale

 A situation in which the long-run average total cost curve for all firms slopes downward over the entire range of market output

 Natural monopoly – an industry in which production cost is

minimized if one firm supplies the entire output.

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Barriers to Entry (continued)

Categories (continued):

 Product differentiation

 A means by which consumers may perceive the product sold by

an incumbent firm to be superior to that offered by prospective rivals.

 Regulatory barriers

 Barriers to entry created by the government through vehicles such

as patents, copyrights, franchises, and licenses

 Government purchases from particular firms

 Limits on nonprice competition, e.g., advertising

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Strategic Behavior by Firms: Incumbents and Potential Entrants

Factors affecting market power:

 Elasticity of demand

 Number of other firms in industry

 Elasticity of market demand

 Elasticity of supply of other firms

 Product homogeneity

 Nature of the competition between firms

 Possibility of entry by new firms

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Figure 11.8 - Potential Entry and

Monopoly

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11.5 THE EFFICIENCY EFFECTS OF MONOPOLY

Explore the efficiency effects of monopoly from static and dynamic perspectives.

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The Efficiency Effects of Monopoly

 Comparison between perfectly competitive industry and monopoly:

 Perfectly competitive firm - horizontal MR

 Monopoly – downward-sloping MR

 Marginal cost curve is horizontal for both industry structures

 For the same demand and cost conditions, price will

be higher and output lower under monopoly than

under competition.

 Deadweight loss – measure of inefficiency due to

the monopoly restriction of output

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Figure 11.9 - The Deadweight Loss of

Monopoly

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A Dynamic View of Monopoly and Its

Efficiency Implications

efficiency of a market at any one point in time

 Monopoly: less efficient than a perfectly competitive industry

time, at the efficiency of a market

 Monopoly: enhances social welfare in the creation of better products

 Which approach is more appropriate? It depends:

 Pricing power provides incentive to innovate

 Competition increases total surplus

 Pricing power forestalls benefits of competition

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Figure 11.10 - A Dynamic View of

Monopoly

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11.6 PUBLIC POLICY TOWARD

MONOPOLY

Provide an overview of public policy toward monopoly.

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Public Policy Toward Monopoly

 Antitrust laws – a series of codes and amendments

intended to promote a competitive market

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Regulation of Price

 Price ceiling:

 government-imposed maximum limit on price

=> restriction on output cannot result n higher price

 eliminates the monopolist’s reason for restraining output

 reduces monopoly profit

 benefits consumers by lowering price

 increases output to the efficient level, eliminating the deadweight loss from monopoly

 Limitations:

 outcome depend upon where price ceiling is set

 Price should be high enough for profit>=0

 Monopoly firm may decrease quality as a result

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Figure 11.11 - Regulation of Price

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11.7 THE MATH BEHIND MONOPOLY*

Explain the mathematics behind monopoly.

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*Denotes digital-only content

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The Monopolist’s Demand and

Marginal Revenue Curves

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The Monopolist’s Profit-Maximizing

Output Choice

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