Lecture Economics (9/e): Chapter 14 - David C. Colander

Chapter 14 - Monopoly and monopolistic competition. After reading this chapter, you should be able to: Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms; determine a monopolist''s price, output, and profit graphically and numerically; show graphically the welfare loss from monopoly; explain why there would be no monopoly without barriers to entry.

Monopoly and Monopolistic Competition

Monopoly is business at the end 

of     its journey.

— Henry Demarest Lloyd

Ø Summarize how and why the decisions facing a

monopolist differ from the collective decisions of

competing firms

Ø Show graphically the welfare loss from monopoly

Ø Determine a monopolist’s price, output, and profit

graphically and numerically

Ø Explain why there would be no monopoly without

barriers to entry

Ø Explain how monopolistic competition differs from

monopoly and perfect competition

A Monopolistic Market

Ø Barriers to entry into the market prevent competition

Ø Monopoly is a market structure in which one firm makes up the entire market

Ø There are no close substitutes for the monopolist’s product

Ø Barriers to entry can be:

• Legal

• Sociological

• Natural

• Technological

The Key Difference Between

a Monopolist and a Perfect Competitor

Ø A monopolistic firm’s marginal revenue is not its price

• Marginal revenue is always below its price

• Marginal revenue changes as output changes and is not equal to the price

Ø A monopolistic firm’s output decision can affect price

Ø There is no competition in monopolistic markets so

monopolists see to it that monopolists, not consumers,

benefit

Determining the Monopolist’s Price and Output Numerically

Ø Marginal revenue (MR) is the change in total revenue

associated with a change in quantity

Ø The monopoly maximizes profit when marginal revenue

equals marginal cost

Ø The goal of the monopolistic firm is to maximize profits,

the difference between total revenue and total cost

Ø Marginal cost (MC) is the change in total cost associated with a change in quantity

Determining the Monopolist’s Price and Output Numerically

If MR < MC,

• The monopoly can increase profit by decreasing its output

If MR > MC,

• The monopoly can increase profit by increasing output

Ø The profit-maximizing condition of a monopolistic firm is:

Ø For a monopolistic firm, MR < P

Ø A monopolistic firm maximizes total profit, not profit per unit

Monopolistic Profit Maximization

Table

Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($)

0 36 0

33 27 21 15 9 3 -3 -9 -15

47

1 2 4 8 16 54 40 56 80

- -47

If MC < MR, increase production

Profit maximizing quantity is where

MC = MR

If MC > MR, decrease production

maximizing condition is:

MR = MR

Welfare Loss from a Monopoly:

The Normal Monopolist

MC

Q

P

D

QM

P

M

• The welfare loss from a monopoly is represented by the triangles B and D

• The rectangle C is a transfer

of surplus from the consumer

to the monopolist

• The area A represents the opportunity cost of diverted resources, which is not a loss

to society

MR

PPC

QPC

A

B D C

The Price-Discriminating Monopolist

Ø When a monopolist price discriminates, it charges

different prices to different individuals or groups of

individuals

• Consumers with less elastic demands are charged higher prices

• Consumers with more elastic demands are charged lower prices

Ø Price discrimination increases output and profits

Ø Examples of price discrimination

• Movie discounts to senior citizens and children

• Airline charge more to fly on Fridays and Sundays

• Tracking consumer information and pricing accordingly

Ø It might seem unfair for a monopolist to charge

different people different prices, but doing so

eliminates welfare loss from monopoly

Ø For a price-discriminating monopolist, because it can

charge what consumers are willing to pay, all

Barriers to Entry

Ø If there were no barriers to entry, profit-maximizing firms

would always compete away monopoly profits

Ø Government-Created Monopolies

• Patents

Ø Natural Ability

• A firm is better at producing the good than anyone else

Ø Natural Monopolies

• Natural monopoly is when a single firm can produce at a lower cost than can two or more firms

Characteristics of Monopolistic Competition

Four distinguishing characteristics:

3. Multiple dimensions of competition make it harder to

analyze a specific industry, but these methods of

competition follow the same two decision rules as

price competition

2. Product differentiation where the goods that are sold

aren’t homogenous

1. Many sellers that do not take into account rivals’

reactions

Monopolistic Competitor

Ø Like a monopoly,

• At profit maximizing output, marginal cost will

be less than price

• Marginal revenue is below price

Ø Like a perfect competitor, zero economic profits exist in

the long run

• The monopolistic competitive firm has some

monopoly power so the firm faces a downward sloping demand curve

Comparing Monopolistic Competition with

Monopoly

Ø For a monopolistic competitor in long-run equilibrium,

(P = ATC) ≥ (MC = MR)

Ø No long-run economic profit is possible in

monopolistic competition because there are no

significant barriers to entry

Ø It is possible for the monopolist to make economic

profit in the long run because of the existence of

barriers to entry

Advertising and Monopolistic Competition

Ø Advertising increases ATC

Ø The goals of advertising are to increase demand and

make demand more inelastic

Ø Perfectly competitive firms have no incentive to

advertise, but monopolistic competitors do

Ø The increase in cost of a monopolistically competitive

product is the cost of “differentness”

Ø A monopolist maximizes profit or minimizes losses where

MR=MC

Ø To determine a monopolist’s profit or loss: Find output

where MR=MC; Determine price and ATC at that output;

Profit or loss = (P – ATC) * Q

Ø Because monopolies reduce output and charge P > MC,

monopolies create a welfare loss for society

Ø Monopoly output is lower and price is higher than in

competitive markets

Ø Natural monopolies exist in industries with strong

Ø A price-discriminating monopolist earns more profit than

a normal monopolist by charging a higher price to those

with less elastic demand and a lower price to those with

more elastic demand

Ø A monopolistic competitor differs from a monopolist in

that a monopolistic competitor makes zero economic

Ø Monopolistic competition is characterized by many

sellers, differentiated products, multiple dimensions of

competition, and ease of entry for new firms

Ø Three important barriers to entry are natural ability,

economies of scale, and government restrictions