1. Monopoly

2. Monopoly, Price Discrimination and Efficiency imperfectly competitive industry An industry in which individual firms have some control over the price of their output. market power An imperfectly competitive firm’s ability to raise price without losing all of the quantity demanded for its product.

3. Monopoly, Price Discrimination and Efficiency Forms of Imperfect Competition and Market Boundaries 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.

4. Monopoly, Price Discrimination and Efficiency Forms of Imperfect Competition and Market Boundaries The Boundary of a Market and Elasticity: We can define an industry as broadly or as narrowly as we like. The more broadly we define the industry, the fewer substitutes there are; thus, the less elastic the demand for that industry’s product is likely to be. A monopoly is an industry with one firm that produces a product for which there are no close substitutes. The producer of brand X hamburger cannot properly be called a monopolist because this producer has no control over market price and there are many substitutes for brand X hamburger.

5. Price and Output Decisions in Pure Monopoly Markets Demand in Monopoly Markets The Demand Curve Facing a Perfectly Competitive Firm Is Perfectly Elastic Perfectly competitive firms are price-takers; they are small relative to the size of the market and thus cannot influence market price. The implication is that the demand curve facing a perfectly competitive firm is perfectly elastic. If the firm raises its price, it sells nothing and there is no reason for the firm to lower its price if it can sell all it wants at P* = £5. £

6. Price and Output Decisions in Pure Monopoly Markets Demand in Monopoly Markets Marginal Revenue Curve Facing a Monopolist At every level of output except 1 unit, a monopolist’s marginal revenue (MR) is below price. This is so because (1) we assume that the monopolist must sell all its product at a single price (no price discrimination) and (2) to raise output and sell it, the firm must lower the price it charges. Selling the additional output will raise revenue, but this increase is offset somewhat by the lower price charged for all units sold. Therefore, the increase in revenue from increasing output by 1 (the marginal revenue) is less than the price. Marginal Revenue Facing a Monopolist (1) Quantity (2) Price (3) Total Revenue (4) Marginal Revenue 0 11 0 – 1 10 10 10 2 9 18 8 3 8 24 6 4 7 28 4 5 6 30 2 6 5 30 0 7 4 28 -2 8 3 24 -4 9 2 18 -6 10 1 10 -8 £

7. Price and Output Decisions in Pure Monopoly Markets Demand in Monopoly Markets Marginal Revenue and Total Revenue A monopoly’s marginal revenue curve bisects the quantity axis between the origin and the point where the demand curve hits the quantity axis. A monopoly’s MR curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it. £

8. Price and Output Decisions in Pure Monopoly Markets The Monopolist’s Profit-Maximizing Price and Output Price and Output Choice for a Profit-Maximizing Monopolist A profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost. Maximum profit is at an output of 4,000 units per period and a price of £4. Above 4,000 units of output, marginal cost is greater than marginal revenue; increasing output beyond 4,000 units would reduce profit. At 4,000 units, TR = PmAQm0, TC = CBQm0, and profit = PmABC. Pounds(£) =£4 =£3 =£1.5

9. Price and Output Decisions in Pure Monopoly Markets The Absence of a Supply Curve in Monopoly A monopoly firm has no supply curve that is independent of the demand curve for its product. A monopolist sets both price and quantity, and the amount of output that it supplies depends on both its marginal cost curve and the demand curve that it faces.

10. Price and Output Decisions in Pure Monopoly Markets Perfect Competition And Monopoly Compared A Perfectly Competitive Industry in Long-Run Equilibrium In a perfectly competitive industry in the long run, price will be equal to long-run average cost. The market supply curve is the sum of all the short-run marginal cost curves of the firms in the industry. Here we assume that firms are using a technology that exhibits constant returns to scale: LRAC is flat. Big firms enjoy no cost advantage.£ £

11. Price and Output Decisions in Pure Monopoly Markets Perfect Competition And Monopoly Compared Comparison of Monopoly and Perfectly Competitive Outcomes for a Firm with Constant Returns to Scale In the newly monopoly, the marginal cost curve is the same as the supply curve that represented the behaviour of all the independent firms when the industry was organized competitively. Quantity produced by the monopoly will be less than the perfectly competitive level of output, and the monopoly price will be higher than the price under perfect competition. Under monopoly, P = Pm = £4 and Q = Qm = 2,500. Under perfect competition, P = Pc = £3 and Q = Qc = 4,000. Pounds(£) =£4 =£3 =£2

12. Price and Output Decisions in Pure Monopoly Markets Monopoly in the Long Run: Barriers to Entry barriers to entry Factors that prevent new firms from entering and competing in imperfectly competitive industries. natural monopoly An industry that such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

13. Price and Output Decisions in Pure Monopoly Markets Monopoly in the Long Run: Barriers to Entry Economies of Scale A Natural Monopoly A natural monopoly is a firm in which the most efficient scale is very large. Here, average total cost declines until a single firm is producing nearly the entire amount demanded in the market. With one firm producing 500,000 units, average total cost is £1 per unit. With five firms each producing 100,000 units, average total cost is £5 per unit. Pounds(£)

14. Price and Output Decisions in Pure Monopoly Markets Monopoly in the Long Run: Barriers to Entry Patents patent A barrier to entry that grants exclusive use of the patented product or process to the inventor. Government Rules Ownership of a Scarce Factor of Production

15. The Social Costs of Monopoly Inefficiency And Consumer Loss Welfare Loss from Monopoly A demand curve shows the amounts that people are willing to pay at each potential level of output. Thus, the demand curve can be used to approximate the benefits to the consumer of raising output above 2,000 units. MC reflects the marginal cost of the resources needed. The triangle ABC roughly measures the net social gain of moving from 2,000 units to 4,000 units (or the loss that results when monopoly decreases output from 4,000 units to 2,000 units). Pounds(£) =£4 =£2 =£6

16. Price Discrimination price discrimination Charging different prices to different buyers perfect price discrimination Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.

17. Price Discrimination Price Discrimination Consumer A is willing to pay £5.75. If the price- discriminating firm can charge £5.75 to A, profit is £3.75. A monopolist who cannot price discriminate would maximise profit by charging £4. At a price of £4.00, the firm makes £2.00 in profit and consumer A enjoys a consumer surplus of £1.75. For a perfectly price-discriminating monopolist, the demand curve is the same as marginal revenue. The firm will produce as long as MR > MC, up to Qc. At Qc, profit is the entire shaded area and consumer surplus is zero. Pounds(£) Pounds(£) £6 £5.75 £5.50 £4.00 £2.00 £6.00 =£6 £4 per unit.

18. Imperfect Markets: A Review and a Look Ahead A firm has market power when it exercises some control over the price of its output or the prices of the inputs that it uses. The extreme case of a firm with market power is the pure monopolist. In a pure monopoly, a single firm produces a product for which there are no close substitutes in an industry in which all new competitors are barred from entry. Our focus hereon pure monopoly (which occurs rarely) has served a number of purposes. First, the monopoly model describes a number of industries quite well. Second, the monopoly case illustrates the observation that imperfect competition leads to an inefficient allocation of resources. Finally, the analysis of pure monopoly offers insights into the more commonly encountered market models of monopolistic competition and oligopoly.

19. Key Terms • barrier to entry • imperfectly competitive industry • market power • natural monopoly • network externalities • patent • perfect price discrimination • price discrimination • pure monopoly