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24
Monopoly
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Pure Monopoly
A monopoly is a single supplier to a market.Single Sellerthe
firm is the industry.
No Substitutesthe product is unique.
Price Makerthe firm can set whatever price(or quantity) only
subject to the market
demand.
Barriers to Entrythere are barriers preventing
potential competitors from entering the market.
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Barriers to Entry
Barriers to entry are the sources of all
monopoly power.
Technical Barriers to Entry
Legal Barriers to Entry
Strategic Barriers to Entry
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Technical Barriers to Entry
Economies of Scale or Scope: Production may exhibitdecreasing
marginal and average costs over a widerange of output levels or
varieties.Natural Monopoly argument: To achieve low costs and
low
prices, it is better to have a few large firms (and in
theextreme case, only one firm).
Ownership or Control of Essential Resources
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Legal Barriers to Entry
Patent: temporarily created to encourage
innovation.
License: created by government to limit entry
into an industry.
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Strategic Barriers to Entry
Predatory Pricing: cutting prices below cost,intending to drive
competitors out of the market,or create barriers to entry for
potential new
competitors. Maintaining Excess Capacity: maintaining a
plant size beyond what it needs to sustain itsordinary level of
production to signal potential
competitors that if they enter, it will expandproduction and
thus reduce product price.
Acquisition: purchasing competitors outright.
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Pure Monopolys Profit Maximization
A monopolist chooses price p (or quantity q) to
What price (or output) level maximizes profit?
max ( ) ( )
or
max [ ( ) ]
p
q
p c D p
p q c q
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Golden Rule: MR=MC
Price Setting:
Quantity Setting:
( ) ( )
( )( )
( )
( )( ) ( )
p D p p D pMR
p
D p D p p
p
D
D p p c D p
p MC c
p
p
+ =
= +
=
=
( )
( ) ( )
( ) (
( )
)
p q q p q qMR
q
p q q p qq
p qq p q c
q
MC c
+ =
= +
=
+
=
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Inverse-Elasticity Rule
Inverse-Elasticity Rule
The firms markup over marginal cost depends
inversely on the elasticity of market demand.
MR=MC and the Inverse-Elasticity Rule are
equivalent.
1
where .
p c
p
Q PP Q
=
=
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Result: A monopolist would NEVER produce
in the inelastic part of the demand ( ).0 1 1,
so the monopolist MAY pass on toconsumers more than the tax!
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Summary
The most profitable level of output for the monopolistis the one
for which MR=MC Inverse-Elasticity Rule
at this output level, p>MC
the profitability of the monopolist will depend on
therelationship between price and average cost
Relative to perfect competition, monopoly involves aloss of
consumer surplus for demanders some of this is transferred into
monopoly profits
some of the loss in consumer surplus represents adeadweight loss
of overall economic welfare a sign of Pareto inefficiency
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Bonus Q: Monopoly Pricing and Tax
A monopolist faces the demand function asq=2000100p, with $1000
fixed cost and marginal costof $4.
1. Write down the monopolists total revenue functionand total
cost function.
2. Find out its profit-maximizing quantity and profit.
3. What would be the smallest fixed cost for the
monopolist to stop producing?4. Suppose government impose a
quantity tax $2 on the
monopolist. What is the new monopoly price?
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Reading Assignment
Please read Ch 25: Monopoly Behavior before
next lecture.
We will focus on Price Discrimination.
