MBA 505 ECONOMICS AND PUBLIC POLICY
Chapter 9 IMPERFECT COMPETITION
AND MONOPOLY
|
FUNDAMENTAL QUESTIONS
2. How is a monopoly created?
3. What does the demand
curve for a monopoly firm look like, and why?
4. Why would someone want
to have a monopoly in some business or activity?
5. Under what conditions
will a monopolist charge different customers different prices for the same
product?
6. How do the predictions
of the models of perfect competition and monopoly differ?
|
Key Terms
| monopoly |
local monopoly |
predatory dumping |
rent seeking |
| monopoly firm (monopolist) |
regulated monopoly |
deadweight loss |
fair rate of return |
| barrier to entry |
monopoly power |
potential competition |
|
| natural monopoly |
dumping |
X-inefficiency |
|
|
1. The Market Structure of Monopoly
1.a.
Market definition: A monopoly is the only supplier of a product
and sells a product for which there are no close substitutes. The
U.S. Postal Service and public utilities as examples of monopolies in the
United States.
1.b.
The creation of monopolies
1.b.1.
Economies of scale: A
large public utility generating electricity is an example of a monopoly
resulting from economies of scale.
1.b.2.
Actions by firms: BurroughsWellcome's patenting the drug AZT provided
it with a monopoly.
1.b.3.
Government: New York City's issuing a limited number of taxi medallions
creates a monopoly.
1.c.
Types of monopolies: A natural monopoly grows out of economies
of scale and demand conditions; its LRATC curve slopes continually downward.
A local monopoly is the only producer in a geographic area. A regulated
monopoly is a firm whose price and production are controlled by government.
Monopoly power is reflected in the firm's ability to set prices.
Public
utilities are natural monopolies with much power to set prices if not regulated.
In a town with one gas station, the gas station is a local monopoly with
large monopoly power. The local telephone company is a natural, regulated,
and local monopoly.
|
|
2. The Demand
Curve Facing a Monopoly Firm
Because
the monopolist is the sole producer of a product, its demand curve is the
industry demand curve.
2.a.
Marginal revenue:
Marginal revenue equals the changes in total
revenue caused by producing one more unit of output.
Price exceeds
MR
because the monopolist must lower the price to increase sales. This is
important: a monopolists MR is downward-sloping below its demand curve.
2.a.1.
Marginal and average revenue: AR = TR/Q = price. The AR
curve is the demand curve. If AR falls, then MR is less than
AR.
Thus, in monopoly, P exceeds MR. Elasticity and total revenue:
If price elasticity exceeds 1, as price is lowered, TR increases.
If price elasticity is less than 1, as price is lowered, TR falls.
Monopoly
firms always operate in the elastic region of the demand
curve.
|
|
3. Profit
Maximization
MR
= MC
3.a.
What price to charge?
Drawing a vertical line
from where MR = MC up to the demand curve gives the profit maximization
product price.
3.b. Monopoly profit
and loss
The vertical distance from
ATC to the demand curve shows profit per unit. This distance multiplied
by Q generates total profit (area of the rectangle). So P
must exceed
ATC for profits to exist; thus a monopolist could experience
losses in the short run if ATC exceeded P. The monopolist
would make economic profit even in the long run because of barriers to
entry.
3.c. Monopoly myths:
A monopoly is not all powerful. The monopolist cannot charge any
price it wants. The monopolist must earn at least normal profits to remain
in business in the long run.
|
|
4. Price Discrimination
Price discrimination occurs
when different customers are charged different prices for the same product
but the difference is not due to cost differentials. The firm tries to
extract more consumer surplus.
4.a. Necessary conditions
for price discrimination: The firm cannot be a price taker; the
firm must be able to separate customers according to price elasticity;
the buyer must have different elasticities of demand; and the firm must
be able to prevent resale of the products/services from one customer to
another.
4.b. Examples of price
discrimination:
Students are charged different tuition rates at
public universities depending on whether they live in or out of state.
Airlines charge less for weekend flights than for weekday flights.
4.c. The theory of
price discrimination:
The firm will charge a price in each market
so as to equalize the
MR earned in each market.
4.d. Dumping:
When an identical good is sold to foreign buyers for a lower price than
the price charged to domestic buyers, it is called dumping. Predatory dumping
is intended to drive rival firms out of business.
|
|
5. Comparison
of Perfect Competition and Monopoly
5.a. Costs of monopoly:
Inefficiency: The monopolist charges a higher price and produces
a smaller quantity than the perfectly competitive firm would.
Deadweight loss occurs:
The consumer enjoys less consumer surplus under monopoly than under perfect
competition. The monopoly firm enjoys a larger producer surplus than the
competitive firm would.
5.b.
The deadweight loss may be overstated.
5.b.1.
Potential competition:
This causes the monopolist to lower prices,
thereby lessening deadweight loss.
5.b.2.
Government intervention: Government scrutiny lessens deadweight
loss.
5.b.3.
Economies of scale: Large firms can produce at a lower cost, thereby
diminishing deadweight loss.
5.c.
The deadweight losses may be understated.
5.c.1.
Higher costs and X-inefficiency: The absence of entry and rivalry
allows the firm to operate inefficiently, causing consumer surplus to fall.
5.c.2.
Rent seeking: This comprises activities taken to transfer wealth
from one group to another.
Monopolies
can use their above-normal profits for rent seeking. Monopoly oil companies
spend some of their profits lobbying for higher import taxes on foreign
oil.
5.c.3.
Innovation: Monopolies may not have the market incentive to initiate
new products or production techniques because there is no potential rivalry.
5.d.
Supply and the monopoly firm: Only a supply point, not a supply
curve, exists for the monopoly firm.
5.e.
Regulation: Regulatory commissions have allowed public utilities
to charge a fair-rate-of-return price.
|
|
Opportunities
for Discussion
1.
What types of price discrimination have you experienced (for example, out-of-state
vs. instate tuition differences, lower ticket prices at movie theaters
during the week, coupons used at a supermarket)?
2. Write a short essay comparing
and contrasting the results of monopoly and perfect competition. Discuss
your essay in class.
3. List examples of the
different types of monopolies discussed in section 1.c. from which you
have bought products or services.
|
