Pure Monopoly. McGraw-Hill/Irwin. Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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10 Pure Monopoly McGraw-Hill/Irwin Copyright 2012 by

2 Four Market Models Characteristics of the Four Basic Market Models Characteristic Number of firms Pure Competition A very large number Monopolistic Competition Oligopoly Monopoly Many Few One Type of product Standardized Differentiated Standardized or differentiated Control over price None Some, but within rather narrow limits Limited by mutual inter-dependence; considerable with collusion Unique; no close subs. Considerable Conditions of entry Nonprice competition LO1 Very easy, no obstacles None Relatively easy Considerable emphasis on advertising, brand names, trademarks Examples Agriculture Retail trade, dresses, shoes Significant obstacles Typically a great deal, particularly with product differentiation Steel, auto, farm implements Blocked Mostly public relation advertising Local utilities 10-2

3 LO An Introduction to Pure Monopoly Single seller a sole producer No close substitutes unique product Price maker control over price Blocked entry strong barriers to entry block potential competition Non-price competition mostly PR or advertising the product Public utility companies Natural Gas Electric Water Near monopolies Intel Wham-O Professional sports teams

4 LO Barriers to Entry Barrier to entry: a factor that keeps firms from entering an industry Economies of scale Legal barriers: patents and licenses Ownership of essential resources Pricing

5 LO Monopoly Demand The pure monopolist is the industry Demand curve is the market demand curve Downsloping demand curve Marginal revenue is less than price

6 LO Monopoly Demand Marginal revenue < price Monopolist is a price maker Monopolist sets prices in elastic region of demand curve

7 LO Output and Price Determination Steps for Graphically Determining the Profit-Maximizing Output, Profit- Maximizing Price, and Economic Profits (if Any) in Pure Monopoly Step 1 Step 2 Step 3 Determine the profit-maximizing output by finding where MR=MC. Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist s demand curve. Determine the pure monopolist s economic profit by using one of two methods: Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any). Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any).

8 LO2 Price, Costs, and Revenue 10-8 Output and Price Determination $ P m =$ MC Economic Profit ATC A=$94 MR=MC D 25 0 MR Quantity

9 LO Misconceptions of Monopoly Pricing Not highest price Total profit Possibility of losses

10 LO2 Price, Costs, and Revenue Misconceptions of Monopoly Pricing MC A P m V Loss ATC AVC D MR=MC MR 0 Q m Quantity

11 LO Economic Effects of Monopoly Pure competition is efficient Monopoly is inefficient P c S=MC P=MC= Minimum ATC P m P c d b a c MC D MR D Q c Q m Q c (a) Purely Competitive Market (b) Pure Monopoly

12 LO Economic Effects of Monopoly Income transfer Cost complications Economies of scale X-Inefficiency Rent seeking expenditures Technological advance

13 LO3 Average total costs X-Inefficiency ATC x ATC 1 X ATC x' ATC 2 X' Average Total Cost 0 Q 1 Q 2 Quantity

14 LO Price discrimination Price Discrimination Charging different buyers different prices Price Discrimination Price differences are not based on cost differences Examples: business travel, electric utilities, movie theaters, golf courses, railroad companies, coupons, international trade

15 LO Price Discrimination Conditions for success: Monopoly power Market segregation No resale

16 LO Regulated Monopoly Natural monopolies Socially optimal price Set price = marginal cost Fair return price Set price = ATC

17 LO5 Price and Costs (Dollars) Regulated Monopoly Monopoly Price P m Fair-Return Price P f a f Socially Optimal Price ATC P r 0 MR r b Q m Q f Q r Quantity MC D

Pure Competition in the Short Run

08 Pure Competition in the Short Run McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved. LO1 8-2 Four Market Models Pure competition Pure monopoly Monopolistic competition