Roger LeRoy Miller Economics Today Twelfth Edition Chapter 24 Monopoly Introduction The cement market in Mexico is dominated by a single company that accounts for more than 70 percent of all sales. Why does this result in cement prices in Mexico being twice as high as in the United States? Copyright 2004 Pearson Addison Wesley. All rights reserved. Slide 24-2 Learning Objectives Learning Objectives Identify situations that can give rise to monopoly escribe the demand and marginal revenue conditions a monopolist faces iscuss how a monopolist determines how much output to produce and what price to charge Evaluate the profits earned by a monopolist Understand price discrimination Explain the social cost of monopolies Slide 24-3 Slide 24-4 1
Chapter Outline Chapter Outline efinition of a Monopolist The emand Curve a Monopolist Faces Elasticity and Monopoly Cost and Monopoly Profit Maximization Calculating Monopoly Profit On Making Higher Profits: Price iscrimination The Social Cost of Monopolies Slide 24-5 Slide 24-6 id You Know That... efinition of a Monopolist OPEC accounts for less than half of world oil production? Oil producing nations could boost their revenues if they banded together to set a monopoly-level price? Monopolist A single supplier that comprises its entire industry for a good or service for which there is no close substitute Slide 24-7 Slide 24-8 2
efinition of a Monopolist Monopolist May be large or small What do you think? Is Microsoft a monopolist? How to become a monopoly Create a barrier to entry and make longrun economic profits by preventing resources from entering your market Slide 24-9 Slide 24-10 Ownership of resources without close substitutes If you owned all the oil reserves, who could enter the refining business? The Aluminum Company of America (ALCOA) at one time owned 90 percent of the world s bauxite. Problems in raising adequate capital Choose a product that requires a substantial capital investment Why not enter the microprocessor market and compete with Intel? Slide 24-11 Slide 24-12 3
Economies of scale Low unit costs and prices drive out rivals Natural Monopoly A monopoly that arises from the peculiar production characteristics in an industry It usually arises when there are large economies of scale Slide 24-13 Slide 24-14 The Cost Curves that Might Lead to a Natural Monopoly: The Case of Electricity Figure 24-1 Price per Kilowatt Kilowatts of Electricity per Time Period LAC LMC Slide 24-15 Legal or governmental restrictions Licenses, franchises, and certificates of convenience Is the postal service still a monopoly? Consider UPS FedEx Fax machines The Internet Slide 24-16 4
Example: Pharmaceutical Patents as a Barrier to Entry Recent federal legislation has strengthened patents in the pharmaceutical industry. Sales of generic drugs have decreased as name-brand medicines have received this added protection. Strong patent protection contributes to consistently high profits in pharmaceuticals. Legal or governmental restrictions Patents Intellectual property Tariffs Taxes on imported goods Regulation Slide 24-17 Slide 24-18 The emand Curve a Monopolist Faces Cartels An association of producers in an industry that agree to set common prices and output quotas to prevent competition Monopolist s demand = market demand Monopolist is the industry Slide 24-19 Slide 24-20 5
The emand Curve a Monopolist Faces emand Curves for the Perfect Competitor and the Monopolist Recall Panel (a) Panel (b) In perfectly competitive markets: All firms combined create the industry supply Industry supply relative to market demand () determines equilibrium price and quantity The industry faces the market demand Price per Unit d Price per Unit d = Slide 24-21 q emand If Individual Supplier Is in Perfect Competition Figure 24-2, Panels (a) and (b) Q emand If Individual Supplier Is the Only Supplier in a Pure Monopoly Slide 24-22 The emand Curve a Monopolist Faces Marginal Revenue: Always Less Than Price Monopoly Perfect Competition MR = area A area B Single Seller One of many sellers Faces market demand Must lower price to sell more Perfectly elastic demand (price takers) Must only produce more to sell more Price of Electricity P 1 P 2 Area B ( ) Loss emand curve = AR curve Area A (+) Gain MR < P All units sold for same price (P = MR) Slide 24-23 Figure 24-3 Q Q + 1 Quantity of Electricity per Time Period Slide 24-24 6
Elasticity and Monopoly Elasticity and Monopoly A monopoly is a single seller of a welldefined good or service with no close substitutes. The more imperfect substitutes there are, and the better these substitutes are, the greater the price elasticity of demand of the monopolist s demand curve Question Hint If a monopoly raises price, what will happen to quantity demanded? Remember how consumers respond to a change in price. Slide 24-25 Slide 24-26 Cost and Monopoly Profit Maximization Monopoly Costs, Revenues, and Profits Price Searcher A firm that must determine the priceoutput combination that maximizes profit because it faces a downward-sloping demand curve Slide 24-27 Figure 24-4, Panel (a) Slide 24-28 7
Monopoly Costs, Revenues, and Profits Cost and Monopoly Profit Maximization Total Costs and Total Revenue ($) 100 90 80 70 60 50 40 30 20 10 Losses Panel (b) TC Losses TR Maximum profit Price, Marginal Costs, and Marginal Revenue per Unit ($) 10 9 8 7 6 5 4 3 2 1 Panel (c) MC MC = MR MR Profitmaximizing rate of output Why produce where marginal revenue equals marginal cost? Producing past where MR = MC Incremental cost > Incremental revenue Producing less than where MR = MC Incremental revenue > Incremental cost 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Output per Time Period 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Output per Time Period Figure 24-4, Panels (b) and (c) Slide 24-29 Slide 24-30 Maximizing Profits Calculating Monopoly Profit 18 Figure 24-5 Price, Marginal Cost, and Marginal Revenue per Unit P m A B C F Q 1 Q m Q 2 MR Quantity per Time Period MC Slide 24-31 Figure 24-6 Price, Marginal Revenue, and Cost per unit ($) 17 16 15 14 13 12 11 10 9 8 P m 7 6 5 4 3 2 1 0 ATC Monopoly profit 1 2 3 4 5 6 7 8 9 10 Q m Output per Time Period 11 MC 12 MR 13 Slide 24-32 8
Monopolies: Not Always Profitable On Making Higher Profits: Price iscrimination MC Price iscrimination Price, Marginal Revenue, and Cost per unit C 1 P m A Losses ATC Selling a given product at more than one price, with the difference being unrelated to differences in cost Q m MR Figure 24-7 Output per Time Period Slide 24-33 Slide 24-34 On Making Higher Profits: Price iscrimination On Making Higher Profits: Price iscrimination Price ifferentiation Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers Necessary conditions for price discrimination The firm must face a downward-sloping demand curve The firm must be able to separate markets at a reasonable cost Slide 24-35 Slide 24-36 9
On Making Higher Profits: Price iscrimination Necessary conditions for price discrimination The buyers in the various markets must have different price elasticities of demand The firm must be able to prevent resale of the product or service On Making Higher Profits: Price iscrimination Example Cheaper airfares for some, really expensive fares for others Why can the airlines charge a business traveler more than a vacation traveler for the same seat? How can an airline distinguish between a business traveler and a vacation traveler? Slide 24-37 Slide 24-38 On Making Higher Profits: Price iscrimination The Social Cost of Monopolies Scenario Price per Round Trip P 7 P 6 P 5 P 4 P 3 P 2 P 1 Start with a perfectly competitive market in long-run equilibrium P e : Q d = Q s MR = MC P e = MC Zero economic profits Q 1 Q 2 Q 3 Q 4 Q 5 Q 6 Q 7 Quantity of Round-Trip Tickets Figure 24-8 Slide 24-39 Slide 24-40 10
The Social Cost of Monopolies The Effects of Monopolizing an Industry Scenario Panel (a) S = ΣMC Panel (b) S = MC Now, assume the industry is acquired by one firm with no impact on cost. Price per Unit P e E Price, Marginal Revenue, and Marginal Cost per Unit P m MC m Q e Q m MR Quantity per Time Period Quantity per Time Period Slide 24-41 Figure 24-9, Panels (a) and (c) Slide 24-42 Issues and Applications: Overcoming Barriers to Entry in the Mexican Cement Market Web Links The Mexican company Cemex sells cement throughout the world, but charges its highest prices in Mexico, where it has few competitors. What barriers to entry protect Cemex s position? Fixed costs in establishing production facilities. Tax advantages granted by Mexican government. Government prohibitions on competition from foreign firms. The following Web links appear in the margin of this chapter in the textbook: http://www.uspto.gov http://www.loc.gov/copyright http://www.wtrg.com/opecshare.html Slide 24-43 Slide 24-44 11
Summary iscussion of Learning Objectives Why a monopoly can occur Barriers to entry emand and marginal revenue conditions faced by a monopolist The monopolist s demand curve is the industry demand curve Marginal revenue is less than price Summary iscussion of Learning Objectives How a monopolist determines how much output to produce and what price to charge Produce where marginal cost equals marginal revenue Set price for that output on the demand curve Slide 24-45 Slide 24-46 Summary iscussion of Learning Objectives A monopolist s profits Price minus average total cost times output equals profits (losses) Summary iscussion of Learning Objectives Price discrimination Selling at more than one price with the price differences being unrelated to differences in production costs Buyers with the more elastic demand pay a lower price Slide 24-47 Slide 24-48 12
Summary iscussion of Learning Objectives Social cost of monopolies Price exceeds marginal cost End of Chapter The price is higher and output is lower for a monopolist as compared to a perfectly competitive industry Chapter 24 Monopoly Slide 24-49 Copyright 2004 Pearson Addison Wesley. All rights reserved. 13