Chapter 13: Monopoly

A market with a single firm that produces a good or service for which no close substitutes exists and that is protected by a barrier of entry to other firms


i.e other firms can't sell that good or service

A monopoly arises when:
•there are no close substitutes
•there is barrier to entry for other firms

Monopolies are constantly under attack from new products and ideas that substitute for products produced by monopolies.


e.g When email was introduced, it weakened the SA Post Office monopoly


-a new monopoly can be created from a new product

Barriers to entry

Natural barriers to entry:
•create a natural monopoly - market in which economies of scale enable one firm to supply the entire market at the lowest possible cost compared to other firms in the same market. e.g firms that deliver water and electricity are natural monopolies

Ownership barrier to entry:
•occurs if one firm owns a significant portion of a key resource


e.g De Beers controlling 90% of suppply of diamonds in 1800s

Legal barrier to entry
•create a legal monopoly - market in which competition and entry are restricted by the granting of a public franchise, government license, patent or copyright

Monopoly price setting strategies

If a firm wants to sell a larger quantity, they have to set a lower price ∴ monopoly needs a price setting strategy

•Firms in a monopoly are not price takers, they are price setters.
•the demand curve for a firm is the market demand curve as there is only one firm
•DEMAND IS ALWAYS ELASTIC IN A MONOPOLY
i.e a monopoly will never produce an output in the inelastic range of mkt. demand curve

Single price monopoly:
•a firm that must sell each unit of its output for the same price to all its customers

Price discrimination:
•when a firm sells different units of a good or service for a different price


-this allows a firm to charge the highest possible price for each unit sold and make the largest profit possible

Single price vs Price discrimination monopoly

Price discimination

Single price monopoly and its output decision

Marginal revenue and elasticity:
•marginal revenue is related to elasticity of demand, ∴ firms will want to sell goods at point where demand is unit elastic (=1) to maximise profit
-see figure 13.3 pg 285
•where MC = MR and P = D

When demand is:
•Inelastic, Qd is high and marginal revenue is 0
•elastic, marginal revenue is positive and Qd is increasing


•unit elastic, marginal revenue is 0 and total revenue is at its maximum

•When MR > MC, profit increases if output increases
•When MC > MR, profit increases if output decreases
•When MC = MR, profit is MAXIMISED

•Price discrimination captures economic surplus and turns it into economic profit
-by getting buyers as close as possible to the max willingness to pay

Firms price discriminate in 2 ways: Among groups of buyers & Among units of a good


Among groups of buyers:
•because different people place different amounts of value on a good, this affects their willingness to pay. ∴ a firm must profit by price discriminating between different groups of buyers

Among units of a good:
•as people consume more units of a good or service, their marginal social benefit decreases.
•for this reason, if all units are sold at a single price, the consumer's surplus is equal to the value they place on that product - the price they paid.
∴by price discriminating through charging a lower price for a 2nd unit of a good, a firm captures some of that surplus

Perfect competition vs. Monopoly

Perfect Competition
•Equilibrium P and Q where S = D
•Efficient: MSB = MSC
•Surplus is maximised
•LRAC is minimised


Monopoly
•Equilibrium P and Q where MR = MC and P = D
•Smaller Q and higher P than perfect competition
•Inefficient: MSB > MSC
•Surplus is redistributed, and also shrinks due to deadweight loss
•LRAC is not minimised

Rent seeking
•Surplus = economic rent
•Pursuit of wealth through capturing economic rent = rent seeking
•Monopoly redistributes consumer surplus to producer surplus (profit)
•So, pursuit of monopoly profit = rent seeking •Monopolists engage in rent seeking in two ways: •Buy a monopoly
•Create a monopoly


Rent-seeking Equilibrium
•No barrier to entry into rent seeking
•Rent seeking is like perfect competition •Competition among rent seekers pushes up ATC •Rent seeker makes zero economic profit •Deadweight loss is larger by amount of lost producer surplus

Perfect price discrimination
•Occurs if a firms is able to sell each unit of output for the highest price anyone is willing to pay for it.
-allows entire consumer surplus to be captured by the producer for profit

How to regulate a natural monopoly:
Marginal cost pricing rule:
Regulate a firm to set its price = marginal cost


Rate of return regulation
a firm must justify its price by showing that its return on capital doesn't exceed a specified target rate
-not commonly used as it gives firms an incentive to inflate costs


Price cap regulation
a regulation that is a price ceiling. Specifies the highest price the firm is permitted to set

  • gives firms an incentive to operate efficiently and keep costs under control

Make marginal revenue = price, ∴ demand curve become marginal revenue curve.
With MR = P a firm can obtain a greater profit by increasing output up to the point at which MR = P = MC
∴economic profit is maximised when the lowest price = MC

If marginal revenue is positive, total revenue is increasing!
if marginal revenue is negative, total revenue is decreasing!