Monopoly

Barriers to Entry

• A contraint that protects a firm from potential competitors

Natural

• A market in which economies of scale enable one firm to supply the entire market at the lowest possible cost

Ownership

• If one firm owns a significant portion of a key resource

Legal

• Competition are restricted by granting of a public franchise, government license, or patent/copyright

Price Setting Strategies

• A monopoly is a price setter since the demand for the monoply's output is the market demand

Single-price monopoly

• A firm that must sell each unit of its output for the same priec to all its customers
• Marginal revenue - the change in total revenue that results from a one-unit increase in the quantity sold
• For a single price monopoly, marginal revenue is less than price at each level of output $MR<P$

Compared to Competition

• Single-price monopoly $Q <$ competitive $Q$
• Single-price monopoly $P >$ competitive $P$

Marginal Revenue Curve

• Marginal revenue is related to the elasticity of demand of it's good
  • If elastic, the fall in price brings an increase in total revenue
  • If ineasltic, a fall in price brings a decrease in total revnue

• Never produces an output at which demand is inelastic
  • Since a firm can increase economic profit by decreasing output if it producing such an output

ATC Curve

• Tells us the average total cost
• Economic profit is the profit per unit multiplied by the quantity produced (blue triangle)

Maximizing Profit

• Selects the profit-maximizing quantity in the same manner as a competitive firm $MR=MC$

  • Also referred to as $Q_M$

• Equilibrium price $P_M$ occurs on the demand curve at the profit maximizing quatity

Total Surplus

• The sum of consumer surplus and producer surplus is maximized

Inefficiency of monopoly

• Price exceeds marginal social cost, marginal social benefit exceeds marginal social cost
• Deadweight loss arises

Rent Seeking

• Any surplus (consumer, producer, economic profit) is called economic rent
• Rent seeking - is the pursuit of wealth by capturing economic rent
  • Buy a monopoly
  • Create a monoply
• Rent-seeking equilibrium - the resources used in rent seeking can exhaust the monopoly's economic profit and the monopoly breaks even

Other facts

• Faces the same types of technology constraints as competitive firm

• Might make an economic profit in the long run since the barrier protects the firm from market entry by competitor forms

• Might shutdown temporarily in the short run or exit the market in the long run if it incurs an econimic loss

Price discrimination

• The practice of selling different units of a good or service for different prices
  • Does not have to be monopoly firms

• Can descriminate among

  • Among a group of buyers (airline tickets)
  • Among units of a good (quantity discounts)

• Product cannot be resold

• Increase the firm's profit by converting consumer surplus into economic profit

• Perfect price descrimination - if a firm is able to sell each unit of output for the highest price anyone is willing to pay
  • Marginal revenue equals the price; demand curve is the marginal revenue curve
  • The profit maximizing output increases to the quantity at which price equals marginal cost
  • Economic profit increases above that of a single-price monopoly
  • Deadweight loss is eliminated

Efficiency and Rent Seeking

• The more perfectly a monopoly can price discriminate, the closer its output is to the competitve output ($P=MC$) and the more efficient is the outcome
• Different from the outcome of perfect competition
  • The monopoly captures the entire consumer surplus
  • The increase in economic profit attracts even more rent-seekinga ctivity that leads to inefficiency

Monopoly Regulation

Regulation - rules administrated by a government agency to influence prices, quantities, entry, and other aspects of economic activity

Social interest theory - the political and regulartory process relentlessly seeks out inefficiency and regulates to eliminate deadweight loss

Public Choice theory - people in government (elected or employed) respond to incentives, they attempt to advance their own self interest

Capture theory - predicts regulations serve self-interest of producers, who "capture" the regulator

Efficient Regulation of a Natural Monopoly

• Regulate natural monopoly so that it produces the efficient quantity
• Marginal cost pricing rule - a regulation that sets the price equal to the monopoly's marginal cost
  • The quantity demanded at a price equal to marginal cost is the efficient quantity

Unregulated

• Maximizes economic profit by producing the quantity at which marginal revenue equals marginal cost
• Charging the highest price at which that quantity will be bought

Regulated

• $MSB=MSC$
• Demand curve is the MSB curve
• Marginal cost curve is the MSC curve

• The quantity produced is efficient
• May suffer economic loss when the average cost exceeds the price
  • May be permitted to price discriminate to cover the loss from marginal cost pricing
  • Charge a one-time fee to cover its fixed lost and then charge a price equal to marginal cost
• An alternative would be produce the quantity at which price equals to average cost and to set the price equal to average cost - the average cost pricing rule

• The government may also pay a subsidy equal to the monopoly's loss

• Rate of return regulation - set a price to acheive target rate of return on capital

• Price cap regulation - set price ceiling to achieve target rate of return on capital