CHAPTER 10: PURE MONOPOLY
Pure monopoly – single firm is the sole producer of a product for which there are no close substitutes; characteristics: * Single seller – sole producer or sole supplier; firm and industry are synonymous * No close substitutes – consumer who chooses not to buy the monopolized product must live without it * Price maker – pure monopolist controls the total quantity supplied, so has considerable control over the price; changes product price by changing quantity supplied; will use this power whenever it is advantageous to do so * Blocked entry – no immediate competitors because certain barriers (economic, technological, legal, etc.) keep potential competitors from entering the industry * Nonprice competition – product may be standardized (natural gas, electricity), which engage in public relations advertising, or differentiated (Windows, Frisbees), which engage in product attribute advertising Examples of monopoly: public utilities, sports teams, Wham-O (near-monopolies)
Major barriers to entry:
* Economies of scale – because of technology, economies of scale are extensive; only a few large firms (or, in the extreme, only a single large firm) can achieve low average total costs. When long-run ATC is declining, only a monopolist can produce any particular output at minimum total cost * Legal barriers:
* Patents – exclusive rights of an inventor to use (or to allow another to use) his or her invention * Licenses – government limitations on entry into an industry; used in radio, television, taxis, etc. * Ownership or control of essential resources – using private property as an obstacle to potential rivals (etc. sports leagues) * Pricing and other strategic barriers to entry – slashing prices, stepping up advertising, etc. to block competitors
Model of pure monopoly – three assumptions
1. Patents, economies of scale, or resource ownership secure the firm’s monopoly 2. No unit of government regulates the firm
3. The firm is a single-price monopolist (charges the same price for all units of output)
Crucial difference between a pure monopolist and a purely competitive seller = demand * Competitive seller – perfectly elastic demand at price determined by market supply and demand * Monopolist – firm demand curve is the market demand curve; demand curve is downsloping
Marginal revenue is less than price – pure monopolist can increase sales only by charging a lower price; thus, the marginal revenue is less than price (average revenue) for every unit of output except the first; this occurs because the lower price of the extra unit of output also applies to all prior units of output. With the setup to the right, the monopolist can produce one more unit at $132/unit than it can at $142/unit, which gives the company a gain of $132. However, to sell that extra unit, the monopolist had to sell the 3 prior units at $10 less per unit, resulting in a total loss of $30. Taken together, the net gain is 132-30 = $102. This net gain (marginal revenue) is clearly less than the $132 price of the fourth unit
The monopolist is a price maker – change in quantity produced causes a change in price
The monopolist sets prices in the elastic region of demand – if demand is elastic, decreases in price increase total revenue; if demand is inelastic, decreases in price decrease total revenue; the implication is that a monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease (marginal revenue to be negative).
Things to note:
* Because it must lower price on all units sold in order to increase its sales, an imperfectly competitive firm’s marginal-revenue curve lies below its downsloping demand curve * Total revenue increases at a decreasing rate, reaches a maximum, and then declines. In the elastic region, TR is increasing and MR is positive; when TR reaches its maximum, MR is 0; when TR is...
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