MONOPOLY

Introduction: We will see that market power alters the relationship between the
costs a firm incurs producing a good and the price at which it sells that good. So
far, we have seen that a competitive firm takes the price of its output as given by
the market and then chooses the quantity it will supply so that price equals
marginal cost. By contrast, a monopoly charges a price that exceeds marginal
cost. And a high price reduces the quantity purchased
Ex: Imagine there's only one movie theater in a small town, that’s monopoly,
since it’s the only theater, it has significant market power.
- If they increase the price, there’s nothing to worry because there are no other
theaters around
- Even if their costs go down (like getting cheaper popcorn), they might keep
ticket prices high because they don’t face competition
 It is not surprising that monopolies charge high prices for their products
- The outcome in a market with a monopoly is often not the best for society
because they’re not affected by competition
- The government: One of the Ten Principles of Economics in Chapter 1 is that
governments can sometimes improve market outcomes
15.1 Monopoly:
- A firm is a monopoly if it is the sole seller of its product and if its product does
not have any close substitutes.
- Monopoly can be considered as Price maker
- The fundamental cause of monopoly is barriers to entry
Example: Imagine there is only one bakery in your town, let’s call it “Breadtopia”.
Breadtopia is the only place where people can buy bread. Since there are no other
bakeries around, Breadtopia controls the entire supply of bread in the town.
 Single Seller: Breadtopia is the only bakery.
 No Competition: No other bakeries exist.
  Price Control: Breadtopia can set the price of bread without worrying about
competition.
So, Breadtopia has complete control over the market for bread in the town,
making it a monopoly.
Barriers to entry:
- A monopoly remains the only seller in its market because other firms cannot
enter the market and compete with it.
- Barriers to entry, in tum, have three main sources:
Monopoly resources/ Ex: DeBeers owns most of the world’s diamonds mines (mỏ
kim cương)
Government regulation/ Ex: patent (bằng sang chế), copyright laws
The production process
Monopoly resources:
- Is a key resource required for production is owned by a single firm
- In this situation, there is only one well (giếng nc) in town and it is impossible to
get water from anywhere else, then the owner of the well has a monopoly on
water  the monopolist can command a higher price for water
Government regulation
- As we see, government gives a single firm the exclusive right to produce some
good or service
- When a pharmaceutical company discovers a new drug, it can apply to the
government for a patent
- When a novelist finishes a book, she can copyright it. The copyright is a
government guarantee that no one can print and sell the work without the
author's permission
- The effects of patent and copyright laws are easy to see. Because these laws give
one producer a monopoly, they lead to higher prices and higher profits
Natural monopolies
- An industry is a natural monopoly when a single firm can supply a good or
service to the entire market at a lower cost than could two or more firms.
- A natural monopoly arises when there are economies of scale over the relevant
range of output. Ex: Let’s take an example about providing water to residents of a
town, a firm must build a network of pipes throughout the town. If two or more
firms were there to compete, each firm would have to incur the fixed cost of
building a network (each would need to build their own separate network of
pipes, doubling or tripling these high costs)
- And we can note that club goods are excludable but not rival in consumption, Ex:
Excludable:
• Only people who pay for the gym membership (club good) can use the gym
facilities. If you don't have a membership, you can't get in.
Not Rival in Consumption:
 Multiple members can use the gym at the same time without preventing
others from using it. One person using a treadmill (máy chạy bộ) doesn't
stop others from using the weights or other equipment.
Figure 1
- When a firm’s average-total-cost curve continually declines, the firm has what is
called a natural monopoly. In this case, when production is divided among more
firms, each firm produces less, and average total cost rises. As a result, a single
firm can produce any given amount at the lowest cost.
- Because when production is divided among more firms, each firm produces less,
and average total cost rises. Larger firms often enjoy lower costs per unit because
they can buy materials in bulk, use more efficient machinery, and spread fixed
costs over more units
15.2 Production and Pricing Decisions
Monopoly Competitive firm
Price maker Price taker
The market demand curve The horizontal demand curve
Because a monopoly is the sole Because the competitive firm sells a
 producer in its market, its demand product with many perfect
curve is simply the market demand substitutes, the demand curve that
curve. any one firm faces is perfectly elastic
A monopolist's demand curve slopes downward because they are the only seller
in the market. This means that to sell more of their product, they must lower the
price. Here's a simple breakdown:
 Monopoly Control: As the sole provider, the monopolist sets the price.
 Price and Quantity Relationship: To sell additional units, they need to
reduce the price, because not all consumers are willing to pay high prices.
A monopoly’s total revenue equal price multiplied by quantity (P x Q)
A monopoly’s average revenue
- Is the revenue per unit sold
- It’s equal the total revenue divided by quantity (TR/Q)
- As we discussed in the previous chapter, average revenue always equals the
price of the good. This is true for monopolists as well as for competitive firms.
A monopoly’s marginal revenue
- Is the amount of revenue that the firm receives for each additional unit of
output
- We compute marginal revenue by taking the change in total revenue when
output increases by 1 unit
- For a monopoly, marginal revenue is lower than price because a monopoly faces
a downward-sloping demand curve. To increase the amount sold, a monopoly
firm must lower the price it charges to all customers
Explain: MR < P Can be negative
- When a monopolist lowers the price to sell an extra unit, they also lower the
price on all previously sold units.
- This can reduce total revenue if the price cut leads to a smaller increase in
quantity sold.
Example:
  If selling 10 units at $10 each = $100 revenue.
 If selling 11 units requires dropping the price to $9, total revenue is $99.
 Here, selling the extra unit actually decreases total revenue by $1.
 So, marginal revenue is lower than the price and can be negative if the
Table 1
Columns (1) and (2) show the monopolist's demand schedule. If the monopolist
produces 1 gallon of water, it can sell that gallon for $10. If it produces 2 gallons,
it must lower the price to $9 to sell both gallons. If it produces 3 gallons, it must
lower the price to $8. And so on. If you graphed these two columns of numbers,
you would get a typical downward-sloping demand curve
Increase in quantity sold
 The output effect: More output is sold, so Q is higher, which increases total
revenue.
 The price effect: The price falls, so P is lower, which decreases total
revenue.
Figure 3 explanation:
- These two curves always start at the same point on the vertical axis because the
marginal revenue of the first unit sold equals the price of the good
- The monopolist's marginal revenue on all units after the first is less than the
price. (When a monopolist sells additional units of a good, they must lower the
price to sell more. This lower price applies not just to the extra units, but to all
units sold. Therefore, the marginal revenue (the revenue from selling one more
unit) is less than the price, because the monopolist loses revenue on the units
that could have been sold at a higher price if they hadn't lowered it. So, as the
quantity increases, the marginal revenue decreases, always staying below the
price.)
 Thus, a monopoly's marginal-revenue curve lies below its demand curve.
Profit maximization
- When marginal cost is less than marginal revenue (MC > MR), the firm can
increase profit by producing more units
- When marginal cost is greater than marginal revenue (MC < MR), the firm can
increase profit by producing less units
- To maximize profit the firm will produce quantity where MR=MC
- When there is an intersection of the marginal-revenue curve and the marginal-
cost curve and we’ll find the price on the demand curve
Figure 4 explanation
- It’s easy to find where the marginal cost = marginal revenue  Point A
- And we look at this line (thẳng đứng) we can see the Price here but would it sell
for this Price, we know where the demand curve actually here  Point B
- Because it is sole producer so it can sell up to this price
Profit maximization (Competitive firm vs Monopoly)
- As you can see there’s a similar between CF and M (both have MC = MR)
- But a key difference between markets with competitive firms and markets with a
monopoly firm: In competitive markets, price equals marginal cost. In
monopolized markets, price exceeds marginal cost
A Monopoly's Profit
Calculate: How much profit does a monopoly make? To see a monopoly firm's
profit in a graph, recall that profit equals total revenue (TR) minus total costs (TC):
Profit = TR - TC.
- We can rewrite this as: Profit= (TR/Q - TC/Q) x Q.
- TR/Q is average revenue, which equals the price, P, and TC/Q is average total
cost, ATC. Therefore: Profit= (P - ATC) x Q.
Case study: A natural place to test this theory is the market for pharmaceutical
drugs because this market takes on both market structures.
When a firm discovers a new drug, patent laws give the firm a monopoly on the
sale of that drug. But if the firm's patent expires, and any company can make and
sell the drug.
 At that time, the market switches from being monopolistic to being
competitive.
Figure 6 explanation
- When the patent on a drug expires, other companies quickly enter and begin
selling generic products. As the previous slide, the competitive market price is
below the monopolist’s price which mean they sell generic product with lower
price
- The expiration of a patent, however, does not cause the monopolist to lose all of
its market power. Then why, because some consumers remain loyal to the brand-
name drug maybe because of fear that the new generic drugs are not actually the
same as the drug they have been using for years
 As a result, the monopolist can continue to charge a price above the price
charged by its new competitors
15.3 The welfare cost of monopolies
Total surplus: measures the economic well-being of buyers and sellers in a
market. Total surplus is the sum of consumer surplus and producer surplus.
Consumer surplus: On slide
Producer surplus: On slide
Benevolent planner (in competitive market): The planner tries to maximize total
surplus
- By producing quantity where the demand curve and the marginal-cost curve
intersect also where the socially efficient quantity is found
- A social planer would charge a price equal to marginal cost (P = MC)
Figure 7 explanation
- The demand curve reflects the value of the good to consumers, as measured by
their willingness to pay for it.
- The marginal-cost curve reflects the costs of the monopolist.
 Thus, the socially efficient quantity is found where the demand curve and the
marginal-cost curve intersect which is also where total surplus is maximized
because the value to consumers perfectly matches the cost of production,
ensuring no resources are wasted
- Below this level, the value of the good to the marginal buyer (as reflected in the
demand curve) exceeds the marginal cost of making the good.
- Above this level, the marginal buyer is less (value to buyers) than marginal cost
Conclusion:
- The monopolist chooses to produce and sell the quantity of output at which the
marginal-revenue and marginal-cost curves intersect
- And produces less than the socially efficient quantity of output.
- A monopolist would charge a price higher than marginal cost
- Deadweight loss: On slide
Figure 8 explanation
- As a monopoly would charges a price above marginal cost, not all consumers are
willing to buy at this price
 The quantity is below the socially efficient quantity that would cause a
deadweight loss (represented by the triangle between the demand curve and the
marginal-cost curve)
The monopoly’s profit: a social cost?
- A monopoly firm does earn a profit by virtue of its market power because it sells
at higher price which leads to higher profit
- But it doesn’t cause a reduction of economic welfare when consumers pay at
monopoly price (higher than normal price) they will be worse off and the
producer is better off by the same amount.
 Bigger producer surplus and smaller consumer surplus
Because total surplus equals the sum of consumer and producer surplus, this
transfer from consumers to the owners of the monopoly does not affect the
market's total surplus  Not a social problem
- Social loss = Deadweight loss: from the inefficiently low quantity of output
- Higher price makes buyers buy fewer products so it leads to lower quantity sold
- Due to fewer goods being produced and sold, some consumer can’t buy the
product which is the social loss. So in this case, social loss = deadweight loss
Ex: Imagine a town with one ice cream shop. The shop produces 100 cones at a
price where supply meets demand (efficient level). If they decide to only produce
70 cones and charge higher prices, some people can't get ice cream.
 Efficient: 100 cones, everyone who wants ice cream gets it.
 Inefficient: 70 cones, some people don't get ice cream, causing social loss
or deadweight loss.