Econ 2 Files
Econ 2 Lecture
Notes
Lecture 22: Monopoly
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Economics 2 |
Lecture 22: Monopoly
what is a monopoly?
demand curve facing a monopolist
profit maximization
price discrimination
inefficiency of monopoly
What is a Monopoly?
A monopoly exists when there is only one supplier of a product for which there are no close substitutes.
- single seller and many buyers
- unique product
- entry is impossible
- perfect information
Types of Monopolies:
- closed monopoly
- protected by legal restrictions on competition
- natural monopoly
- grows out of economies of scale and demand conditions
- its long-run average cost curve slopes continually downward over the relevant range of output
- long run average cost is minimized when only one firm enters the market
- open monopoly
- one firm is the sole supplier of a product but has no special protection from competition
Demand Curve Facing a Monopolist
A monopolist faces the market demand curve.
The demand curve lies above the marginal revenue curve meaning that MR < P because the monopolist must lower the price to increase sales.
Profit Maximization
The profit maximizing level of output is where MR = MC. Because there is no possibility of another firm entering the market, a monopolist can earn above-normal (or economic profits) in the long run.
Price Discrimination
Price discrimination occurs when different customers are charged different prices for the same product but the price difference is not due to cost differentials. The purpose is to increase profits by extracting more consumer surplus. Some examples of price discrimination are senior citizen discounts and in-state versus out-of-state tuition.
- firm cannot be a perfect competitor
- customers must have different price elasticities of demand for the product
- firm must be able to separate customers according to price elasticity of demand
- firm must be able to prevent resale of the product
The profit maximizing price discriminator will charge a price in each market so as to equalize marginal revenue in each market. This occurs simply by setting MR = MC in each market. The higher price is charged in the market with the buyers that are less responsive to price changes, that is, with the relatively inelastic demand.
Inefficiency of Monopoly
Social efficiency requires a balancing of the costs and benefits of any action. We create benefits for people by giving them something they value; the value of something is equal to what people are willing to pay for it. The demand curve tells us people's marginal willingness to pay. So, under certain assumptions, the benefits society receives from consuming a good are represented by the demand curve. The industry supply curve measures the social costs of producing the good. The industry supply curve is the same as the marginal cost curve. Therefore, the efficient level of output is given by the intersection of the demand and marginal cost curves. For levels of output below the efficient quantity, the benefits society receives from consuming a unit of the good are greater than the costs of producing a unit of the good; for levels of output greater than the efficient amount, the costs are greater than the benefits from consuming a unit of the good.
| The monopoly output is where MR=MC. So, the monopoly produces too little output and charges too high a price compared to the efficient outcome generated by a perfectly competitive market. The deadweight loss is a measure of the inefficiency of a monopoly. It represents the net social benefits from the lost output from having a monopoly in the market rather than perfect competition. (Perfect competition results in efficient outcomes.) The deadweight loss may be overstated because the monopoly fears that entry or government intervention could occur. It may be understated if monopoly firms tend to operate inefficiently and devote resources to maintaining their monopoly positions. |
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David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 e-mail: 
web: www.yk.psu.edu/~dxl31 |
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