Chapter 14: Monopoly and Monopolistic Competition

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsSummarize how and why the decisions facing a monopolist differ from the collective decisions of competing firmsShow graphically the welfare loss from monopolyDetermine a monopolist’s price, output, and profit graphically and numericallyExplain why there would be no monopoly without barriers to entryExplain how monopolistic competition differs from monopoly and perfect competitionA Monopolistic MarketBarriers to entry into the market prevent competitionMonopoly is a market structure in which one firm makes up the entire marketThere are no close substitutes for the monopolist’s productBarriers to entry can be:LegalSociologicalNaturalTechnologicalThe Key Difference Between a Monopolist and a Perfect CompetitorA monopolistic firm’s marginal revenue is not its priceMarginal revenue is always below its priceMarginal revenue changes as output changes and is not equal to the priceA monopolistic firm’s output decision can affect priceThere is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit Determining the Monopolist’s Price and Output NumericallyMarginal revenue (MR) is the change in total revenue associated with a change in quantityThe monopoly maximizes profit when marginal revenue equals marginal cost The goal of the monopolistic firm is to maximize profits, the difference between total revenue and total costMarginal cost (MC) is the change in total cost associated with a change in quantityDetermining the Monopolist’s Price and Output NumericallyIf MR MC, The monopoly can increase profit by increasing outputThe profit-maximizing condition of a monopolistic firm is: MR = MCFor a monopolistic firm, MR MR, decrease productionThe profit-maximizing condition is: MR = MR Welfare Loss from a Monopoly: The Normal MonopolistMCQPDQMPMThe welfare loss from a monopoly is represented by the triangles B and DThe rectangle C is a transfer of surplus from the consumer to the monopolistThe area A represents the opportunity cost of diverted resources, which is not a loss to society MRPPCQPCABDCThe Price-Discriminating MonopolistWhen a monopolist price discriminates, it charges different prices to different individuals or groups of individuals Consumers with less elastic demands are charged higher prices.Consumers with more elastic demands are charged lower pricesPrice discrimination increases output and profitsThe Price-Discriminating MonopolistExamples of price discriminationMovie discounts to senior citizens and childrenAirline charge more to fly on Fridays and SundaysTracking consumer information and pricing accordinglyIt might seem unfair for a monopolist to charge different people different prices, but doing so eliminates welfare loss from monopolyFor a price-discriminating monopolist, because it can charge what consumers are willing to pay, all consumer surplus is captured by the monopolistBarriers to EntryIf there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits Government-Created MonopoliesPatentsNatural AbilityA firm is better at producing the good than anyone elseNatural MonopoliesNatural monopoly is when a single firm can produce at a lower cost than can two or more firmsCharacteristics of Monopolistic Competition Four distinguishing characteristics:Multiple dimensions of competition make it harder to analyze a specific industry, but these methods of competition follow the same two decision rules as price competitionProduct differentiation where the goods that are sold aren’t homogenousMany sellers that do not take into account rivals’ reactionsEase of entry of new firms in the long run because there are no significant barriers to entryOutput, Price, and Profit of a Monopolistic CompetitorLike a monopoly, At profit maximizing output, marginal cost will be less than priceMarginal revenue is below priceLike a perfect competitor, zero economic profits exist in the long runThe monopolistic competitive firm has some monopoly power so the firm faces a downward sloping demand curveComparing Monopolistic Competition with MonopolyFor a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entryIt is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entryAdvertising and Monopolistic CompetitionAdvertising increases ATCThe goals of advertising are to increase demand and make demand more inelasticPerfectly competitive firms have no incentive to advertise, but monopolistic competitors doThe increase in cost of a monopolistically competitive product is the cost of “differentness”Chapter Summary A monopolist maximizes profit or minimizes losses where MR=MC To determine a monopolist’s profit or loss: Find output where MR=MC; Determine price and ATC at that output; Profit or loss = (P – ATC) * QBecause monopolies reduce output and charge P > MC, monopolies create a welfare loss for societyMonopoly output is lower and price is higher than in competitive marketsNatural monopolies exist in industries with strong economies of scaleChapter Summary A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demandA monopolistic competitor differs from a monopolist in that a monopolistic competitor makes zero economic profit in long-run equilibriumMonopolistic competition is characterized by many sellers, differentiated products, multiple dimensions of competition, and ease of entry for new firmsThree important barriers to entry are natural ability, economies of scale, and government restrictions