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A monopoly is the sole producer of a commodity that has no close substitutes and faces many buyers.
The firm and the industry y are identical. The demand curve faced by the firm is the downward-sloping industry demand curve. A monopoly l acts as a price-maker i k
Monopoly
The existence of the downward-sloping downward sloping demand curve sets a constraint on the monopolists monopolist s actions The monopolist can either set the price and then sell the quantity indicated by the demand curve Or O determine d t i the th quantity tit t to b be sold ld and d then find the price at which this quantity can be b sold ld
Market power
A monopolist, as we shall see, has market power That is, it can set a price above marginal cost Whether a market is a monopoly market or not depends on the definition of the market The market must be such that the monopolist monopolists s product has no close substitutes If we define the market too broadly, a monopolist may appear to have rivals If we define it too narrowly, y, we may y identify ya firm as a monopoly when it is not
Patents and Copyrights Patent The exclusive right to a product for some period from the date the product is invented. invented Copyright A government-granted exclusive right t produce to d and d sell ll a creation. ti Public Franchises Public franchise A designation by the government that a firm is the only legal provider of a good or service.
17-9
C t' R
400
10
15
20 Quantity
Marginal Revenue
For a straight line demand curve P = a bQ, what h ti is the th MR equation? ti ? TR = PQ = aQ bQ2 Then MR = dTR/dQ = a 2bQ AR = TR/Q = a bQ for Q > 0.
7 6 5 4 3 2 1 0
Marginal Revenue
7 Output
P and MR
Note: MR = dTR/dQ. dTR/dQ But TR = PXQ. Hence MR = P + Q(dP/dQ) = P(1 1/e)
MC P1 P* AC P2
Lost profit
D = AR MR Q1 Q* Q2
Lost profit
Quantity
The monopolist will operate on the elastic portion of the demand curve.
40
MC
30
P fit Profit
AC AR
20 15 10 MR 0 5 10 15 20
Quantity
Miscellaneous
The Monopolist does not face a Supply
- The elasticity of demand affects a monopolists li t price i relative l ti to t its it marginal i l cost - Check the price-marginal cost margin: (p MC)/p )/p
Monopoly
If demand is very elastic elastic, there is little benefit to being a monopolist The larger the elasticity elasticity, the closer to a perfectly competitive market
Taxation of a monopolist
What happens if a tax is imposed on a monopolist? If the tax is a lump lump-sum sum tax T, T it is clear that there will be no effect on either monopoly price or quantity, quantity because the monopolist will now be maximizing T.
Taxation of a monopolist
Suppose that a specific tax of t per unit is imposed. Consider linear demand and cost curves: P = a Q, C = cQ, a > c. Then Q* = (a c)/2 and P* = (a + c)/2. Next, , let the tax be imposed p on quantity q y at the rate t, a > (c+t).
Taxation of a monopolist
The total cost curve facing the monopolist becomes C = (c+t)Q. Quantity is now Q** = (a c t)/2 and price P** = (a+c+t)/2. Hence, H P** - P* = t/2 t/2, which hi h shows h that th t price has increased by only half the amount t of f th the t tax per unit. it
Taxation of a monopolist
However, , it is not generally g y true that the price p increases by less than the tax. Suppose that the demand curve is a constantelasticity demand curve. curve MR = P(1 1/e). Equating q g this to MC = c and solving, g, we get g P = c/(1 1/e). After the tax is imposed, price is P = (c+t)/(1 1/e). 1/e) P P = t/(1 1/e). Since e > 1, , 1 1/e / is a fraction and therefore the increase in price exceeds t.
MONOPOLY
The Th Effect Eff of faT Tax
Suppose a specific tax of t dollars per unit is levied, so that the monopolist must remit t dollars to the government for every unit it sells. If MC was the firms original marginal cost, its optimal production decision is now given by
With a tax t per unit, the firms effective marginal cost is increased by the amount t to MC + t. In this example, the increase in price P is larger than the tax t.
The pass-through rate is the increase in price that occurs in response to a small increase in marginal cost, measured d per dollar d ll of f increase in marginal l cost In a competitive market, the pass-through rate is never greater than one g The monopolists pass-through rate depends on the shape of the demand curve
Can be greater than one with a constant-elasticity demand curve
Nonprice Effects of Monopoly: Investments Rent seeking is socially useless effort devoted to securing a monopoly position Welfare effects of monopoly need not always be so bad Expenditures E dit firms fi make k to t gain i monopoly positions can be socially valuable l bl (e.g., ( R&D spending di in i the th search for patentable drugs)
If price is lowered to PC output increases to its maximum QC and th there i is no d deadweight d i ht loss. l
$/Q Pm
Price Regulation
MC
MR
P2 = PC
AC
Natural Monopoly
Suppose pp that the total cost function is C = 50 + 10Q. If output per day is 25, one firm can produce this amount at an average cost of f Rs.12 R 12 and d total l cost of Rs.300. On the other hand, hand if there are two firms and one produces 12 units while the other produces 13 units, the total cost of production is 170 + 180 = Rs.350 which is greater than the cost of production of a single firm.
Quantity
Pm
Setting the price at Pr yields the largest possible output;excess profit is zero.
Pr PC MR
Qm Qr
AC MC AR
QC
Quantity
Regulatory Failure
Difficulties associated with price regulation:
It is very difficult to estimate the firm's firm s cost and demand functions because they change with t e evolving o g market a et co conditions dto s Regulated monopolists make many decisions other than about p price regulation g may y lead to inefficiencies wrt these decisions
Regulatory Goals
Regulators may pursue goals other than the maximization of aggregate surplus - Official mandate may include other objectives, e.g. provision of services to poor consumers p - Regulators may be appointed/elected y can try y to improve p chances of repeat p they appointment or reelection - Regulators g may y be captured p by y the regulated firm
Government ownership
If the government owns the monopoly, - There is no need for elaborate regulatory hearings saves resources - Managers have no incentive to overstate costs But there is no focus on profits which leads to efficiency - the politicians and bureaucrats have their own agendas
Dorfman-Steiner model
Consider a profit-maximizing monopolist: = pq(a, ( p) ) C[q(a, C[ ( p)] )] a To maximize profit: /p = q + pq/p (C/q)(q/p) = 0 /a = pq q/a (C/q)(q q/a) )1=0 From (1), q + (p C/q)(q/p) = 0 [p C/q]/p = -(q/p)/(q/p) = 1/ep Lerner condition
(1) (2) ( )
(3)
Dorfman-Steiner model
From (2) (2), (p C/ q)(q/ a) = 1 (p ( C/q) ) = 1/(q/ /a) ) (p C/q) = (a/q)/(a/q)(q/a) (p C/q) = (a/q)/(1/ea) From (3) and (4), (4) we get [(a/q)/ea][1/p] = 1/ep a/pq / = ea/e / p
(4)