Pure Monopoly

A single firm producing a homogenous or differentiated (unique) good and facing the market demand. No substitutes No new entries allowed The monopoly is a price maker P>MR Possibility of a sustained economic profit

What circumstances lead to the formation of a monopoly?

Extensive economies of scale: natural monopolies Exclusive patent rights Copy rights to intellectual properties Government franchises Exclusive access to a essential resource (input) Cartels

A monopoly is a profit maximizer too!

Demand Faced by A Monopoly

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MR

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SATC

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The Dynamics of a Monopolistic Market

As a profit maximizer a monopoly may try to take advantage of economies of scale A monopoly tends to try to protect its monopolistic position A monopoly may take advantage of technological advances A monopoly may face changes in demand A monopoly may try to promote its product to maintain demand

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ATC>MC, P>MR, P>MC, P>ATC
SMC

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SATC

LATC

Q Qe L-R Positive Economic Profit o MR

Monopolies and Profit Maximization

A monopoly faces the industry demand curve To maximize profit: MR = MC P = 80 - .0008Q ; MR = 80 - .0016Q TC = 10,000 + .0092Q2 ; MC = .0184 Q Set MR = MC Q = 4000; P = 76.8 Profit = 307,200 147,200 10,000 = 150,000 Profit = (P- ATC). Q

Things Change
Demand may go down Cost could increase In an attempt to keep the potential competitors out, the monopolist may lower its price to near its average cost Rent seeking: an attempt to maintain its monopolistic position by influencing the political processes-e.g., zoning laws Closer substitutes may emerge

ATC>MC, P>MR, P>MC, P = ATC

SMC

SATC

LATC

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Qe L-R Zero Economic Profit o MR

The Case of Natural Monopolies

A natural monopoly emerges out of competition among firms in an industry with extensive economies of scale; the downward-sloping segment of the LATC curve extends to or beyond the market capacity (or market demand). Smaller firms are gradually driven out by the larger (more efficient) firms. The surviving firm would become a (natural) monopoly. If unchecked, a natural monopoly behaves like a monopoly; it under-produces and overcharges.

SAC1
Natural Monopolies

SAC2

SAC3
LAC

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Q2

Q3

$
LATC

Natural Monopolies Monopoly Pricing

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AC LMC

SAC

SMC

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MR

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$ A Comparison

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Price Discrimination
Segmenting the market into separate classifications or regions Assuming that each class of consumers have different demand, a monopoly can charge different prices in each market segment To price-discriminate
The firm must identify consumer groups/classes with different downward-sloping demand curves The firm must be able to prevent consumers of one class from reselling its product to the consumers of another class; no intermarket redistribution of the product is allowed

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Price Discrimination

Monopsony vs. Monopoly

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Cartels
P,C P,C P,C P
MCB MCA ATCA ATCB

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QA Firm A

QB Firm B

o Industry