Lab 13 Monopoly. Perfect

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1 Lab 13 Monopoly 1. Monopoly 1.1 Definition: A Monopoly is a firm that is the only seller of a good or service that does not have a close substitute. Example: electric company, Microsoft 1.2 Monopoly V.S. Perfectly competitive market Perfect Monopoly Competition Number of firms Many firms Only One Type of product Identical Product Unique product Easy to enter or not No barrier Entry blocked Take or make price Price Taker Price Maker Profit-max condition P=MC=MR P>MR=MC 2. Why monopoly exists? To form a monopoly in the market, the barriers to entering the market must be so high that no other firms can enter. Usually, there are four reasons to create a monopoly: 1) Government blocks the entry of more than one firm into a market. Usually, government blocks entry in two ways: a) By granting a patent or copyright to an individual or firm, giving it the exclusive right to produce a product. Ex: patent on Windows operating system, copyright on a textbook b) By granting a firm a public franchise, making it the exclusive legal provider of a good or service. 2) One firm has control of a key resource necessary to produce a good. Ex: The De Beers Diamond Company can form a monopoly since it controls most of Diamond resource in the world. 3) There are important network externalities in supplying the good or service Network externalities mean that in the consumption of a product, the usefulness of the product increases with the number of people who use it. Network externalities can serve as a barrier to entry since consumers are more likely to choose products from companies in which network externalities are already formed and new company usually find it hard to attract new consumers. 4) Economies of scale are so large that one firm has a natural monopoly A natural monopoly occurs when economies of scale are so large that one firm can supply the entire market at a lower average total cost than two or more firms, which means that at the point where demand curve intersect ATC curve, ATC curve is still decreasing. See the graph on the next page. When there is only one firm in the market, ATC for producing one kilowatt-hour is $0.04 (at point A). When there are two firms in the market, ATC for producing one kilowatt-hour is driven to $0.06 (at point B). In this case, if one of firms expends production, it will move down the ATC curve. With lower average cost, this firm can drive other firm out of business and become (natural) 1

2 monopoly in the market. Natural monopoly is most likely to occur in markets where fixed costs are very large relative to variable costs. 3. Profit maximization for monopoly firm 1) For any profit maximization firm (including monopoly firm), necessary condition is always MR=MC 2) For a monopoly firm: Market demand curve=firm demand curve: DOWNWARD sloping curve 3) Marginal Revenue curve is also a downward sloping curve below demand curve 4) How to find the monopoly level of output and monopoly price? Step 1: Find the point where MC = MR. Find the Qm Step 2: Find the Pm on the demand curve where Q=Qm. 5) Profit for monopoly firm= (Pm -ATC)*Qm 2

3 4. Efficiency loss from monopoly A monopoly firm will produce less and charge a higher price than would a perfectly competitive industry producing the same good. See the graph and table below for its welfare analysis. D E F Competitive market Monopoly market Consumer Surplus A+B+D D Producer Surplus C+E+F A+E+F Economic Surplus A+B+C+D+E+F A+D+E+F Deadweight Loss 0 B+C Efficient Yes No A is consumer surplus transfer from consumer to monopoly firm 5. Government regulation toward monopoly a) Antitrust Laws: laws aimed at eliminating monopoly or collusion and promoting competition among firms. b) Market Power: The ability of charging P>MC c) Horizontal Merger: two firms are in same industry. Ex.: Exxon and Mobile d) Vertical Merger: two firms are in different production stage. 3

4 Exercise: 1. (3.3 Page 500) Ed Scahill has acquired a monopoly on the production of baseballs (don t ask how), and faces the demand and cost situation given in the following table: a. Fill in the remaining values in the table. Price Quantity (per week) Total Revenue=P*Q Marginal Revenue= TR/ Q Total Cost Marginal Cost= TC/ Q $20 15,000 $300,000 $330, , ,000 $16 365,000 $ , , , , , , , , , , , , b. If Ed wants to maximize profits, what price should he charge and how many baseballs should he sell? How much profit will he make? Answer: Ed should choose price and quantity where Marginal Revenue equal to Marginal Cost. So he should charge price= $16 and should sell quantity=35,000. Profit= TR-TC=560, ,000=$60,000 c. Suppose the government imposes a tax of $50,000 per week on baseball production. Now what price should ED charge, how many baseballs should he sell, and what will his profits be? Answer: After the government imposes the $50,000 tax, total cost increases by $50,000. Therefore, we can calculate the new total costs and use it to calculate new marginal costs. Price Quantity (per week) Total Revenue=P*Q Marginal Revenue= TR/ Q New Total Cost New Marginal Cost= TC/ Q $20 15,000 $300,000 $380, , ,000 $16 415,000 $ , , , , , , , , , , , , Since the new marginal costs are the same as before, it will not influence the optimal price and quantity 4

5 chosen by Ed. The price =$16, quantity=35,000. Profit= TR- new TC=560, ,000=$10,000 5

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