Conditions of Monopolies, Competitive Markets, Profit-Maximizing Monopolies, Dead Weight Loss of Monopolies, Price Discrimination
What is a Monopoly?
A single firm in a market with barriers to entry & no close substitute goods. Best example are local utilities (such as water, electric, etc).
Why Do Monopolies Exist?
They arise through legal barriers of entry; cities grant rights (usually with price controls) to 1 firm to provide water, electricity, natural gas, cable & phone service to simplify infrastructure.
Sometimes, legal protection (via copyrights or patents) is given to incentivize new products. Drug companies spend lots of money to research & develop medicine, so patents increase their chances of receiving most of the benefits from a new drug.
Economic barriers of entry also lead to monopolies. If a single firm faces significant economies of scale, they might become a monopoly by driving out smaller competitors. If huge investments are required to enter the market, that can also make it difficult for competitors to enter.
Another reason includes making a new technical advancement that no other firm can match. Monopolies may also erect deliberate barriers of entry such as large amounts of advertising or tying products to other products. They could also be the only one to access a resource.
These reasons fall within 2 Categories: barriers to entry or cost advantages over small firms.
How Does Market Demand Relate to Monopolies?
Monopolists face the demand for the entire market (Monopolies ARE the market). Monopolies are not ‘price-takers’ but rather price-makers. If monopolists raise prices, quantity demanded will fall but not necessarily to 0. If price is lowered, quantity demanded will rise.
How Does Marginal Revenue Relate to Monopolies?
To change quantity exchanged, monopolists must change price. Therefore, to find the effect of the increased sales, the following equation will apply:
Therefore, for monopolists Marginal Revenue is ALWAYS less than price!
If monopolists change quantity produced, but do not change price, there will a surplus/shortage!
Marginal Revenue is only positive when demand is elastic!
Do Monopolists Have Supply Curves?
No, because they decide price & how much to produce (restricted by demand conditions & cost).
How Does Profit Maximization Work for Monopolies?
If Marginal Cost < Marginal Revenue, firm should expand production (by changing price).
If Marginal Cost > Marginal Revenue, firm should decrease production (by changing price).
Monopolists will produce the quantity where MC=MR. They will do so by setting the price such that the quantity demanded will be equal to the quantity they should produce.
How are Economic Profits Calculated?
Comparing Competitive Markets & Monopolies
Monopolists will have higher economic profits than a competitive firm’s. In the long run, monopolists will not produce a quantity where average cost is at a minimum. However, in the long run, competitive firms will.
Economic Efficiencies in Monopolies
Monopolies are not allocatively efficient. Competitive firms are allocatively & technically efficient when MC intersects with the demand curve (marginal revenue curve). Monopolies aren’t necessarily technically efficient.
When is a Monopoly Natural?
When economies of scale are so significant that a single firm can produce output at a lower average cost than is possible for a number of small firms producing a similar amount of output. They are known as natural monopolists. That does not mean it’s a big company. A bank in a small town can operate as a monopoly.
What are Legal Monopolies?
Patent & copyright law allow people who create a product or service the ability to have a temporary monopoly on that product. This ensures that people don’t copy the original creator & drive the original creator out of business, practically disincentivizing innovation.
What is Price Discrimination?
When a producer charges a different price based on different units of output of the same product or discriminating between types of buyers. This allows firms to increase price on consumers with inelastic demand & decrease price on consumer with elastic demand.
Examples include senior/children discounts, quantity discounts (buying wholesale), discount coupons, financial aid by colleges, etc.
A monopolist will engage in price discrimination in order to increase profits while continuing to produce the same amount of quantity.