Marginal cost Essay

1 Monopoly Why Monopolies Arise? Monopoly is a rm that is the sole seller of a product without close substitutes. The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its market because other rms cannot enter the market and compete with it. Barriers to entry have three main sources: 1. Monopoly Resources. A key resource is owned by a single rm. Example: The DeBeers Diamond Monopoly|this rm controls about 80 percent of the diamonds in the world. 2. Government-Created Monopolies. Monopolies can arise because the government grants one person or one rm the exclusive right to sell some good or service. Patents are issued by the government to give rms the exclusive right to produce a product for 20 years. 3. Natural Monopoly: a monopoly that arises because a single rm can supply a good or service to an entire market at a smaller cost than could two or more rms. A natural monopoly occurs when there are economies of scale, implying that average total cost falls as the rm’s scale becomes larger. Monopoly versus Competition The key di erence between a competitive rm and a monopoly is the monopoly’s ability to control price. The demand curves that each of these types of rms faces is di erent as well. 1. A competitive rm faces a perfectly elastic demand at the market price. The rm can sell all that it wants to at this price. 2. A monopoly faces the market demand curve because it is the only seller in the market. If a monopoly wants to sell more output, it must lower the price of its product. A monopoly’s marginal revenue will always be less than the price of the good (other than at the rst unit sold). 1. If the monopolist sells one more unit, his total revenue (P Q) will rise because Q is getting larger. This is called the output e ect. 2. If the monopolist sells one more unit, he must lower price. This means that his total revenue (P Q) will fall because P is getting smaller. This is called the price e ect. Remember that demand tends to be elastic along the upper lefthand portion of the demand curve. Thus, a decrease in price causes total revenue to increase. Further down the demand curve, the demand is inelastic. In this region, a decrease in price results in a drop in total revenue (implying that marginal revenue is now less than zero). Pro t Maximization The monopolist’s pro t-maximizing quantity of output occurs where marginal revenue is equal to marginal cost. 1. If the rm’s marginal revenue is greater than marginal cost, pro t can be increased by raising the level of output. 2. If the rm’s marginal revenue is less than marginal cost, pro t can be increased by lowering the level of output. Even though MR = MC is the pro t-maximizing rule for both competitive rms and monopolies, there is one important di erence. 1. In competitive rms, P = MR at the pro t-maximizing level of output, P = MC . 2. In a monopoly, P > MR at the pro t maximizing level of output, P > MC . The monopolist’s price is determined by the demand curve (which shows us the willingness to pay of consumers). Question: Why a Monopoly Does Not Have a Supply Curve? 1. A supply curve tells us the quantity that a rm chooses to supply at any given price. 2. But a monopoly rm is a price maker the rm sets the price at the same time it chooses the quantity to supply. 3. The market demand curve tells us how much the monopolist will supply. A Monopoly’s Pro t Pro t = TR ; TC : Also, TR TC Pro t = ; Q Q or Pro t = (P ; ATC ) Q Q: The Welfare Cost of Monopoly The socially e cient quantity of output is found where the demand curve and the marginal cost curve intersect. This is where total surplus is maximized. Because the monopolist sets marginal revenue equal to marginal cost to determine its output level, it will produce less than the socially e cient quantity of output. Public Policies Toward Monopolies 1. Increasing Competition with Antitrust Laws. Antitrust laws are a collection of statutes that give the government the authority to control markets and promote competition. Antitrust laws allow the government to prevent mergers and break up large, dominating companies. (a) The Sherman Antitrust Act was passed in 1890 to lower the market power of the large and powerful rusts† that were viewed as dominating the economy at that time. (b) The Clayton Act was passed in 1914 it strengthened the government’s ability to curb monopoly power and authorized private lawsuits. 2. Regulation. Regulation is often used when the government is dealing with a natural monopoly. Most often, regulation involves government limits on the price of the product. While we might believe that the government can eliminate the deadweight loss from monopoly by setting the monopolist’s price equal to its marginal cost, this is often di cult to do. (a) If the rm is a natural monopoly, its average total cost curve will be declining because of its economies of scale. (b) When average total cost is falling, marginal cost must be lower than average total cost. (c) Therefore, if the government sets price equal to marginal cost, the price will be below average total cost and the rm will earn a loss, causing the rm to eventually leave the market. (d) Therefore, governments may choose to set the price of the monopolist’s product equal to its average total cost. This gives the monopoly zero pro t, but assures that it will remain in the market. Note that there is still a deadweight loss in this situation because the level of output will be lower than the socially e cient level of output. 3. Public Ownership. Rather than regulating a monopoly run by a private rm, the government can run the monopoly itself. However, economists generally prefer private ownership of natural monopolies than public ownership. 4. Do Nothing. Sometimes the costs of government regulation outweigh the bene ts. Therefore, some economists believe that it is best for the government to leave monopolies alone. Question: Should the government break up Microsoft? Price Discrimination Price discrimination is the business practice of selling the same good at di erent prices to di erent customers. Perfect price discrimination describes a situation where a monopolist knows exactly the willingness to pay of each customer and can charge each customer a di erent price. Without price discrimination, a rm produces an output level that is lower than the socially e cient level. If a rm perfectly price discriminates, each customer who values the good at more than its marginal cost will purchase the good and be charged his or her willingness to pay. 1. There is no deadweight loss in this situation. 2. Because consumers pay a price exactly equal to their willingness to pay, all surplus in this market will be producer surplus. Examples of Price Discrimination: 1. Movie Tickets 2. Airline Prices 3. Discount Coupons 4. Financial Aid 5. Quantity Discounts.