CHAPTER+15+.+MONOPOLY+;)

=Monopoly =

Basic Terms
Monopoly: a firm that is the sole seller of a product with-out close substitutes Natural Monopoly: a monopoly that arises because a single firm can supply a good or service to an entire marget at a smaller cost than could two or more firms

Key Points
1. One Seller 2. Price Maker 3. High Barrier 4. Price > Marginal Revenue 5. At Profit-Maximizing-Point, Marginal Cost < Price 6. Because Price is greater than Marginal Cost, the Profit-Maximizing Quantity is less than the social optimum, which means under allocation. (Inefficient) 7. Dead-weight loss is created 8. Price Discrimination reduces consumer surplus and increases producer surplus. (If perfect price discrimination is possible, then consumer surplus would be zero) 9. Natural Monopoly --> When the marginal cost is small, and the fixed cost in the beginning of the business is huge. (ex: a bridge) 10. How to Regulate: **a)** Lower the price until it is same as the average-total-cost **b)** Lower the price until it is the same as the marginal cost 11. Only produces when the marginal revenue is greater than zero.

Monopoly is the case where there are only one seller in the market. Because there are no competition in the market, the seller does not has to follow the price set by the market, and can become the price maker of the market. The fact that there is only one seller in the market makes it hard for other firms to enter; there is a high barrier and entering the market is hard.

The graph of a monopolistic firm looks like the following. Note that the blue line is named demand, but it is really the same line as the price. (Demand =Price) in the graph

The reason for this graph is this.

As mentioned in previous chapters, the goal of a firm is always 'Profit-Maximizing' and in order to do so, the firm has to produce at the point where Marginal Cost (MC) meets Marginal Revenue (MR). If we add the MC line to the graph, then it looks like the following.



Therefore, if the firm produces at the point where the MC meets the MR, then it is the point lower than the point where MC meets price (or demand). This causes the MC to be smaller than the price too. (MC < Price) What this shows is that resources are not used efficiently and the firm is producing less than the social optimum, but is producing at the point that gives the highest profit. Under-allocation means that the market itself is not fully efficient.

(UNDER-ALLOCATION !!!!)

Now lets take a look at the long run graph of a monopolistic firm. In the long run of a monopoly market, because there are only one firm, the firm must be earning an economic profit. If the firm was doing poorly in a monopoly, then in the long run the firm itself will exit, then there would be no firm in the market since that firm was the one and only firm in the market. (Definition of monopoly #1 : ONE SELLER) This means that the Average Total Cost (ATC) has to be greater than the point where MR and MC meets, to create economic profit.

Lets revisit this graph. The AC graph is higher than the point where MC and MR meets. The green-dashed box is the profit of the monopolistic firm.

However, dead-weight loss is also created since the monopolistic firm is under-allocating and is producing at an inefficient point. The dead-weight loss is the blue-dashed area in the following graph.

Price Discrimination
Price discrimination means to change the price according to the willingness-to-pay of the consumers. Perfect Price Discrimination is when the firm sells its product at the exact willingness-to-pay of all consumers. (of course, it is impossible in real-world since the firm cannot know the willingness-to-pay of all consumers) Price Discrimination increases producer surplus and reduces consumer surplus. In the case of perfect price discrimination, consumer surplus does not exist anymore, since the price itself changes into the willingness to pay.



Natural Monopoly
Natural monopoly is the case where the marginal cost is small, while the fixed cost in the beginning is huge. Bridges or highways would be an example. To build bridges and highways, we need a lot of money in the beginning. However, after they are done, they don't really need any other huge cost. All they need is perhaps money for small repairing. In cases like this, where the beginning cost is great but the marginal cost is small, natural monopoly occurs.

How to Regulate
1. Bring down the price to the point where price = ATC. This causes the firm to earn normal profit. Although the firm would want to earn economic profit, since it is not having an economic loss, they might follow what the government tells them to do.

2. Bring down the price to the point where price = MC. This creates the problem because this causes the firm to have an economic loss. The monopolistic firm would not follow the government's regulation if they are having an economic loss. Therefore, in order to make the firms follow the regulation, the government needs to give out subsidies to make up the economic loss that the firm is in.