7. The theory of monopoly. State regulation of monopoly markets.

Pure Monopoly: a market structure in which: one firm sells a unique product, no substitutes, entry is blocked. the single firm (control over product price). However, still needs to deal with customers. They have considerable (not whole) control over price.

Characteristics:

Single Seller: only one firm = industry = monopoly.

Demand curve is the demand curve for industry and firm. No close substitute: As a monopolistic firm is the only firm producing a certain product, there are no substitutes that can compete with the firm's product. Unique product.

Price Maker: The pure monopolist controls the total quantity supplied and price. Increase and decrease output to control price

Blocked entry: Barriers to entry keep potential competitors from entering the indutry, thus there are no immediate competitors. Economies of scale--difficult for new, small firms to compete with the monopoly's low ATC. Legal protection in forms of patents, licenses, and copyrights. Strategic pricing--monopoly's power to adjust price and run at short term losses in order to outcompete new competitors.

Control of essential resources. Nonprice competition: The product produced by a pure monopolist may be either standarized (as with natural gas and electricity) or differentiated (as with Windows or Frisbees). Nonprice competition (i.e. advertisement).

Examples of Monopoly:

Government owned/regulated public utilities (i.e. natural gas, electric companies, water, cable TV, local telephone company).

Natural Monopolies => Professional sports teams - they are the only suppliers of a particular service. In a pure monopoly are the strong barriers to entry effectively block all potential competition.

Monopoly demand

Assumptions: Patents, economies of scale, or resource ownership secure the monopolist's status. No unit of government regulates the firm. The firm is a single-price monopolist; it charges the same price for all units of output.

Because the pure monopolist is the industry, its demand curve is the market demand curve. And because market demand is not perfectly elastic, the monopolist's demand curve is downsloping (Qd increases as P decreases).

The three implications of the downward-sloping demand curve are:

Marginal revenue is less than price:

The monopolist's downwoard sloping demand curve means that it can increase sales only by charging a lower price. MR is less than price for every level of output except the first. This is because the lower price applies not only to the extra unit sold but also to all prior units of output. Thus, the MR decreases because the monopoly has sacrificed this price for greater output. Each additional unit of output sold increases total revenue by an amount equal to its own price minus the sum of the price cuts that apply to all prior units of output. Hence, MRDARP is not one line in pure monopoly markets; rather, D=AR=P is a downsloping curve and MR is another downsloping curve that starts at the same point as D but decreases faster (steeper). Because MR is the change in TR, MR is positive when TR is increasing. When TR is at its maximum, MR = 0; when TR is decreasing, MR is negative.

The monopolist is a price maker:

Firms with downward-sloping demand curves are price makers. All imperfect competitors (pure monopoly, oligopoly, monopolistic competition) have downward-sloping demand curves. Firms can influence total supply through own output decisions; by changing market supply, firms can influence product price.

For pure monopoly:

ONE firm controls total output and price, because it is the sole producer of said product. Monopolists face downsloping demand curve in which EACH output is associated with some UNIQUE price. Monopolists are indirectly determining price they will charge when deciding on quantity of output, becauase each quatity decided equals a different price, the degree of this is steeper in this type of market structure due to the nature of extending the price line up from the mc=mr point.

Monopolists can make the price through their control of output (↑ output = ↓ price; ↓ output =↑ price)

Output and price determination

Cost data:

Assumption - a pure monopolist hires resources competitively and has the same technology as a purely competitive firm.

MR=MC rule: A monopolist seeking to maximize total profit will employ the same rationale as a profit-seeking firm in a competitive industry; they will produce at the point where MR = MC.

Profit maximizing price: Find MC= MR and draw a vertical line up to the demand curve. Draw a horizontal line. This is the price they set.

Possibility of losses by monopolist:

Pure monopolist’s likelihood of earning economic profit greater than that of purely competitive firm’s. PC – long-run – destined to earn only normal profit. PM has high barriers of entry; therefore, the concept of “entry eliminates profits” does no apply to PM.

Pure monopoly does not guarantee profit:

Monopoly is not immune from upward-shifting cost curves caused by escalating resource prices. Monopoly is not immune from changes in tastes that reduce the demand for its product. Both of these factors can lead to losses - initially it will persist in operating at a loss and to stop incurring loss, the firm's owners will reallocate their resources.