Econ 101, Chapter 15

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monopoly
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a firm that is the sole seller of a product without any close substitutes
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Competitive/monopoly price taker/price maker
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monopoly price maker competitive price taker
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what is the fundamental cause to monopoly
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barriers to entry: a monopoly remains the only seller in its market because other firms cannot enter the market and compete with it
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what are the 3 main sources of barriers to entry
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1. monopoly resources: a key resource required for production is owned by a single firm 2. government regulation: the government gives a single firm the exclusive right to produce some good or service 3. the production process: a single firm can produce output at a lower cost than can a larger number of firms
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Monopoly resources
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potential cause of monopoly arises when a single firm owns a key resource and can command a high price compared to a competitive market. Rare because resources owned by many people and international trade makes it so that there are close substitutes ex. Diamond company in South Africa ex. one water well in town
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Government-created monopolies
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monopoly can arise because government has given one person or firm the exclusive right to sell some good or service. (ex. Kings granted business rights to friends and allies) ex. patent and copyright laws (patent a new drug so company has exclusive rights to sell it) (copyright makes novelist a monopolist) patents encourage research so they can sell their product at a higher price. Copyright encourages writers to write better/more to sell book at higher price.
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Define natural monopoly
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a type of monopoly that arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms (when average total cost curve declines; marginal cost is lower than ATC)
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The Production Process: natural monopolies
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arises when there are economies of scale over the relevant range of output. a single firm can produce any amount of output at the lowest cost, a larger number of firms leads to less output per firm and higher average total cost ex. distribution of water by building pipes throughout town ex. building a bridge with a large fixed cost and negligible variable costs calculating the average total cost of trips across bridge (total cost/ number of trips). falls as number of trips increases
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define economies of scale
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whereby long run average total cost falls as the quantity of output increases
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what are natural monopolists concerned about? not concerned about?
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not concerned about new entrants challenging their product/service (usually monopolists have trouble maintaining position without ownership of key resource or gov help cuz monopolist profit attract entrants). New entrants not incentivized to enter monopolist market because they know that they can’t achieve same low prices and each firm would have a smaller piece of the market concern: as a market expands, a natural monopoly can evolve into a more competitive market (ex. more populated area means more bridges)
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Difference with competitive market vs monopoly
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price taker so price perfectly elastic demand curve is same as price line cuz sells a product with many perfect substitutes firm demand curve is same as market demand curve
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difference with monopoly vs competitive
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price maker sole producer to demand curve slopes down constraint on market demand curve= cannot set price at free will… must set price and production equal to demand curve
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What are the key concepts to look at in a monopoly’s revenue and what do these tell us
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quantity, price, total revenue, average revenue (amount of revenue each firm receives per unit sold), marginal revenue (amount of revenue that the firm receives for each additional unit of output) monopolist’s marginal revenue is less than the price of its good, so it must lower the price to all customers
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What happens when a monopoly increases the amount it sells?
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the output effect: more output sold, so Q is higher, which tends to increase total revenue the price effect: the price falls, so P is lower, which tends to decrease total revenue
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what is the price effect and why does it happen to monopolies and not competitive firms?
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when a monopoly increases the production by 1 unit, it has to decrease the price (refer to demand curve) for every unit it sells. This cuts revenue on units it was already selling so marginal revenue is less than its price. competitive firm is price taker so it marginal revenue equals the price of its good.
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in a monopoly the demand curve also equals the _______ curve because
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equals the average revenue curve because firm’s price equals average revenue
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can marginal revenue become negative
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yes, when the price effect is greater than the output effect. when the firm produces an extra unit of output, the price falls by enough to cause the firm’s total revenue to decline, even though the firm is selling more units
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how does a monopolist determine profit maximization?
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choosing the quantity at which marginal revenue equals marginal cost. At this quantity, look for demand curve to denote price that will induce consumers to buy
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profit maximizing for a competitive market and for a monopoly
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competitive…P=MR=MC (price=marginal cost) monopoly… P>MR=MC (price exceeds marginal cost)
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equation for profit
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(P – ATC) x Q
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how to find profit on graph
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height is P-ATC width is quantity sold price above ATC then profit price below ATC then loss
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consumer surplus
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consumers’ willingness to pay for a good MINUS the amount they actually pay for it
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Producer surplus
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amount producers receive for a good MINUS their costs of producing it (single producer=monopolist)
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is the welfare cost of monopoly maximizing total surplus?
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no, fails to maximize total economic well-being. produces less than the socially efficient quantity of output which causes deadweight loss
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total surplus
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value of good to consumers MINUS cost of making good incurred by monopolists
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where does total surplus maximize in a monopoly
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socially efficient quantity found where demand curve and marginal cost curve intersect. Social Planner would choose this outcome
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how is a monopolist like a private tax collector
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is causes deadweight loss by charging a price above marginal cost. takes away the same total surplus that a tax would. Private firm gets the monopoly profit, not government with tax
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how is monopoly a social problem
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the firms produce and sell a quantity of output below the level that maximizes total surplus because incentive shrinks for consumers to buy product based on high price. economic pie shrinks as result. Not a problem that profit earned from price is too high. economic pie bigger slice for producers
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exception to deadweight loss caused by monopoly
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if government enstated monopoly has to hire lobbyists to lobby to keep their market power/monopoly status, some of their extra profit goes to the lobbyists
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define price discrimination
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the business practice of selling the same good at different prices to different customers
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when is price discrimination allowed
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NOT in competitive markets. price takers. no firm is willing to sell at a lower cost when consumers willing to pay at market price. would not charge higher cuz customer would go somewhere else
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what are the 3 lessons learned about price discrimination
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1. pd is a rational strategy for a profit-maximizing monopolist 2. pd requires the ability to separate customers according to their willingness to pay (geographically, age, income, etc.) 3. pd can raise economic welfare by eliminating inefficiency/deadweight loss (everyone got to buy a book)
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what is an exception to the second lesson on price discrimination?
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Arbitrage: process of buying a good in one market at a low price and selling it in another for profit
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Perfect price discrimination
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when a monopolist knows exactly each customer’s willingness to pay and charges each category accordingly. Monopolist gets entire surplus in every transaction
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list examples of price discrimination
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movie tickets, airline prices, discount coupons, financial aid, quantity discounts
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how can policy makers respond to the problem of monopoly?
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1. trying to make monopolized industries more competitive 2. regulating the behavior of the monopolies 3. turning some private monopolies into public enterprises 4. doing nothing at all
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how does government increase competition with antitrust laws?
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a collection of statutes aimed at curbing monopoly power. Gov uses these in court to say no to large companies who want to merge/buy out other large companies. Used to promote competition
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Sherman Antitrust Act
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congress passed in 1890 to reduce the market power of the large and powerful “trusts” that were viewed as dominating the economy at the time
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Clayton Antitrust Act
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1914, strengthened the government’s powers and authorized private lawsuits
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Define synergies
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when companies merge to reduce costs through more efficient joint production; benefit from merger
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how does government regulate the behavior of monopolies
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“rate of return regulation” government agencies regulate prices of natural monopolies with goal of achieving fair profit (common among natural monopolies like water or electric)
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what are problems with marginal-cost pricing (make price equal to marginal cost) as a regulatory system induced by gov?
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1. marginal cost is lower than natural monopoly declining average total cost so monopoly will lose money (either firm will exit industry, or gov can subsidize extra loss but this causes deadweight loss with tax, or firm can use average-cost pricing but this causes deadweight loss cuz produce less quantity) 2. it gives monopolist no incentive to reduce costs cuz when costs reduce so does price. monopolist does not benefit either way
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how does government turn private monopolies into public enterprises (public policy toward natural monopolies)
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government will own the utility itself ex. telephone, water, electric, postal service
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why do economists prefer to have private run natural monopolies instead of public run?
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private: has private incentive to keep costs low in order for profit to be high. Managers will get fired if they don’t do a good job public: bureaucrats have no incentive because they do not get directly effected.. taxpayers and customers do
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How does the government doing nothing at all helpful with monopolies
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sometimes the degree of market failure is less severe than the degree/drawbacks of political failure when gov intervenes
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competition versus monopoly
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