ECONOMICS TOPIC 4 LESSON 2

ECONOMICS TOPIC 4 LESSON 2

MONOPOLIES

ESSENTIAL QUESTION

How does competition affect markets?

Characteristics of a Monopoly

While there are different types of monopolies, all are characterized by a single seller that controls an entire market. This arrangement allows monopolies to control output and charge higher prices.

A monopoly forms when barriers prevent firms from entering a market that has a single supplier. 

Open Ended

In a monopoly, one company controls the entire market. Analyze Information What are some barriers to entry that might allow a monopoly to exist?

Economies of Scale

If a firm’s start-up costs are high, and its average costs fall for each additional unit it produces, then it enjoys what economists call economies of scale. Economies of scale are characteristics that cause a producer’s average cost to drop as production rises.

Open Ended

With economies of scale, production costs continue to fall as output increases. Analyze Graphs Describe the cost curve for a firm without economies of scale.

Natural Monopolies

 A natural monopoly is a market that runs most efficiently when one large firm provides all of the output. If a second firm enters the market, competition will drive down the market price charged to customers and decrease the quantity each firm can sell. One or both of the firms will not be able to cover their costs and will go out of business.

Technology and Change

Sometimes the development of a new technology can destroy a natural monopoly. A new innovation can cut fixed costs and make small companies as efficient as one large firm.

Multiple Choice

Determine Central Ideas What do all types of monopolies have in common?

• economies of scale

• a single seller that controls an entire market

• government action to ensure that prices don’t get too high

• a unique product to sell

The Role of Government

In the case of a natural monopoly, the government allows the monopoly to form and then regulates it. In other cases, however, government actions themselves can create barriers to entry in markets and thereby create monopolies. A government monopoly is a monopoly created by the government.

Technological Monopolies

One way that the government can give a company monopoly power is by issuing a patent. A patent gives a company exclusive rights to sell a new good or service for a specific period of time. 

Patents guarantee that companies can profit from their own research without competition. For this reason, patents encourage firms to research and develop new products that benefit society as a whole, even though the research and development costs may be very high. The patent allows firms to set prices that maximize their opportunity to make a profit. 

Franchises and Licenses

A franchise is a contract issued by a local authority that gives a single firm the right to sell its goods within an exclusive market. National companies often grant franchises to entrepreneurs, who then sell that company’s product in a local market.

A government entity can also grant a franchise.

Franchises and Licenses

On a larger scale, governments can issue a license granting firms the right to operate a business, especially where scarce resources are involved. 

Multiple Choice

Summarize How does having a patent give a company a monopoly?

• A patent is a contract issued by a local authority that gives a single firm the right to sell its goods within an exclusive market.

• A patent gives firms the right to operate a business, especially where scarce resources are involved.

• A patent gives a company exclusive rights to sell a new good or service for a period of time.

• A patent allows the companies in an industry to restrict the number of firms in a market.

Output Decisions

Even a monopolist faces a limited choice—it can choose either output or price, but not both. The monopolist looks at the big picture and tries to maximize profits. This usually means that, compared to a purely competitive market for the same good, the monopolist produces fewer goods at a higher price.

The Monopolist’s Dilemma

The law of demand means that when the monopolist increases the price, it will sell less, and when it lowers the price, it will sell more. Another way to interpret this graph is that if a monopolist produces more, the price of the good will fall, and if it produces less, the price will rise.onopolist’s Dilemma

Falling Marginal Revenue

To maximize profits, a seller should set its marginal revenue, or the amount it earns from the last unit sold, equal to its marginal cost, or the extra cost from producing that unit. This same rule applies to a firm with a monopoly. The key difference is that in a purely competitive market, marginal revenue is always the same as price, and each firm receives the same price no matter how much it produces. Neither assumption is true in a monopoly.

SETTING A PRICE

These points form the marginal revenue curve shown in blue in Figure 4.4. The marginal revenue curve is at the bottom of the graph, because a monopolist’s marginal revenue is lower than the market price.

SETTING A PRICE

Marginal cost equals marginal revenue at point a in Figure 4.4. This is the most profitable level of output. The monopolist produces 9,000 units, the quantity at which marginal revenue and marginal cost are both $3. According to the market demand curve, the market price is $11 when 9,000 units are sold (point b). Therefore, the monopolist will set the price of each dose at $11 or set production at 9,000 units.

Fill in the Blanks

Profits

How much profit does the monopolist earn? Well, profit can be determined by comparing price and average cost. F

Multiple Choice

Draw Conclusions What happens if a monopolist increases the price of a good?

• The monopolist will sell less.

• The monopolist will sell more.

• Sales will not change.

• Government intervention will be required.

Price Discrimination

the monopolist may be able to divide consumers into two or more groups and charge a different price to each group. This practice is known as price discrimination.

Targeted Discounts

companies divide consumers into large groups and design pricing policies for each group. The different prices that firms charge each group for the same good or service are not related to production costs.

Market power is the ability to control prices and total market output. 

Limits of Price Discrimination

For price discrimination to work, a market must meet three conditions. Firms that use price discrimination must have some market power, customers must be divided into distinct groups, and buyers must not be in a position in which they can easily resell the good or service.

Open Ended

Analyze Charts Why are distinct customer groups an essential component of price discrimination?

Multiple Choice

Paraphrase Price discrimination can only work if

• a group of firms determines the highest maximum price.

• customers can resell the good for a lower price.

• prices are discounted by the age of the customer.

• firms have some control over the price.

Open Ended

How does competition affect markets?