Skip to main content

Microeconomics: monopoly

Definition of the term monopoly:

A monopoly is a firm that is the only supplier of a unique good or service in a market.
  • Monopoly markets have barriers to entry, which prevents other firms from entering the market and competing with the monopolistic firm.
  • Since monopolies do not have to compete with other producers, they have a strong influence over the price and quantity in their markets, only limited by consumer's demand.
Factors that cause monopoly power:

  • Geography; a remote and isolated area might only have one grocery store. Because the store lacks competition, it is able to charge significantly higher price for its produce than stores that face competition.
  • Government monopoly; when the government entirely provides a good or service. For example, a local government might decide to have a public trash collection service.
  • Natural monopoly: it exists if and only if a firm experiences extreme economies of scale and is able to serve the market more cheaply than any other firms. Example, utility companies (water,gas, and electricity).
  • Legal barriers; a firm can become a monopoly when the government grants a patent or copyright to a single company.
Monopoly: demand, and marginal revenue

Because the monopolistic firm is the only firm in the market, it faces the entire down sloping demand curve. In this case, the total revenue curve forms a concave parabola (TR= Q*P(Q)). To find the maximum revenue, just find where the MR (marginal revenue) is equal to zero.
  • Revenue is maximized when the demand curve is unit elastic ( equal to 1).

Profit Maximization:

  • Just like in a competitive firm model, a monopolistic firm maximizes its profit by producing where its MC is equal to its MR. 
  • However, unlike a competitive firm, the MR is not equal to the price, instead once the quantity which satisfies the MR=MC relationship is found, plug this quantity (Q*) into the demand function and solve for the price.
  •  Profit corresponds to a rectangular area, where the height is equal to the distance between ATC and the demand curve and the length equals to Q*.

Inefficiency:


  • Productive inefficiency:
    1. A monopoly does not produce at the lowest point on the ATC. Therefore, it is not productively efficient.
  • Allocative inefficiency:
    1. A monopoly price is greater than the marginal cost of production. Therefore, a monopolistic firm will produce less than a market with perfect competition. Notice that a perfectly competitive market produces where MC equals demand. This result in a dead-weight loss created by the monopoly (see graph).


The reader should notice that there is something wrong with my MC curve, since it does not intersect at the minimum of the ATC. This is because I chose to use a function that is similar to the real MC but makes the pattern observed in a monopoly more obvious.

Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 101-106. 





Labels:
Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Econometrics: Bivariate population model

Hello I'm finally back from my extended break. I thought that we should start studying Econometrics.  Let's begin by analyzing a simple bivariate regression. Assume that this equation describes the relationship between two variables X and Y. We say that Y is the dependent variable, whereas X is the independent variable. In other words, we assume that Y (the output) depends on X (the input). Epsilon is the error term, it represents other factors that affect Y. The error term must be uncorrelated with the variable X so that we do not need to include them in our regression, and thus the coefficient of X (beta) should not change, even though Epsilon also determines Y.  beta-0 is the constant term. It tells us what would be Y if X=0. beta-1 is the effect on Y if X changes by one unit. To see this, assume X=education is a continuous function, let's take the derivative of Y=wage with respect to X: Thus, if education goes up by one unit, we should expect, on average, wage to go up ...
Post a Comment
Read more

Exercise: short and long run effects of a fiscal policy

  You are in charge of the government budget for the year 2021. You are told that schools and public roads need to be updated, and you estimate an appropriate budget in order to carry out the task. Describe what will happen in the short run to the economy, and what type of inflation do we see? Describe the supply side effect from this policy, explain what happens in the long run. Assume that there is no crowding out effect. First, note that updating public infractures, assuming taxes stay the same, will require an increase in government spending, which will also have an impact on the investment and consumption level in the economy (remember the spending multiplier?). Therefore, the aggregate demand curve will shift to the right. This will cause inflation (i.e positive change in the price level) and a higher output in the short-run.  Note that if we were to assume a large crowding out effect, the short run aggregate supply curve would shift to the left (increase in production c...
Post a Comment
Read more