10/22/2014CRC Microeconomics1. 10/22/2014CRC Microeconomics2 What did you study last time? 1.What is...

04/11/23 CRC Microeconomics 1


What did you study last time?

1. What is meant by perfect competition?

2. How much output a (perfectly) competitive firm should produce to maximize profit?

3. Where do the firm’s and the market supply curves come from?

4. What happens in the long run in a (perfectly) competitive market?


Do you know … why monopolies arise? what is meant by a monopoly? how much output a monopoly should

produce to maximize profit? if monopolies are good or bad? how governments regulate

monopolies? how a monopoly price discriminates?


1. Why do monopolies arise?

Because of barriers to entry, as a result of:

A key resource owned by a single firm;

The government’s authorization; Natural monopoly, resulted from

economies of scale.


2a. Monopoly—Main characteristics

Sole seller. No close substitute. Barriers to entry.


2b. Monopoly—Main Ideas

The monopoly is a price maker/setter.

TR = P x Q, where P varies. AR = TR / Q = P MR = TR / Q < (AR = P) The monopoly’s demand curve,

(AR = P), is downward sloping. It is also the market demand curve.


2b. Monopoly—Main ideas

= (P – ATC)*Q < = > 0. The monopolistic market is

inefficient. There exists a DWL, because Qm < Qc.

Regulations are necessary. A monopoly can practice price

discrimination.


3. How much should a monopoly produce to maximize profit?

To maximize profit, a monopoly produces the output Q*, where

(AR = P ) > MR = MC


Graphs of profit maximization

Case 1. > 0 Case 2. = 0


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 1. > 0

$

Q

MC

ATC

AVC

Pm

Em

Qm

ARm

MRm

The graph below shows the cost and revenue curves of a monopoly.

The “equilibrium” point is Em, where MRm = MC.


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 1. > 0

$

Q

MC

ATC

AVC

Pm

Em

Qm

ARm

MRm

The firm produces Qm to maximize profit. Its TR is Pm*Qm…

TR = Pm x Qm

At Qm, the firm’s VC (= AVC x Qm) is …

VC = AVC x Qm


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 1. > 0

$

Q

MC

ATC

AVC

Pm

Em

Qm

ARm

MRm

TR = Pm x Qm

VC = AVC x Qm

At Qm, the firm’s FC (= AFC x Qm) is …

FC

At Qm, the firm’s TC = VC + FC is …

TC


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 1. > 0

$

Q

MC

ATC

AVC

Pm

Em

Qm

ARm

MRm

TR = Pm x Qm

VC = AVC x Qm

FC

TC

At Qm, the firm’s = TR - TC is …


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 2. = 0

$

Q

MC

ATC

AVCPm

Em

Qm

ARm

MRm

The graph below shows the cost and revenue curves of a monopoly.

The “equilibrium” point is Em, where MRm = MC.


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 2. = 0

$

Q

MC

ATC

AVCPm

Em

Qm

ARm

MRm

The firm produces Qm to maximize profit. Its TR is Pm*Qm…

At Qm, the firm’s VC (= AVC x Qm) is …

TRVC


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 2. = 0

$

Q

MC

ATC

AVCPm

Em

Qm

ARm

MRm

TRVC

At Qm, the firm’s FC (= AFC x Qm) is …

At Qm, the firm’s TC = VC + FC is …

FC

TC


0 .0 0

1 0 .0 0

2 0 .0 0

3 0 .0 0

4 0 .0 0

5 0 .0 0

6 0 .0 0

0 1 2 3 4 5 6 7 8 9 1 0

Case 2. = 0

$

Q

MC

ATC

AVCPm

Em

Qm

ARm

MRm

TRVC

FC

TC

At Qm, the firm’s = TR - TC = 0

TR


4. Are monopolies good or bad?P

Q

Dc

Sc

Qc

Ec

Pc

The graph below shows a competitive market.

Now suppose that it becomes a monopoly.

= MCm

= ARm

Thus, ARm = Dc, and MCm = Sc.



Q

Dc

Sc

Qc

Ec

Pc = MCm

= ARm

The monopoly has a MR curve.

MRm

The monopoly’s Em is where MRm=MCm.

Em



Q

Dc

Sc

Qc

Ec

Pc = MCm

= ARmMRm

Em

The monopoly’s output is Qm < Qc, and

the monopoly’s price is Pm > Pc.

Qm

Pm

The monopoly causes a DWL.

DWL


4. Are monopolies good or bad?

Define: Qc = output in perfect competition,

where the market if efficient. Qm = output produced by a monopoly. Since a monopoly produces less:

- Qm < Qc, - there is a loss of production due to monopoly, - i.e. there exists a DWL.


4. Are monopolies good or bad?

Monopolies are bad, because monopolistic markets are inefficient.

A monopoly is “like” a private tax collector.

The monopoly charges a higher price than the free-market equilibrium price, reduces output below the free-market equilibrium output. The effect is like a tax on a free market.


5. How governments regulate monopolies

Governments: make monopolies more competitive

• with antitrust laws (e.g. prevent mergers, break up big companies, etc.)

regulate monopolies’ behavior• with marginal-cost pricing, or• with average-cost pricing


5. How governments regulate monopolies

Governments: turn monopolies into public

enterprises.• e.g. U.S Postal Service

leave monopolies alone.• e.g. Microsoft


5. Regulating monopolies’ behaviorP

Q

The graph below shows a natural monopoly.

MCm

ARmMRmEm

Qm

Pm

ATCm

Without any regulation, the monopoly’s outputis Qm, where MRm = MCm, and the profit is ...



Q

MCm

ARmMRmEm

Qm

Pm

ATCm

Under MC-pricing, the monopoly is required to charge aprice equal to MC. It will produce Qc at MCm = Pc.

Qc

EcLoss under MC-pricing = Subsidy

MCm = Pc

The monopolistic market is efficient, DWL = 0. However, the monopoly loses and needs to be subsidized.



Q

MCm

ARmMRmEm

Qm

Pm

ATCm

Under AC-pricing, the monopoly is required to charge aprice equal to ATC. It will produce Qa at P = ATCm.

Qc

EcMCm = Pc

The monopolistic market is inefficient, DWL > 0. The monopoly breaks even, earns only normal profit.

Qa

EaPa

DWL


6. How does a monopoly price discriminate?

A monopoly can charge its customers: one single price, i.e. there is no price

discrimination; two different prices or more, i.e. there

is (imperfect) price discrimination; as many different prices as the

number of customers, i.e. there is perfect price discrimination.



In imperfect price discrimination, the monopoly

• raise price on customers with inelastic demand, and• lower price on customers with elastic demand

e.g. bus fare, movie ticket prices, etc.



In perfect price discrimination, the monopoly charge customers their WTP, i.e. each customer would pay a different price.

Perfect discrimination results in efficiency, because there is no DWL. The monopoly would produce an output Qm = Qc.

The issue is that all consumer surplus becomes the monopolist’s profit.


Perfect price discrimination by a monopolyP

Q

The graph shows a monopoly.

ARmMRmEm

Qm

Pm

MCm = ATCm

DWL

With a single-price, the monopoly’s outputis Qm, price Pm, and the profits are ...

There exists a DWL.


Perfect price discrimination by a monopolyP

QQc

Ec

ARmMRmEm

Qm

Pm

MCm = ATCm

DWL

With perfect price discrimination, themonopoly’s output is Qc, price Pc.

The profits are … There is no DWL.

Pc = MCm = ATCm


Now you know …

why monopolies arise. what is meant by a monopoly. how much output a monopoly should

produce to maximize profit. if monopolies are good or bad. how governments regulate monopolies. how a monopoly price discriminates.


What will you study next time?

What is meant by an oligopoly? What is a duopoly? What are some special issues

about oligopolies? How do governments deal with

oligopolies?

10/22/2014CRC Microeconomics1. 10/22/2014CRC Microeconomics2 What did you study last time? 1.What is...

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