Monopoly

“One is the Loneliest Number”

Single Seller in the Market

No close substitutes

Price MAKER

Blocked Entry

Non-Price Competition

PURE Monopolies are RARE…Local water suppliers—whether

Government owned or privately ownedCable TVDeBeers DiamondIntel ---computer chipsMicrosoft---basic operating software

IMPORTANT:

A Monopoly DOES NOT have a SUPPLY CURVE!!!

Its MARKET DEMAND CURVE is going to determine the QUANTITY that the Monopolist is going to supply

MonopolyPriceOf ___

Quantity of _______

DM*

1 2 3 4 5 6 7 8

11

10

9

8

7

6

5

4

3

2

1

0

-1

-2

-3

-4

0 $11 1 $102 $9 3 $84 $75 $6 6 $57 $4 8 $3

x

x

x

xx

x

x

x

x

PriceQuantity

This data determines our Demand Curve for the Monopolist

The Monopolist faces a Downward sloping DemandCurve because if it wants toSell more output it mustLower its price.

MonopolyPriceOf ___

Quantity of _______

DM*

1 2 3 4 5 6 7 8

11

10

9

8

7

6

5

4

3

2

1

0

-1

-2

-3

-4

Total Revenue(P X Q)

0 $11 $0 $0 1 $10 $10 $10 2 $9 $18 $9 3 $8 $24 $8 4 $7 $28 $7 5 $6 $30 $6 6 $5 $30 $5 7 $4 $28 $4 8 $3 $24 $3

x

x

x

xx

x

x

x

x

PriceQuantityAverageRevenue

TR/Q

= AVERAGE REVENUE

NOTE: PRICE =AVERAGE REVENUE

DEMAND CURE = AVERAGE REVENUE CURVE

MonopolyPriceOf ___

Quantity of _______

MR

D*=Average Revenue

1 2 3 4 5 6 7 8

11

10

9

8

7

6

5

4

3

2

1

0

-1

-2

-3

-4

Total Revenue(P X Q)

Marginal Revenue(ΔTR/ΔQ)

0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

x

x

x

xx

x

x

x

x

PriceQuantity

x

x

x

x

x

x

x

x

AverageRevenue

TR/Q

When MR is plotted, remember Marginal means “each additional.”The MR (determined by looking at the “Price” axis) is going to fall inBetween the numbers because you Are moving from one to the other.

Monopoly Total Revenue(P X Q)

0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

PriceQuantity

AverageRevenue

TR/QMarginal Revenue

(ΔTR/ΔQ)

· A monopolist faces a downward sloping Demand curve. The firm D curveis the market D curve!· A monopolist can sell additional output only by lowering its price (due tothe law of demand).· A monopolist must lower the price of all of its output, not just themarginal units, since it is a single-price seller.· As a result, as output increases, the firm's marginal revenue falls fasterthan the price.


0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

PriceQuantity

AverageRevenue


(ΔTR/ΔQ)

Look at the “PRICE” columnand the “Marginal Revenue “column


0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

PriceQuantity

AverageRevenue


(ΔTR/ΔQ)

As we move from the production of the 1st unit to the 2nd unit, the price (and AVG Revenue) drops from $10 to $9 but the MR drops to $8. Why???

If we sell the 2nd unit for $9.00 then we get $9.00 in revenue for that unit. BUT if we sell that unit for $9.00 THEN we must sell the 1st Unit for $9.00 as well and we will “LOSE “$1.00 on that unit. So the $9.00 we get for unit 2 minus the $1.00 we lose for unit one gives us a change in revenue (MR) of $8.00…


0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

PriceQuantity

AverageRevenue


(ΔTR/ΔQ)

As we move from the production of the 3rd unit to the 4th unit, the price (and AVG Revenue) drops from $8 to $7 but the MR drops to $4. Why???

If we sell the 4th unit for $7.00 then we get $7.00 in revenue for that unit. BUT if we sell that unit for $7.00 THEN we must sell Units 1,2,3 Unit for $7.00 as well and we will “LOSE “$1.00 on each of those units. So the $7.00 we get for unit 4 minus the $3.00 we lose for units 3,2,1 gives us a change in revenue (MR) of $4.00…


0 $11 $0 $0 $01 $10 $10 $10 $102 $9 $18 $9 $83 $8 $24 $8 $64 $7 $28 $7 $45 $6 $30 $6 $26 $5 $30 $5 $07 $4 $28 $4 $-28 $3 $24 $3 $-4

PriceQuantity

AverageRevenue


(ΔTR/ΔQ)

As we move from the production of the 7th unit to the 8th unit, the price (and AVG Revenue) drops from $4 to $3 but the MR drops to $-4. Why???

If we sell the 8th unit for $3.00 then we get $3.00 in revenue for that unit. BUT if we sell that unit for $3.00 THEN we must sell Units 7,6,5,4,3,2,1 Units for $3.00 as well and we will “LOSE “$1.00 on each of those units. So the $3.00 we get for unit 8 minus the $7.00 we lose for units 7,6,5,4, 3,2,1 gives us a change in revenue (MR) of $-4.00 ($3.00 minus $7.00)

BOTTOM LINE: Marginal RevenueWill ALWAYS be less than the priceBecause the price of the previous Units has to decrease as the price Of the last (or marginal) unit Decreases…Marginal RevenueCurve is going to ALWAYS lie INSIDEOf the Demand Curve….

1 2 3 4 5 6 7 8

TotalRevenue

302520151050

x

x

xx x x x

x

The Total Revenue Curve reachesIt’s peak when Total Revenue is at It’s maximum. NOTE: Total RevenueIs MAXIMIZED when MR=0 , REPEAT, Total Revenue is MAXIMIZED when MR=0!!!!!!!

MonopolyPriceOf ___

Quantity of _______MR

D*

ATC

MC

Insert the MC and ATC Curves. NOTE: MC intersects ATC at the LOWEST POINT OF THE ATC CURVE!!!!

MonopolyPriceOf ___


D*

ATC

MC

Qe

A Monopolist is going to followThe PROFIT MAXIMIZING

QUANTITY RULE:MR=MC

MonopolyPriceOf ___


D*

ATC

MC

Qm

At the PROFIT MAXIMIZING QUANTITY the Monopolist Is going to charge a PRICE Dictated by its DEMAND CURVE

PM

Price as determined by Demand Curve

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

The Price the Monopolist gets for ALL The units of this good they produce (Qm)is Pm but the ATC of producing ALL units of the good is LESS than the Price they get For the good. To find the ATC we look Where the vertical line indicating the ProfitMaximizing Quantity CROSSES the ATC Curve

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

Economic Profit

The difference between PmAnd ATC is ECONOMIC PROFIT on Each unit produced.

MonopolyPriceOf ___


D*

ATC

MC

Pm =

Qm

ATC*

A Monopoly can “break-even”.

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

A Monopoly can have Economic Losses.ATC*Economic Loss

What is the Social Cost of MonopolyIs Price higher than it “should” be?

Is Quantity lower than it “should”?

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

Economic ProfitP1

Qs.o.

Monopolies create DEAD-WEIGHT LOSS. The DWL. The Dead-Weight LossIs the TRIANGLE A+B.

A

B

We can get an idea of the social cost of monopoly if we were to look at the Monopoly Graph.

We know in Prefect Competition Price (MR,AR, D)= MC at the lowest point of the ATC (this is LONG RUN situation f or a Perfect Competitor)

Lets Assume THREE things:

Govt now regulates this MonopolyThey want to achieve ALLOCATIVE EFFICIENCYThey want to achieve PRODUCTIVE EFFICIENCY

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

Economic Profit

Notice the FIRM is STILL Making Economic Profits, Even though P=MR=AR=D

P1

Qs.o.

If Price = MC then theMarket is achieving

ALLOCATIVE EFFICIENCY.This means consumers are

Paying for and producers are Producing the Quantity

Society desires. The Monopolist

Does NOT do this on its own!

Notice: The MONOPLY STILLEarns ECONOMIC PROFITS!!

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

Economic Profit

Now lets assume the RegulatorsWant to ACHIEVE PRODUCTIVE EFFICIENCY…The monopolist Would be required to produceWhere P=ATC = MR=D

P1

Qs.o.

If Price = lowest point on ATC then the Market is achieving

PRODUCTIVE EFFICIENCY.This means consumers are

Paying for and producers are Producing the Quantity

At the LOWEST POSSIBLE PRICE.The Monopolist would NOT do this

On its own

P=

Qs.o.1

MonopolyPriceOf ___


D*

ATC

MC

Pm

Qm

ATC*

Qs.o.

NOTE: At P=ATC = MR=D the firm Making ONLY NORMAL PROFITS! It No longer making economic profits(which include Opportunity Costs). It IS making ACCOUNTING PROFITS

P=

Qs.o.1

Economic losses by a monopolist:

P, c

osts

QD=AR=P

MR

ATC

MC

P1

ATC1

Loss

Q1

Monopolist experiencing losses

AVC

MonopolyProfit maximization

The Shut-down Rule:If the price at the profit-maximizing level of output is lower than the firm's average variable cost, then the firm would minimize its losses by shutting down. When P<AVC, the firm cannot even cover its variable costs of production

This monopolist experienced an increase in costs that eliminated its profits.

The area of loss equals the firm's (ATC - AR) x Q.

In what case would this monopolist shut down?

MonopolyProfit maximization

P, c

osts

QD=AR=P

MR

ATC

MC

AVCP1 =ATC1

Q1

Monopolist breaking even

A monopolist breaking even:

The firm is producing at the profit-maximizing level of output, where MR=MC

At Q1 the firm's ATC equals its average revenue. The firm is covering all its explicit costs and earning a normal profit, but there are no economic profits.

If demand increases or if the firm lowers its costs, economic profits will be restored.

D

Q

ATC / P(Million $)

Nuclear Power Plants

ATClr

70

40

1 4 8

150

If Demand intersects long-run average total cost while it is still downward sloping, then economies of scale present a barrier to entry.

Society is better off (more productively efficient) with only one firm producing this product.

This situation is known as a Natural Monopoly

Suppose total demand for nuclear power plants is 8 units.

·It would cost one firm a total of $320m [8x40] to build eight plants ·It would cost two firms a total of $560m [2(4x70)] to build eight plants·It would cost 8 small firms firms a total of $1,200m [8(150)] to build eight plants

The most efficient (least cost) production is achieved when only one firm produces all eight power plants. Building power plants requires large economies of scale. Total cost is minimized when one large firm builds all the plants.

MonopolyNatural Monopoly

Natural Monopoly:

Quantity

Cost

s / P

rice

Natural Monopoly

QmQfr

D=AR=P

MR

ATCMC

Pm

Qso

Pso

Pfr

Pm/Qm - the price/output combination of the unregulated monopolistPso/Qso - the socially optimal price/output combinationPfr/Qfr - the "fair-return" or break-even price set by the government

Who? - ·Natural monopolistic industries·Product is considered a necessity to consumers i.e. electric utilities, natural gas, etc...

Why? ·Because of economies of scale, only one firm is likely to produce·When firm produces at the profit-maximizing level of output, P>MC, meaning there is an under-allocation of resources in this market. ·Not enough is produced and the price is higher than socially optimal.

MonopolyNatural Monopoly - Regulated by Government

Sometimes the government regulates a firm's price or output decisions in order to achieve a more equitable or efficient allocation of resources towards certain goods or services.

How can the government regulate?The government may set a price ceiling equal to the socially optimal price (P=MC).

OR equal to the firm's ATC, so that the firm can earn a normal profit. This is called fair return price Blog Post: "To regulate or not to

regulate"

MonopolyPrice discrimination

Price discrimination: The charging of different prices to different consumers for the same product.

Perfect price discrimination: When every consumer pays exactly what he or she is willing to pay. The consumer has NO consumer surplus.

Conditions that must exist for price discrimination to occur:·Monopoly Power: possible only when a firm has market power

·Market segregation: firm must be able to segregate buyers based on their willingness to pay for the product, or their elasticities of demand

·No resale: the original buyer cannot be able to resell the product, or else they could undermine the the monopolist's market power

Blog posts: "Price Discrimination"

Airline ticket pricing: Prices based on when ticket is bought, whether the traveller stays over a weekend, length of stay, etc...

Movie theaters: Matinee prices, senior and teen discounts, concession stands get more money from those whose willingness to pay for the movie experience is higher.

Golf courses and ski resorts: Weekend vs. mid-week rates, age discounts

Grocery stores: use coupons to attract consumers with more elastic demand for particular groceries, whose willingness to pay is lower.

Computer hardware and software: Microsoft and Apple offer student and educator discounts, since they know such consumers' willingness to pay is less than some.

Discussion Question: If you were the manager of a monopolistic firm, why would you LOVE to be able to practice perfect price discrimination?

Answer: By charging each consumer exactly what he or she is willing to pay, a firm maximizes the difference between its marginal revenue and its marginal cost. For each unit of output, the firm sells it to whoever is willing to pay the most. Thereby total profits are maximized and consumers experience ZERO surplus. Welfare is thereby transferred from consumers to the monopolist.

MonopolyPrice discrimination

Examples of price discrimination:

Blog Post: "Price Discrimination 101"

P, c

osts

Q

D=AR=P

MR

ATC

MC

P1

ATC1

Economic Profit

Qm

Single price monopolist

P, c

osts

Q

MR=D=AR=P

ATC

MC

ATC1

Economic Profit

Qpd

Price discriminating monopolist

P=MC

P=MC at the last unit sold ~ Allocative Efficiency!

MonopolyConsequences of price discrimination

·More profit for the firm: green triangle bigger than the green rectangle·More output: Qpd is greater than Qm

·Zero consumer surplus: only in perfect price discrimination·Greater allocative efficiency: the last price paid equal MC

When a firm can perfectly price discriminate, it will charge each customer exactly what he is willing to pay. Therefore, MR = Price, since the firm does not have to lower the price of all previous units to sell additional output. P=MC=MR

MonopolyPractice Free Response Question

ATC

MC

D

MR

P5

P4

P3

P2

P1

Q1 Q2Q3 Q4 Q5

P/C

Q

The diagram to the right shows the cost and revenue curves for a monopoly.

(a) How does a monopolist determine its profit-maximizing level of output and price?

(b) Using the information in the graph, identify each of the following for the monopolist.

(i) The profit maximizing level of output and price

(ii) The line segment of the demand curve that is elastic

(c) Suppose that the industry depicted in the graph became perfectly competitive without changing the demand or cost curves. Identify the equilibrium price and output that would prevail in the perfectly competitive market.

(d) Using the information in the graph, identify the area of consumer surplus for each of the following.(i) The profit-maximizing monopoly(ii) The perfectly competitive industry

(e) Define allocative efficiency

(f) To be allocatively efficient, what level of output should the monopolist produce?

(g) Should the government use a per-unit tax or a per-unit subsidy to lead the monopolist to produce the allocatively efficient level of output? Explain how this tax or subsidy would achieve the allocatively efficient level of output?

Monopoly

Economy & Finance

Transcript of Monopoly