monopoly -...

Monopoly 15

Monopoly

Monopoly is business at the end of

its journey.

— Henry Demarest Lloyd

CHAPTER 15

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Monopoly 15

A Monopolistic Market

• A monopoly is a market structure in which one firm makes up the entire market

• Firm=Industry

• There are no close substitutes for the monopolist’s product

• The monopolist is a price maker

15-2

Monopoly 15

A Monopolistic Market

• Barriers to entry prevent competition

• If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits

McGraw-Hill/Irwin Colander, Economics 3

Monopoly 15

Barriers to Entry

• 1. Geography

• Location or control of resources limits competition and leads to one supplier

• 2. Government

• Government allows monopoly for public benefits or to stimulate innovation

• Think water/sewer system


Monopoly 15

Barriers to Entry

• 3. Technology or Common Use

• Patents and widespread availability of certain products lead to only one major firm controlling a market

• Example: Microsoft

• 4. Mass Production and Low Costs

• If there were three competing electric companies they would have higher costs

• Having only one electric company keeps prices lowMcGraw-Hill/Irwin Colander, Economics 5

Monopoly 15

Profit Maximizing Level of Output

• The goal of the monopolistic firm is to maximize profits (difference between total revenue and total cost)

• The profit-maximizing condition of a monopolistic firm is:

• MR = MC

15-6

Monopoly 15


• For a monopolistic firm, MR < P (ALWAYS)

• This is because to sell more units a monopolist has to lower its price

• A monopoly maximizes total profit, not profit per unit

• When marginal revenue is zero, a monopolist has maximized total revenue

15-7

Monopoly 15


• If MR > MC,

• The monopoly can increase profit by increasing output

• If MR < MC,

• The monopoly can increase profit by decreasing its output


Monopoly 15

Q

$15

10

5

$64

40

20

TR

D

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MR

Demand and Marginal Revenue Curves

What happens to TR when MR hits zero?

Total Revenue is at its peak when MR

hits zero

9

P

TR

Monopoly 15

Drawing the Monopoly Graph

• The demand curve is always downward sloping and is the market demand curve

• Draw your MC curve

• The MR curve starts at the same point on the price axis as does P

• It bisects the demand curve


Monopoly 15


• The output (Q) the monopolist will produce is where MC=MR

• Put a dot where MC=MR and take the point down to the Q axis


Monopoly 15


• Determine the price the monopolist will charge

• Take the point where MC=MR and draw a dotted line up to the demand curve

• Draw a dotted line to the price axis


Monopoly 15

Profits and Monopoly

• Determine profit or loss

• Subtract ATC from price at that level of output and multiply by the output

• (P-ATC)*Q (know this)


Monopoly 15

Profits and Monopoly

• If price is greater than ATC (P>ATC) at this output, the monopolist will make a profit

• If price equals ATC (P=ATC), the monopolist will not make a profit (zero profit/loss)

• If price is less than ATC (P<ATC) at this output, the monopolist will incur a loss


Monopoly 15

Draw the Monopoly Graph(We will add the ATC later)

MC

Q

DMR

P

Qprofit max

P1

15-15

The “big dot” is where MC=MR

Monopoly 15

Graph: Monopolist Earning a Profit

• Find output where MC = MR (profit maximizing quantity)

• Find how much consumers will pay where the profit max Q intersects demand, this is the monopolists’ price

• Find profit per unit where the profit max Q intersects ATC


Monopoly 15

Graph: Monopolist Earning a Profit

• Extend the lines from where the quantity line intersects the demand curve and the ATC to the price axis

• This rectangle is the monopolists’ profit

• Since P>ATC at the profit maximizing quantity, this firm is earning a profit


Monopoly 15

Draw the Graph: A Monopoly Earning a Profit

Find output where MC = MR, this is the profit

maximizing Q

Find profit per unit where the profit max Q

intersects ATC

Since P>ATC at the profit maximizing quantity, this firm is earning profits

Find how much consumers will pay where the profit max Q intersects demand, this is

the monopolist price

15-18

Profit

Q

P

ATC

Qprofit max

P1

MC

DMR

Monopoly 15

Graph: A Monopoly with Zero Profit or Losses

• Find output where MC = MR (profit maximizing Q)• Find how much consumers will pay where the profit

max Q intersects demand, this is the monopolists’ price


• Since P=ATC at the profit maximizing quantity, this firm is earning zero profit or loss


Monopoly 15

Draw the Graph: A Monopoly with Zero Profit or Losses

Q

P

ATC

Qprofit max

P1


maximizing Q

Find profit per unit where the profit max Q intersects ATC



MC

DMR

Since P=ATC at the profit maximizing quantity,

this firm is earning zero profit or loss

15-20

Monopoly 15

Graph: A Monopoly with a Loss

• Find output where MC = MR (profit maximizing Q)• Find how much consumers will pay where the profit

max Q intersects demand, this is the monopolists’ price


• Since P<ATC at the profit maximizing quantity, this firm is earning a loss


Monopoly 15

Losses

Draw the Graph: A Monopoly with a Loss

Q

P

ATC

Qprofit max

P1


maximizing Q

Find profit per unit where the profit max Q

intersects ATC



MC

DMRSince P<ATC at the

profit maximizing quantity, this firm is earning a loss

15-22

Monopoly 15

Monopolistic Profit Maximization Graph

MC

Q

P


maximizing Q

D

4 = Qprofit max

P = $24

Marginal revenue is not constant as Q increases because:• Revenue increases as the

monopolist sells more• Revenue decreases because the

monopolist must lower the price to sell more



MR

15-23

Monopoly 15Monopoly: Elastic and Inelastic Range

24

Q

$15

10

5

$64

40

20

TR

D

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MR

P

TR

Total Revenue TestIf price falls and TR

increases, then demand is elastic

Elastic

Total Revenue TestIf price falls and TR falls, then demand

is inelastic

A monopoly will only

produce in the elastic

range

Inelastic

So, when MR is zero, demand is unit elastic

Monopoly 15

Are Monopolies Efficient?

1. NO

2. They charge a higher price

3. They don’t produce enough

• Not allocatively efficiency

4. Produce at higher costs

• Not productively efficiency

5. Have little incentive to innovate


Monopoly 15

Socially Optimal Level (Allocatively Efficient) for a Monopoly

15-26

•Socially optimal (allocatively efficient) is where MC=D•This is where we maximize CS and PS

MC

Q

P

D

Q1

P1

MR

Monopoly 15

Fair Return Level for a Monopoly

15-27

•Fair return is when the government regulates price with a price ceiling•This is where D=ATC and where TR=TC (no economic profit)

MC

Q

P

D

Q1

P1

MR

ATC

Monopoly 15

The Key Difference Between a Monopolist and a Perfect Competitor

• A monopolistic firm’s marginal revenue is notits price

• MR is always below its price

• To sell more units, a monopolist has to decrease its price—this makes the MR curve less than demand

• Monopolies create DWL

15-28

Monopoly 15

Monopolist and a Perfect Competitor• Let’s compare where perfect competitors produce and

where monopolists produce


Profit

Q

P

ATC

Qprofit max

P1

MC

DMR

MC

Q

P

ATC

P = D = MR

Qprofit max

P1 Profits

Monopoly 15

Monopoly Compared to Perfect Competition Graph

MC

Q

P

DM

QM

PM

Outcome: Monopoly output is lower and price

is higher than perfect competition

MRM

• In a monopoly, P>MR, • In perfect competition, P=MR=D• MR=MC is the profit max rule

for both

PPC

QPC

First find the monopoly Q and P

Then find the perfectly competitive Q and PDPC= MRPC

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Monopoly 15

Why is there DWL?

• The welfare loss (DWL) from a monopoly is represented by the triangles A and B

• This is because a monopolycharges a higher price and produces a lower quantity than a perfect competitor

• Monopolies are allocatively inefficient

• To maximize CS and PS a monopolist would have to produce where MC=D

15-31

MC

Q

P

D

QM

PM

MR

PPC

QPC

B

A

Graph shows a monopolist’s price and perfect competitors' price

Monopoly 15

CS, PS, and DWL for a Monopoly

15-32

MC

Q

P

D

QM

PM

MR

DWL

CS

PS

Monopoly 15

Lump-sum tax vs. Per-unit tax

• Lump-sum tax is a one-time tax

• It affects fixed costs: AFC and ATC

• A per-unit tax is added to every unit produced

• It affects variable costs: AVC, ATC, and MC

(Learn and know these!)


Monopoly 15

The Price-Discriminating Monopolist

• All of the graphs we just learned are for non-price discriminating monopolists

• When a monopolist price discriminates, it charges different prices to different individuals (or groups of individuals)

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Monopoly 15

The Price-Discriminating Monopolist

• Consumers with less elastic demands are charged higher prices

• Consumers with more elastic demands are charged lower prices

• Price discrimination increases output and profits


Monopoly 15

Graph: The Price-Discriminating Monopolist

MC

Q

P

D=MR

15-36

QM

ATC

•Q is where it would be for a perfect competitor, where MC=MR•P, is anywhere on the demand curve because those willing to pay a higher price will•There is no CS

Profit

Monopoly 15

Examples of Price Discrimination

• Movie discounts to senior citizens and children

• Airline discounts for Saturday-night stay overs

• Cars are rarely sold at list price

• Tracking consumer information and pricing accordingly

15-37

Monopoly 15

Natural Monopoly

• Natural monopoly is when a single firm can produce at a lower cost than can two or more firms

• Significant economies of scale exist—more than one firm would prevent the monopolist from taking advantage of economies of scale

• No DWL

15-38

Monopoly 15

Natural Monopoly

• If demand intersects ATC while demand is downward sloping, we can conclude the industry is a natural monopoly

• If a firm charges at its profit maximizing point, where MC=MR, it is charging much higher than the socially optimal price (where MC=D)

• It also restricts its output (or under produces)

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Monopoly 15

Natural Monopoly

15-40

• How can society achieve a socially optimal level with a natural monopoly?

• The government can intervene with price controls and subsidies

Monopoly 15

Natural Monopoly

• A price control instituted at the socially optimal price would cause the firm to earn economic losses and shutdown

• A monopolist needs a per-unit subsidy to be able to produce the socially optimal level

• The natural monopoly is then referred to as a regulated monopoly


Monopoly 15

A Natural Monopoly Graph, Profit and Regulation

Q

Average Cost

CC

QCQM

CM

ATC

• A natural monopolist produces QM and charges PM, therefore earning a profit

• If there is government regulation and a competitive solution where P = MC is required, the monopolist produces QC and charges PC, therefore earning a loss

DMR MC

PM

PC

Profits

Losses

15-42

Monopoly 15

Natural Monopoly

Q

QSOQ profit max

ATC

D

MR

MC

P profit max

PSO

15-43

Monopoly 15

Natural Monopoly

Q

QSOQ profit max

ATC

D

MR

MC

P profit max

PG

15-44

The government would institute a price control at PG (a price ceiling) and then subsidize the firm to reduce MC

Monopoly 15

Natural Monopoly

• What happens is this: MC and ATC shift down into the negative revenue range of the graph and the government subsidizes the firm to produce at the socially optimal level

• See next graph: I don’t think you will ever see this on the AP exam, but this is what the graph would look like

• See Welker natural monopoly video


Monopoly 15

Natural Monopoly Graph

QQSO

Q

profit max

ATC

DMR

MC

P profit max

PG

MC2 with subsidyATC2

Monopoly 15

Chapter Summary

• Monopoly is a market structure, protected by barriers to

entry, in which a single firm produces a product for which

there are no close substitutes

• A monopolist maximizes profit or minimizes losses where

MR=MC

• To determine a monopolist’s profit or loss:

• Find output where MR=MC

• Determine price and ATC at that output

• Profit or loss = (P – ATC) * Q

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Monopoly 15

Chapter Summary

• Monopoly output is lower and price is higher than in

competitive markets

• Because monopolies reduce output and charge P > MC,

monopolies create a welfare loss for society

• A price-discriminating monopolist earns more profit than a

normal monopolist by charging a higher price to those with

less elastic demand and a lower price to those with more

elastic demand

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Monopoly 15

Chapter Summary

• Natural monopolies exist in industries with strong economies of scale, so it is more efficient for one firm to produce the entire output

• In a natural monopoly the competitive outcome where P=MC results in losses

• Normative arguments against monopoly are:

• Monopolies are inconsistent with freedom

• Distributional effects of monopoly are unfair

• Monopolies encourage people to waste time and money trying to get monopolies

15-49

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