principles of microeconomics - monopoly

8/3/2019 Principles of Microeconomics - Monopoly

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Monopolies

Dr. Katherine Sauer

Principles of Microeconomics

ECO 2020


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Overview:

I. The Firms Marginal Revenue and Demand

II. The Firms Output and Price

III. The Firms Profits: Graphically

IV. EfficiencyV. Price Discrimination


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Recall the characteristics of a monopoly market:

one firm

unique product

complete barriers to entry

Monopolies exist because ofbarriers to entry.

- control the resource

- government license

- natural monopoly

A monopoly is a price setter. That is, the firm can

determine what price to charge.

- charge according to demand


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I. The Firms Marginal Revenue and Demand

TR = P x Q

AR = P

MR = change in TR

change in Q

MR P


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The demand curve for a monopoly firm is downward

slopingbecause it is the market demand curve.

- the monopoly is the only firm therefore the

market demand is the same as the firm demand


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The marginal revenue curve is also downward sloping.- for linear demand, marginal revenue is twice as

steep

Ex: demand: P = 100 1/3Qmarginal revenue: MR = 100 2/3Q

demand: P = 50 Q

marginal revenue: MR = 50 2Q


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Q

P

D

MR


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II. The Firms Level of Output and Price

We learned previously that the firm will produce the levelof output where marginal revenue is equal to marginal cost.

Graphically: P

Q

MC

Q*

D

MR


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Since a monopolist is a price setter, it can charge a price as

high as demand will allow.

P

P*

Q

MC

Q*

D

MR


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Notice that for a monopolist, at Q*, theprice is higher than

marginal cost and marginal revenue.

- monopolist is not allocatively efficient

P

P*

Q

MC

Q*

D

MR

P = MR = MC


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Algebraically:

The Whatsa Widget Company has a monopoly in the sale of

widgets. Here is the firms demand and total cost:

Output Price TR TC MR MC Profit

0

1

2

3

4

5

15

14

13

12

11

10

0

14

26

36

44

50

8

11

16

26

39

57

---

14

12

10

8

6

---

3

5

10

13

18

-8

3

10

10

5

7

This firm will produce 3 units of output.

This firm will charge $12 per unit.


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III. The Firms Profits Graphically

Because a monopoly IS the entire market, we rarely need

to worry about the shut down point.

We will instead focus on the ATC and profits.

if P > ATC, then profits

if P = ATC, then break even

if P < ATC, then loss

A monopoly firm will compare P to ATC at the profit

maximizing level of output to determine its profits.

- at the quantity where MR = MC, compare the

price to the ATC


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P

P*

Q

MC

A. At Q*, P > ATC

ATCATC*

profits

(P ATC)Q > 0

Q*

DMR


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B. At Q*, P = ATC

There is no profit area to

illustrate because profits

are equal to zero.P

P*

Q

MC

ATCATC* =

(P ATC)Q = 0

Q*

DMR


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P

P*

Q

MC

C. At Q*, P < ATC

ATCATC*

loss

(P ATC)Q < 0

Q*

DMR


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Recap:

1) Produce the level of output where MR = MC.

2) Charge theprice according to the demand curve at Q*.

3) Compare the price to the ATC at Q* to determine

profits or losses.


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IV. Efficiency

A monopoly firm may or may not beproductively

efficient.

(producing at minimum of ATC)

A monopoly firm is neverallocatively efficient

P > MC always


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Monopoly Market vs Competitive Market

Monopoly markets result in some deadweight loss.

The demand curve represents the value thatbuyersplace

on each additional unit of a good or service.

The marginal cost curve represents the additional cost of

producing each unit of a good or service.

The socially efficient quantity of output is found wherethe demand curve and the marginal cost curve intersect.

This is where total surplus is maximized.


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P

P*

Q

MC

Q*

D

MR

Psocially

optimal

Qsocially

optimal

DWL

A monopoly market

results in a lower quantity

and higher price than acompetitive market

would have.

Because the quantity islower and the price is

higher, there is

deadweight loss.

Total surplus is not at its

maximum.


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Remember, there are somebenefits to monopolies:

- although patents create monopolies, the patent

system encourages innovation

- the costs of production may make a single

producer more efficient due to economies of scale


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V. Price Discrimination

We know that people have different price elasticities ofdemand.

We also know that a firms revenues depend on elasticity

of demand.- a firm can charge a higher price to someone with

an inelastic demand

- to get someone with elastic demand to purchasethe item, a firm would charge a lower price


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price discrimination: the business practice of selling

the same good at different prices to different

customers

- based on their price elasticity of demand


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Examples

Movie tickets:

matinees and evening shows are different prices

Student /Senior Citizen discounts:

show your ID and get a discount


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Coupons:if you have a coupon, the item is cheaper

Business travel vs leisure travel:travel from a Tuesday to Thursday is more expensive than

from a Friday to Sunday

Quantity discount: buy more and get a price break


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In orderto be able to price discriminate, a firm must:

1) have the ability to set its price

2) be able to group consumersby their willingness to pay3) be able to keep the markets separate (prevent

arbitrage)

Price discrimination results in higher profits for the firmbecause more output is sold and consumer surplus is

reduced.

- lower the price in the elastic market gain sales

- raise the price in the inelastic market lose fewsales

Some consumers are also better off.


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Q

P

D

MR

Student Demand Professor Demand

for Movie Tickets for Movie Tickets

Q

P

DMR

MC MC

Q* Q*

P*

P*

principles of microeconomics - monopoly

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