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Chapter 12

Monopoly

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FIGURE 12-1

Natural Monopoly

When the LAC curve is declining throughout, it is always cheaper for a single firm to serve the entire industry.

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FIGURE 12-2

The Total Revenue Curve for a Perfect Competitor

Price for the perfect competitor remains at the short-run equilibrium level P* irrespective of the firm’s output. Its total revenue is thus the product of P* and the quantity it sells: TR = P*Q.

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FIGURE 12-3

Demand, Total Revenue, and Elasticity

For the monopolist to increase sales, it is necessary to cut price (top panel). Total revenue rises with quantity, reaches a maximum value, and then declines (middle panel). The quantity level for which the price elasticity of demand is unitary (= –1) corresponds to the midpoint of the demand curve, and at that value total revenue is maximized.

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FIGURE 12-4

Total Cost, Revenue, and Profit Curves for a Monopolist

Economic profit [(Q) in the bottom panel] is the vertical distance between total revenue and total cost (TR and TC in the top panel). Note that the maximum-profit point, Q* = 175, lies to the left of the output level at which TR is a maximum (Q = 200).

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FIGURE 12-5

Changes in Total Revenue Resulting from a Price Cut

The area of rectangle A ($1000/wk) is the loss in revenue from selling the previous output level at a lower price. The area of rectangle B ($2500/wk) is the gain in revenue from selling the additional out-put at the new, lower price. Marginal revenue is the difference of these two areas ($2500 – $1000 = $1500/wk) divided by the change in output (50 units/wk). Here MR equals $30/unit, which is less than the old price of $60/unit.

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FIGURE 12-6

Marginal Revenue and Position on the Demand Curve

When Q is to the left of the midpoint (M) of a straight-line demand curve (for example, Q = Q0), the gain from added sales (area B) outweighs the loss from a lower price for existing sales (area A). When Q is to the right of the mid-point (for example, Q = Q1), the gain from added sales (area D) is smaller than the loss from a lower price for existing sales (area C). At the midpoint of the demand curve, the gain and the loss are equal, which means marginal revenue is zero.

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FIGURE 12-7

The Demand Curve and Corresponding Marginal Revenue Curve

For the case of a straight-line demand curve, the correspond-ing marginal revenue curve is also a straight line. It has the same vertical intercept as and twice the slope of the demand curve. Its horizontal intercept is therefore half that of the demand curve.

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FIGURE 12-8

A Specific Linear Demand Curve and the Corresponding Marginal Revenue Curve

The marginal revenue curve has the same vertical intercept as and twice the slope of the corresponding linear demand curve.

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FIGURE 12-9

The Profit-Maximizing Price and Quantity for a Monopolist

Maximum profit occurs at the output level Q*, where the gain in revenue from expanding output (or loss in revenue from contracting output), MR, is exactly equal to the cost of expanding output (or the savings from contracting output), SMC. At Q*, the firm charges P* and earns an economic profit of .

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FIGURE 12-10

The Profit-Maximizing Price and Quantity for Specific Cost and Demand Functions

As Example 12-2 illustrates, although fixed costs do affect the level of profits at any output level, they play no role in determining the profit-maximizing level of output.

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FIGURE 12-11

A Monopolist Who Should Shut Down in the Short Run

Whenever average revenue (the price value on the demand curve) is lower than average variable cost for every level of output, the monopolist does best to cease production in the short run.

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EXERCISE 12-4 Q P MR SMC AVC

0 100 100 150 150

15 85 70 70 107

25 75 50 41 84

34 66 32 32 72

50 50 0 63 63

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FIGURE 12-12

Long-Run Equilibrium for a Profit-Maximizing Monopolist

The profit-maximizing quantity in the long run is Q*, the output level for which LMC = MR. The profit-maximizing price in the long run is P*. The optimal capital stock in the long run gives rise to the short-run marginal cost curve SMC*, which passes through the intersection of LMC and MR.

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FIGURE 12-13

The Profit-Maximizing Monopolist Who Sells in Two Markets

The marginal revenuecurve for a monopolistwho sells in two marketsis the horizontal sum ofthe respective marginalrevenue curves. Theprofit-maximizing outputlevel is where the SMRcurve intersects the MCcurve, here, Q* = 10.Marginal revenue in eachmarket will be the samewhen Q = 4 and Q = 6are sold in markets 1 and2, respectively.

*1

*2

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FIGURE 12-14

A Monopolist with a Perfectly Elastic Foreign Market

The marginal revenue curve MR follows MRH > as long as MRH $ MRF, and then follows MRF. The profit-maximizing output level is where the MR curve intersects the MC curve, here Q* = 12.

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FIGURE 12-15

Perfect Price Discrimination

If the monopolist can sell each unit of output at a different price, he will charge the maximum the buyer is willing to pay for each unit. In this situation, the monopolist captures all the consumer surplus.

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FIGURE 12-16

The Perfectly Discriminating Monopolist

The marginal revenue curve for the monopo- list who can discrimi-nate perfectly is exactly the same as his demand curve. The profit-maximizing output is Q*, the one for which the SMC and demand curves intersect. Economic profit () is given by the shaded area.

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FIGURE 12-17

Second-Degree Price Discrimination

The seller offers the first block of consumption (0 to Q1) at a high price (P1), the second block (Q1 to Q2) at a lower price (P2), the third block (Q2 to Q3) at a still lower price (P3), and so on. Even though second-degree price discrimination makes no attempt to tailor rates to the characteristics of individuals or specific groups, it often enables the monopolist to capture a substantial share of consumer surplus (the shaded area).

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FIGURE 12-18

A Perfect Hurdle

When a hurdle is perfect, the only buyers who become eligible for the discount price (PL) by jumping it are those who would not have been willing to pay the regular price (PH). A perfect hurdle also imposes no significant costs on those who jump it.

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FIGURE 12-19

The Welfare Loss from a Single-Price Monopoly

A monopolist who charges a single price to all buyers will produce Q* and sell at P*. A competitive industry operating under the same cost conditions would produce Qc and sell at Pc. In comparison with the perfectly competitive outcome, single-price monopoly results in a loss of consumer surplus equal to the area of + S1. Since the monopolist earns , the cost to society is S1—called the deadweight loss from monopoly.

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FIGURE 12-20

A Natural Monopoly

The two main objections to single-price natural monopoly are that it earns economic profit ( ) and that it results in the deadweight loss of consumer surplus (S).

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FIGURE 12-21

Cross-Subsidization to Boost Total Output

A regulated monopolist is generally allowed to earn a rate of return that exceeds the actual cost of capital, which provides an incentive to acquire as much capital as possible. To increase output (thereby to increase the required capital stock), the monopolist can sell above cost in his less elastic market (market 1 in panel a) and use the resultant profits (1 > 0) to sub-sidize the losses (2 < 0) sustained by selling below cost in his more elastic market.

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FIGURE 12-22

The Efficiency Losses from Single-Price and Two-Price Monopoly

By being able to offer a discount price PL to those on the lower portion of the demand curve, the two-price monopolist (panel b) expands the market, thereby causing a much smaller efficiency loss (area Z, panel b) than in the case of the single-price monopolist (area W, panel a).

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FIGURE 12-23

Does Monopoly Supress Innovation?

The cost of producing the new, efficient lightbulb, at $.10/kilohour, is only one-tenth the cost of producing the current design, $1/kilohour. Because the monopolist’s profits with the efficient design (area of FGHK) exceed its profits with the current design (area of ABCE), it will offer the new design.

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PROBLEM 1

Firm P MR TR Q TC MC ATC AVC Yourrecommendation

A 3.90 3.00 2000 7400 2.90 3.24

B 5.90 10000 5.90 4.74 4.24

C 9.00 44000 4000 9.00 11.90 10.74

D 35.90 37.90 5000 37.90 35.90

E 35.00 3990 1000 3300at minvalue 23.94

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ANSWER 12-1

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ANSWER 12-2

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ANSWER 12-4

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ANSWER 12-5