Monopoly - MS. LOPICCOLO'S WEBSITElopiccolo.weebly.com/.../4/7774746/ch_15_notes_with_natual_monop… · Monopoly is business at the end of its journey. ... monopolist has to lower

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:

• MC = MR

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 (price is always derived from the demand curve)


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

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

15-17

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

15-19

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

15-21

Monopoly 15

Price

Quantity

Demand

0

Marginal Revenue

Inelastic range

Elastic Range

Price

Quantity0

Total Revenue

•Note that in the inelastic range of the demand curve, MR is negative and TR falls as Q increases.

A monopoly will only

produce in the elastic

range

Total Revenue TestIf price falls and TR

increases, then demand is elastic.If price falls and TR falls, then demand

is inelastic.

So, when MR is zero, demand is unit elastic

Monopoly: Elastic and Inelastic Range

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

15-24

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

Q

P

ATC

Qprofit max

P1

MC

DMR

SO/AE

Monopoly 15

Fair Return Level for a Monopoly

15-25

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

Q

P

ATC

Qprofit max

P1

MC

DMR

FR

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

15-26

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

15-28

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

15-29

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

15-30

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)

15-32

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

15-34

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

15-35

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

15-36

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)

15-37

Monopoly 15

Natural Monopoly

15-38

• 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

15-40

Monopoly 15

Natural Monopoly

Q

QSOQ profit max

ATC

D

MR

MC

P profit max

PSO

15-41

Monopoly 15

Natural Monopoly

Q

QSOQ profit max

ATC

D

MR

MC

P profit max

PG

15-42

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

15-45

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

15-46

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

15-47

Documents

Monopoly - MS. LOPICCOLO'S WEBSITElopiccolo.weebly.com/.../4/7774746/ch_15_notes_with_natual_monop… · Monopoly is business at the end of its journey. ... monopolist has to lower