Slides prepared by Dr. Amy Peng, Ryerson University CHAPTER 8 CHAPTER 8 MONOPOLY MONOPOLY Part Two: Microeconomics Part Two: Microeconomics of Product Markets of Product Markets
Jan 07, 2016
Slides prepared by Dr. Amy Peng, Ryerson University
CHAPTER 8CHAPTER 8MONOPOLYMONOPOLY
Part Two: Microeconomics Part Two: Microeconomics of Product Marketsof Product Markets
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8 2
In this chapter you will learn:In this chapter you will learn:
8.1 The characteristics of a monopoly8.2 About the profit-maximizing price
and output in pure monopoly8.3 About the economic effects of
monopoly8.4 Why a monopolist prefers to charge
different prices in different markets8.5 The choices facing governments
that regulate monopolies8.6 About the deadweight loss
associated with monopoly
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 3
MonopolyMonopoly
Characteristics:• Single Seller• No Close Substitutes• Price-Maker• Blocked EntryExamples of Monopoly
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 4
Quantity (millions)Quantity (millions)
$20$20
1515
1010
00 5050 100100 200200
ATCATC
DD
If ATC declines over the entire market demand,If ATC declines over the entire market demand,least-cost production is realized only ifleast-cost production is realized only if
there is one producer - a natural monopolythere is one producer - a natural monopoly
If ATC declines over the entire market demand,If ATC declines over the entire market demand,least-cost production is realized only ifleast-cost production is realized only if
there is one producer - a natural monopolythere is one producer - a natural monopoly
Barrier to Entry – Barrier to Entry – Figure 8-1 Economies of ScaleFigure 8-1 Economies of Scale
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 5
Barriers to EntryBarriers to Entry
• Economies of Scale• Legal Barriers to Entry: Patents
and Licences• Ownership or Control of
Essential Resources• Pricing and Other Strategic
Barriers to Entry
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 6
Monopoly DemandMonopoly Demand
Three basic assumptions:• Monopoly status is secured• Firm is not governmentally
regulated• Firm charges the same price for
all units
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 7
Monopoly DemandMonopoly Demand
1. Marginal revenue is less than price
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 8
Q P TR
0 $172
1 162
2 152
3 142
4 132
5 122
6 112
7 102
8 92
9 82
10 72
MR
Table 8-1Table 8-1
Q P TR
0 $172
$ 0
1 162 162
2 152 304
3 142 426
4 132 528
5 122 610
6 112 672
7 102 714
8 92 736
9 82 738
10 72 720
MR
$162
MR
$162
142
]]
]]
MR
$162
142
122
102
82
62
42
22
2
-18
Notice that MR < PNotice that MR < PNotice that MR < PNotice that MR < P
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 9
PP
DD
132132
When price decreases When price decreases from $142 to $132, onefrom $142 to $132, onemore unit is sold…more unit is sold…
Gain = $132Gain = $132
$142$142
1 2 3 4 5 6 1 2 3 4 5 6
Revenue will increase by $132Revenue will increase by $132with the extra unit soldwith the extra unit sold
Figure 8-2Figure 8-2Price and Marginal Revenue in Price and Marginal Revenue in
MonopolyMonopoly
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 10 1 2 3 4 5 6 1 2 3 4 5 6
PP
DD
but revenue lossbut revenue loss= $10 X 3 units= $10 X 3 units
Loss = $30Loss = $30
When price decreases When price decreases from $142 to $132, onefrom $142 to $132, onemore unit is sold…more unit is sold…
Gain = $132Gain = $132Marginal revenue Marginal revenue = $132-30= $132-30= $102 < $132 (price)= $102 < $132 (price)
Marginal revenue Marginal revenue = $132-30= $132-30= $102 < $132 (price)= $102 < $132 (price)
132132$142$142
Price and Marginal Revenue in Price and Marginal Revenue in MonopolyMonopoly
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 11
Monopoly DemandMonopoly Demand
1. Marginal revenue is less than price
2. The monopolist is a price-maker3. The monopolist sets prices in the
elastic region of demand
illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.1 12
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ
Do
llar
sD
oll
ars
Do
llar
sD
oll
ars
200
150
200
50
750
500
250 TRTR
DD
Inelastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ
MRMR
Elastic
TRTR
Figure 8-3 Demand, MR, and TR for a Figure 8-3 Demand, MR, and TR for a MonopolistMonopolist
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 13
Output and Price DeterminationOutput and Price Determination
• Cost Data– assume competitive resource
markets
• MR=MC Rule
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 14
ATC TC$10
0
$190
190
135 270
113 340
100 400
94 470
92 550
91 640
94 750
98 880
103 1030
Q P TR0 $17
2$
0
1 162 162
2 152 304
3 142 426
4 132 528
5 122 610
6 112 672
7 102 714
8 92 736
9 82 738
10 72 720
MR
$162
142
122
102
82
62
42
22
2
-18
MC
$90
80
70
60
70
80
90
110
130
150
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
Table 8-1Table 8-1
produce?produce?
produce?produce?
produce?produce?
produce?produce?
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 15
ATC TC$10
0
$190
190
135 270
113 340
100 400
94 470
92 550
91 640
94 750
98 880
103 1030
Q P TR0 $17
2$
0
1 162 162
2 152 304
3 142 426
4 132 528
5 122 610
6 112 672
7 102 714
8 92 736
9 82 738
10 72 720
Profitor loss
$-100-28
+34
+86
+128
+140
+122
+74
-14
-142
-310
MR
$162
142
122
102
82
62
42
22
2
-18
MC
$90
80
70
60
70
80
90
110
130
150
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
]]
Profit Maximization Choice
Same results as TR – TC Rule
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 16
DD
MRMR
200200
175175
150150
125125
100100
7575
5050
25250 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10
PP
Figure 8-4Figure 8-4Profit Maximization by a MonopolistProfit Maximization by a Monopolist
MCMCFind qFind qFind qFind q
MR = MCMR = MC
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 17
MCMC
$122= p $122= p
Find pFind pFind pFind p
DD
MRMR
200200
175175
150150
120120
100100
7575
5050
2525
0 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10
PP
Profit Maximization by a Profit Maximization by a MonopolistMonopolist
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 18
MCMCFind ATCFind ATCFind ATCFind ATC
DD
MRMR
200200
175175
150150
120120
100100
7575
5050
2525
0 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10
PP
ATCATC$122= p $122= p
$94=ATC$94=ATCProfitProfit
ProfitProfit=(p - ATC) X q=(p - ATC) X q=(122-94) X 5=(122-94) X 5=140=140
ProfitProfit=(p - ATC) X q=(p - ATC) X q=(122-94) X 5=(122-94) X 5=140=140
Profit Maximization by a Profit Maximization by a MonopolistMonopolist
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 19
Output and Price DeterminationOutput and Price Determination
• Cost Data– assume competitive resource
markets
• MR=MC Rule• No Monopoly Supply Curve
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 20
Output and Price DeterminationOutput and Price Determination
• Misconceptions Concerning Monopoly Pricing– Not the highest price– Total, not unit, profit
• Possibility of Losses by Monopolist
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.2 21
MCMC
LossLoss
DD
MRMR
PP
ATCATC
QQmm
PPmm
AA
VV
AVCAVC
MR = MCMR = MC
Figure 8-5 Figure 8-5 The Loss-Minimizing Position of a The Loss-Minimizing Position of a
MonopolistMonopolist
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 22
Economic Effects of MonopolyEconomic Effects of Monopoly
• Price, Output, and Efficiency– inefficient relative to a purely
competitive industry
– Pm > MC
– Pm > minimum ATC
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 23
PP
DD
PPcc
QQcc
S = MCS = MC
P=MC=minimum ATCP=MC=minimum ATCP=MC=minimum ATCP=MC=minimum ATC
Figure 8-6 Inefficiency of Figure 8-6 Inefficiency of Monopoly Monopoly
Price and Price and output if the output if the
industry were industry were competitivecompetitive
Price and Price and output if the output if the
industry were industry were competitivecompetitive
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 24
PP
DDMRMR
PPcc
QQcc
PPmm
QQmm
S = MCS = MCMonopolistMonopolist
will sell fewerwill sell fewerunits at aunits at a
higher pricehigher pricethan in purethan in purecompetitioncompetition
MonopolistMonopolistwill sell fewerwill sell fewer
units at aunits at ahigher pricehigher pricethan in purethan in purecompetitioncompetition
Inefficiency of Monopoly Inefficiency of Monopoly
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 25
Economic Effects of MonopolyEconomic Effects of Monopoly
• Income Transfer– monopoly owners enriched at the
expense of consumers
• Cost ComplicationsEconomies of Scale– simultaneous consumption– network effects
X-Inefficiency
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 26
Un
it c
ost
s (d
oll
ars)
Un
it c
ost
s (d
oll
ars)
QuantityQuantity
AverageAverageTotal CostTotal Cost
QQ22
Inefficient internal operation Inefficient internal operation leads to higher-than-necessary leads to higher-than-necessary
costscosts
Inefficient internal operation Inefficient internal operation leads to higher-than-necessary leads to higher-than-necessary
costscosts
Figure 8-7Figure 8-7X-InefficiencyX-Inefficiency
ATCATC22
XX''ATCATCX'X'
QQ11
XXATCATCXX
ATCATC11
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 27
Economic Effects of MonopolyEconomic Effects of Monopoly
• Cost Complications– Economies of Scale
• simultaneous consumption• network effects
– X-Inefficiency– Rent-Seeking Expenditures– Technological Advance
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.3 28
Assessment and Policy OptionsAssessment and Policy Options
• Legitimate concerns• Three policy options:
1. Charges under Canada’s anticombines laws
2. Regulate prices and operations of natural monopolies
3. Ignore monopolies which are unsustainable over the long term
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.4 29
Price Discrimination and Price Discrimination and MonopolyMonopoly
• Same product is sold at more than one price
• Not justified by cost differences• Based on differences in
“willingness to pay”
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.4 30
Price DiscriminationPrice Discrimination
• Necessary Conditions.…– Monopoly Power– Market Segregation– No Resale
• Examples– airlines– theatres, golf courses– coupons– international trade
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.4 31
QQDDMRMR
MC = ATCMC = ATC
PP
QQbb
Pri
ce a
nd
Co
sts
Pri
ce a
nd
Co
sts
PPbb
(a) Small Businesses(a) Small Businesses
Figure 8-8Figure 8-8Price Discrimination to Different Groups Price Discrimination to Different Groups
of Buyersof Buyers
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.4 32
QQDDMRMR
MC = ATCMC = ATC
PP
QQss
Pri
ce a
nd
Co
sts
Pri
ce a
nd
Co
sts
PPss
(b) Students(b) Students
Price Discrimination to Different Groups Price Discrimination to Different Groups of Buyersof Buyers
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.5 33
Regulated MonopolyRegulated Monopoly
• Natural monopolies traditionally have been subject to rate (price) regulation– e.g., natural gas distributors,
regional telephone companies, electricity suppliers
• Trend to deregulation where possible– e.g., long distance telephone
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.5 34
Regulated MonopolyRegulated Monopoly
• May be desirable to maintain but regulate a natural monopoly
• Types of regulation include:– Socially optimal price where P = MC– Fair-return price where P = ATC
Illustrated…
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.5 35
DD
MRMR
MCMCATCATC
PP
UnregulatedUnregulatedmonopoly pricemonopoly priceUnregulatedUnregulated
monopoly pricemonopoly priceMM
QQmm
Pri
ce a
nd
Co
sts
Pri
ce a
nd
Co
sts
PPmm
Figure 8-9 Figure 8-9 Regulated Monopoly – Socially Regulated Monopoly – Socially
OptimalOptimalSocially Optimal PriceSocially Optimal Price
Price = MCPrice = MCSocially Optimal PriceSocially Optimal Price
Price = MCPrice = MC
QQrr
PPrrLOSSLOSS
Allocatively Allocatively efficient efficient BUTBUTSubsidy requiredSubsidy required
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.5 36
DD
MRMR
MCMCATCATC
PP Fair Return PriceFair Return PricePrice = ATCPrice = ATC
Fair Return PriceFair Return PricePrice = ATCPrice = ATC
ff
MM
QQmm QQrrQQff
Pri
ce a
nd
Co
sts
Pri
ce a
nd
Co
sts
PPmm
PPrr
PPff
rrFIRM BREAKS EVENFIRM BREAKS EVEN
still some underallocationstill some underallocationFIRM BREAKS EVENFIRM BREAKS EVEN
still some underallocationstill some underallocation
Regulated Monopoly – Fair Regulated Monopoly – Fair ReturnReturn
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.5 37
Dilemma of RegulationDilemma of Regulation
• Setting price at P = MCfirm earns losses• Setting price at P = ATCstill some underallocation of
resources• Regulation can improve
outcomes
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.6 38
Monopoly and Deadweight LossMonopoly and Deadweight Loss
• Net loss of consumer and producer surplus is deadweight loss
• Monopolist also loses producer surplus, but gains producer surplus at the expense of consumer surplus
• Consumers lose consumer surplus
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.6 39
PP
D=MBD=MB
PPcc
QQcc
S = MCS = MC
ConsumerConsumersurplussurplus
ProducerProducersurplussurplus
EfficientEfficientoutputoutput
EfficientEfficientoutputoutput
Outcomes withOutcomes withpure competitionpure competitionOutcomes withOutcomes with
pure competitionpure competition
Figure 8-10 Monopoly and Figure 8-10 Monopoly and Deadweight LossDeadweight Loss
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8.6 40
PP
D=MBD=MBMRMR
PPcc
QQcc
PPmm
QQmm
S = MCS = MC
ConsumerConsumersurplussurplus
ProducerProducersurplussurplus
Monopoly’s Monopoly’s gaingain BB
CC
Outcomes withOutcomes withpure monopolypure monopolyOutcomes withOutcomes withpure monopolypure monopoly
DeadweightDeadweightlossloss
DeadweightDeadweightlossloss
Monopoly and Deadweight LossMonopoly and Deadweight Loss
©2007 McGraw-Hill Ryerson Ltd.
Chapter 8 41
Chapter SummaryChapter Summary
8.1 Characteristics of Pure Monopoly 8.2 Output and Price Determination in
a Monopoly– MR = MC
8.3 Economic Effects of Monopoly 8.4 Price Discrimination and
Monopoly 8.5 Regulated Monopoly
– Socially optimal price or fair-return price 8.6 Monopoly and Deadweight Loss