Introduction: Thinking Like an Economist 1 CHAPTER 2 CHAPTER 12 Monopoly and Monopolistic Competition Monopoly is business at the end of its journey. —

Introduction: Thinking Like an Economist

1CHAPTER

2CHAPTER

12Monopoly and Monopolistic Competition

Monopoly is business at the end of its journey.

— Henry Demarest Lloyd

CHAPTER

14

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin


14

14-2

Chapter Goals Summarize how and why the decisions facing a

monopolist differ from the collective decisions of competing firms

Show graphically the welfare loss from monopoly

Determine a monopolist’s price, output, and profit graphically and numerically

Explain why there would be no monopoly without barriers to entry

Explain how monopolistic competition differs from monopoly and perfect competition


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14-3

A Monopolistic Market

Barriers to entry into the market prevent competition

Monopoly is a market structure in which one firm makes up the entire market

There are no close substitutes for the monopolist’s product

Barriers to entry can be:• Legal• Sociological• Natural• Technological


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14-4

The Key Difference Between a Monopolist and a Perfect Competitor

A monopolistic firm’s marginal revenue is not its price

• Marginal revenue is always below its price

• Marginal revenue changes as output changes and is not equal to the price

A monopolistic firm’s output decision can affect price

There is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit


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Determining the Monopolist’s Price and Output Numerically

Marginal revenue (MR) is the change in total revenue associated with a change in quantity

The monopoly maximizes profit when marginal revenue equals marginal cost

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

Marginal cost (MC) is the change in total cost associated with a change in quantity


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Determining the Monopolist’s Price and Output Numerically

If MR < MC, • The monopoly can increase profit by decreasing its output

If MR > MC, • The monopoly can increase profit by increasing output

The profit-maximizing condition of a monopolistic firm is:

• MR = MC

For a monopolistic firm, MR < P

A monopolistic firm maximizes total profit, not profit per unit


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14-7

Monopolistic Profit Maximization Table

Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($)

0 36 0 33

27

21

15

9

3

-3

-9

-15

47 1

2

4

8

16

54

40

56

80

--- -47

1 33 33 48 48.00 -15

2 30 60 50 25.00 10

3 27 81 54 18.00 27

4 24 96 62 15.50 34

5 21 105 78 15.60 27

6 18 108 102 17.00 6

7 15 105 142 20.29 -37

8 12 96 198 24.75 -102

9 9 81 278 30.89 -197

If MC < MR, increase

production

Profit maximizing quantity is where

MC = MR

If MC > MR, decrease

production

The profit-maximizing condition is: MR = MR


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Finding the Monopolist’s Price and Output

MC

Q

P

Find the profit maximizing level of output, where MR and MC

curves intersect

DMC = MR

Qm (profit max)

Monopolist Price: D at Qprofit max

$24

Find how much consumers will pay where Qm intersects

demand; this is the price the monopolist will chargeMR

$36

$20.50

Draw the marginal revenue, marginal cost, and demand

curves


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14-9

Comparing Monopoly and Perfect Competition

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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14-10

Profits

Determining Profits Graphically: A Firm with Profit

Q

P

ATC

Qprofit max

P

ATC

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

MC

DMC = MR

D at Qprofit max

MR

ATC at Qprofit max


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Determining Profits Graphically: A Firm with Zero Profit or Losses

Q

P

ATC

Qprofit max

P=ATC


maximizing Q


intersects ATC



MC

DMC = MR

D at Qprofit max

MR

ATC at Qprofit max

Since P=ATC at the profit maximizing quantity,

this firm is earning zero profit or loss


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14-12

Losses

Determining Profits Graphically: A Firm with Losses

Q

P

ATC

Qprofit max

PATC


maximizing Q


intersects ATC



MC

DMC = MR

D at Qprofit max

MR

ATC at Qprofit max

Since P<ATC at the profit maximizing quantity, this firm is earning losses


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14-13

Welfare Loss from a Monopoly: The Normal Monopolist

MC

Q

P

D

QM

PM

• The welfare loss from a monopoly is represented by the triangles B and D

• The rectangle C is a transfer of surplus from the consumer to the monopolist

• The area A represents the opportunity cost of diverted resources, which is not a loss to society MR

PPC

QPC

A

BDC


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The Price-Discriminating Monopolist

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

• Consumers with less elastic demands are charged higher prices.

• Consumers with more elastic demands are charged lower prices

Price discrimination increases output and profits


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B

A

MC

DQPM = QC

PC


• A price-discriminating monopolist produces the same output as the combination of all firms in a competitive market

• All firms in the perfectly competitive market capture only area B

• The price-discriminating monopolist captures all the surplus represented by areas A and B


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Examples of price discrimination• Movie discounts to senior citizens and children• Airline charge more to fly on Fridays and Sundays• Tracking consumer information and pricing

accordingly

It might seem unfair for a monopolist to charge different people different prices, but doing so eliminates welfare loss from monopoly

For a price-discriminating monopolist, because it can charge what consumers are willing to pay, all consumer surplus is captured by the monopolist


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Barriers to Entry

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

Government-Created Monopolies• Patents

Natural Ability• A firm is better at producing the good than anyone

else

Natural Monopolies• Natural monopoly is when a single firm can

produce at a lower cost than can two or more firms


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Average Cost for Natural Monopolist

Q

Average Cost

Q 1/2

C1

Q1Q 1/3

C2

C3

ATC

• One firm producing Q1 has average cost C1

• If two firms share the market, each produces Q1/2 and has average cost C2

• If three firms share the market, each produces Q1/3 has average cost C3


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Profit of Natural Monopolist

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


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Government Policy and Monopoly: AIDS Drugs

A few companies have patents for AIDS drugs that enable them to charge high prices because demand is inelastic

Policy Options• Government regulation where price = marginal cost

benefits society, but discourages research• Government purchase of the patents and allowing

anyone to produce the drugs so their price = marginal cost. This is expensive for taxpayers.


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Characteristics of Monopolistic Competition

Four distinguishing characteristics:

3. Multiple dimensions of competition make it harder to analyze a specific industry, but these methods of competition follow the same two decision rules as price competition

2. Product differentiation where the goods that are sold aren’t homogenous

1. Many sellers that do not take into account rivals’ reactions

4. Ease of entry of new firms in the long run because there are no significant barriers to entry


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Output, Price, and Profit of a Monopolistic Competitor

Like a monopoly,

• At profit maximizing output, marginal cost will be less than price

• Marginal revenue is below price

Like a perfect competitor, zero economic profits exist in the long run

• The monopolistic competitive firm has some monopoly power so the firm faces a downward sloping demand curve


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Monopolistic Competition

Q

P

QMC

MC

D

MR

PMC

ATC

• You can see that a monopolistically competitive firm prices in the same manner as a monopolist, setting quantity where marginal revenue equals marginal cost

• But the firm is also a competitor; competition implies zero economic profit in the long run (determined by ATC)


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Comparing Monopolistic Competition with Monopoly

For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)

No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entry

It is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entry


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Monopolistic Competition Compared with Perfect Competition Graph

Outcome: Monopolistic competition

output is lower and price is higher than perfect competition

• In monopolistic competition in the long run, P > min ATC

• In perfect competition in the long run, P = min ATC

Q

P

ATC

QMC

MC

DMC

MRMC

PMC

PPCDPC

QPC


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Advertising and Monopolistic Competition

Advertising increases ATC

The goals of advertising are to increase demand and make demand more inelastic

Perfectly competitive firms have no incentive to advertise, but monopolistic competitors do

The increase in cost of a monopolistically competitive product is the cost of “differentness”


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Chapter Summary 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

Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society

Monopoly output is lower and price is higher than in competitive markets

Natural monopolies exist in industries with strong economies of scale


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Chapter Summary 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

A monopolistic competitor differs from a monopolist in that a monopolistic competitor makes zero economic profit in long-run equilibrium

Monopolistic competition is characterized by many sellers, differentiated products, multiple dimensions of competition, and ease of entry for new firms

Three important barriers to entry are natural ability, economies of scale, and government restrictions

Introduction: Thinking Like an Economist 1 CHAPTER 2 CHAPTER 12 Monopoly and Monopolistic Competition Monopoly is business at the end of its journey. —

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