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.

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

Chapter Goals

• Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms

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

• Explain why MR = MC maximizes total profit for a monopolist

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Monopoly 15

Chapter Goals

• Show graphically the welfare loss from monopoly

• Explain why a price-discriminating monopolist will earn more profit than a normal monopolist

• Explain why there would be no monopoly without barriers to entry

• Discuss three normative arguments against monopoly

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Monopoly 15

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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Monopoly 15

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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Monopoly 15

Profit Maximizing Level of Output

• 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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Monopoly 15

Profit Maximizing Level of Output

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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Monopoly 15

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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Monopoly 15

Monopolistic Profit Maximization Graph

MC

Q

P

Find output where MC = MR, this is the profit

maximizing Q

DMC = MR

4 = Qprofit max

D at Qprofit max

P = $24

Marginal revenue is not constant as Q increases because:•revenue increases as the monopolist sells more•revenue decreases because the monopolist must lower the price to sell more

Find how much consumers will pay where the profit

max Q intersects demand, this is the monopolist price

MR

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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

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Monopoly 15

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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Monopoly 15

Determining Profits Graphically: A Firm with Zero Profit or Losses

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

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

Since P=ATC at the profit maximizing quantity,

this firm is earning zero profit or loss

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Monopoly 15

Losses

Determining Profits Graphically: A Firm with Losses

Q

P

ATC

Qprofit max

PATC

Find output where MC = MR, this is the profit

maximizing Q

Find profit per unit where the profit max Q

intersects ATC

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

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

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Monopoly 15

The Welfare Loss from a Monopoly

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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Monopoly 15

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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Monopoly 15

The Price-Discriminating Monopolist

• Examples of price discrimination• Movie discounts to senior citizens and children• Airline discounts for Saturday-night stay overs• Cars are seldom sold at list price• Tracking consumer information and pricing

accordingly

• These markets are highly susceptible to price discrimination because the market demand is made up of distinguishable individuals who have different demand elasticites

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Monopoly 15

Barriers to Entry

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

• Government-Created Monopolies• Patents, licenses, and franchises

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

else

• Economies of Scale• Natural monopoly is when a single firm can

produce at a lower cost than can two or more firms

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Monopoly 15

A Natural Monopoly Graph

Q

Average Cost

Q0.5

C1

Q1Q0.33

C0.5

C0.33

ATC

• One firm producing Q1 has average cost C1

• If two firms share the market, each produces Q0.5 and has average cost C0.5

• If three firms share the market, each produces Q0.33 has average cost C0.33

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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

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Monopoly 15

Normative Views of Monopoly

• Monopolies cause potential monopolists to waste resources trying to get monopolies

• Rent-seeking activities

• Monopolies are unjust because they restrict freedom to enter business

• Monopolies transfer income from “deserving” consumers to “undeserving” monopolists

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Monopoly 15

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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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

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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

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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

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Monopoly 15

Preview of Chapter 16: Monopolistic Competition and Oligopoly

• List the four distinguishing characteristics of monopolistic competition

• State the central element of oligopoly

• Demonstrate graphically the equilibrium of a monopolistic competitor

• Explain why decisions in the cartel model depend on market share and decisions in the contestable market model depend on barriers to entry

• Describe two empirical methods of determining market structure

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