Monopoly Sources: Main source textbook, Ch. 11; McAfee’s online text Ch. 15 is also worth a look. Monopoly : a market with a single seller. (Greek: ‘mono’ = one, ‘poly’=seller) - Monopolist’s demand curve: - It is the market demand curve (demand summed across all buyers). - Not perfectly elastic (flat) as in perfect competition: there the firm is a price taker. - Demand is downward sloping in price. 1
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Monopoly
Sources: Main source textbook, Ch. 11; McAfee’s online text Ch. 15 is also worth a look.
Monopoly: a market with a single seller.
(Greek: ‘mono’ = one, ‘poly’=seller)
- Monopolist’s demand curve:
- It is the market demand curve (demand summed across all buyers).
- Not perfectly elastic (flat) as in perfect competition: there the firm is a price taker.
- Demand is downward sloping in price.
- Text definition of monopoly:
- no close substitutes for the firm’s product.
(vs. monopolistic competition: see Ch. 13)
- The downward sloping demand curve drives differences from perfectly competitive firm model.
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- Why so much focus on the monopoly model?
Broader applications
- Markets with a single-seller don’t seem to be that common.
- The model of monopoly has wider application than “single-seller” markets.
e.g. cartels ; markets where firms have ‘market power’
Cartel: a group of businesses acting collectively can give a monopoly outcome.
- Firms may have “monopoly power” or “market power” yet not be the only seller.
- P. McAfee Introduction to Economic Analysis Ch. 15 (website)
A firm has ‘monopoly power’ or ‘market power’ if it:
- faces a downward sloping demand curve;
- can charge more than marginal cost and sustain sales.
- Some models of ‘oligopoly’ and models of ‘monopolistic competition’ are built from the monopoly model.
- Are we in an age of monopoly power? Tech & social media giants, high profits.
The Economist Nov. 17, 2018 Special Report: Competition (https://www.economist.com/special-report/2018/11/15/across-the-west-powerful-firms-
are-becoming-even-more-powerful )
De Loecker and Eeckhout (2017) The Rise of Market Power (http://www.janeeckhout.com/wp-content/uploads/RMP.pdf )
- Benefit of producing extra output: extra revenue(marginal revenue = MR)
- Cost of producing extra output: marginal cost (MC).
- Produce more output if MR>MC.
- Produce less output if MR<MC.
- Don’t change output if MR = MC.
(This reasoning relies on comparisons at the ‘margin’, i.e. focuses on small, marginal changes. These comparisons typically give the desired result and many microeconomic models rely on such comparisons. See text Ch. 1)
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Single-Price Monopoly’s Marginal Revenue:
Total revenue (TR) = Price x (Quantity of output) = P x Q
Marginal revenue = extra revenue from producing an extra unit of outputTR / Q (=∂TR/∂Q with calculus)
denotes change in the following variable (calculus: use a derivative instead; notation: use ∂ in place of ∆)
For a monopolist:
MR = P + Q P/Q (P + Q ∂P/∂Q calculus)
- Why? - sell an additional unit of output for the price P. (first term of MR, area B in graph)
- to sell another unit of output the firm cuts itsprice by P/Q. (P1-P0 in diagram)
- this loses revenue on the Q units the firm would sell if it had not boosted output (area A in graph).
- Note: P/Q < 0 (moving down demand curve)
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- Whether MR is >, < or =0 depends on whether the first or second term of MR is larger:
MR = P + Q P/Q
= P + Q P P (multiply and divide by P) Q P
= P + P 1 Q/Q P/P
= P ( 1 + 1/ )
where: = price elasticity of demand = Q/Q P/P
- So (where | | means absolute value):
MR > 0 if demand is elastic || > 1 ( < -1)
MR = 0 if demand is unit elastic || = 1 ( = -1)
MR < 0 if demand is inelastic || < 1 ( > -1)
(a familiar result: see Ch. 4 )
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- The MR curve: plot MR ($ per unit of extra output) vs. output.
- lies beneath the demand curve (height of the demand curve is P, height of MR is P + Q P/Q ).
- distance between the curves tends to grow with Q (second term of MR gets absolutely larger).
- Linear demand curve and MR:
P = a – b Q a and b intercept and slope of demand curve: constants.
MR = P + Q P/Q = (a – b Q) + Q (-b) = a – 2bQ
note: linear MR curve is twice as steep as its demand curve.
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- MR and elasticity typically differs at different points on the demand curve.
- Note: a monopolist will never choose a point on the inelastic part of the demand curve.
Why? MR is negative here – producing in this range reduces revenues!
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Profit Maximizing output:
- Say for now that the monopolist has typical marginal cost (MC – upward sloping), average cost (AC – u-shaped) and average variable cost (AVC) curves (u-shaped) – see figure next page.
(Typical from point of view of perfect competition)
- Produce positive output only if output levels exist at which the firm can at least cover its variable costs.
i.e., output levels where Price > AVC
(demand curve higher than AVC in short-run)(long-run: Price > AC too)
- Raise output if: MR > MC (makes extra profit of MR-MC)
- Lower output if:MR < MC (avoid loss of MR–MC)
- Best positive level of output (Qmon):
MR = MC
- charge price at which demand just equals Qmon.
(Calculus version:
Profit = Total Revenue – Total Cost = TR - TC
At maximum profit: ∂Profit = 0∂Q
So:∂TR - ∂TC = 0 → ∂TR = ∂TC
∂Q ∂Q ∂Q ∂Q )
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- Profit level:
Profit (or loss) = TR – TC (TC = total cost)
= { (TR/Q) - (TC/Q) } Q
= ( P – AC ) Q
= (Profit per unit output) x Output
( graph: (Pmon-ACmon)∙Qmon )
- See examples: 11-1, 11-2 to work out the solution for the monopolist in a simple case (linear demand curve and constant marginal cost).