Monopoly 15 CHAPTER 15 Monopoly is business at

Monopoly 15 Chapter Goals • Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms • Explain why MR = MC maximizes total profit for a monopolist • Determine a monopolist’s price, output, and profit graphically and numerically 15 -2

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 15 -3

Monopoly 15 A Monopolistic Market • Monopoly is a market structure in which one firm makes up the entire market • Barriers to entry into the market prevent competition • Barriers to entry can be: • Legal • Sociological • Natural • Technological • There are no close substitutes for the monopolist’s product 15 -4

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 15 -5

Monopoly 15 Profit Maximizing Level of Output • The goal of the monopolistic firm is to maximize profits, the difference between total revenue and total cost • The monopoly maximizes profit when marginal revenue equals marginal cost • Marginal revenue (MR) is the change in total revenue associated with a change in quantity • Marginal cost (MC) is the change in total cost associated with a change in quantity 15 -6

Monopoly 15 Profit Maximizing Level of 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 If MR > MC, • The monopoly can increase profit by increasing output If MR < MC, • The monopoly can increase profit by decreasing its output 15 -7

Monopoly Monopolistic Profit Maximization Table Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($) 0 36 0 1 33 33 2 30 60 3 27 81 4 24 96 5 21 105 6 18 108 7 15 105 8 12 96 9 9 81 33 27 21 15 9 3 -3 -9 -15 47 48 50 54 62 78 102 142 198 278 1 2 4 8 16 54 40 56 80 --- -47 48. 00 -15 25. 00 10 18. 00 27 15. 50 34 15. 60 27 17. 00 6 20. 29 -37 24. 75 -102 30. 89 -197 15 The profitmaximizing condition is: MR = MR If MC < MR, increase production Profit maximizing quantity is where MC = MR If MC > MR, decrease production 15 -8

Monopoly 15 Monopolistic Profit Maximization Graph 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 P MC D at Qprofit max P= $24 Find output where MC = MR, this is the profit maximizing Q MC = MR MR 4 = Qprofit max D Q Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price 15 -9

Monopoly 15 Monopoly Compared to Perfect Competition Graph • In a monopoly, P>MR, • In perfect competition, P=MR=D • MR=MC is the profit max rule for both P MC First find the monopoly Q and P PM PPC DPC= MRPC DM MRM QM QPC Q Then find the perfectly competitive Q and P Outcome: Monopoly output is lower and price is higher than perfect competition 15 -10

15 Monopoly Find output where MC = MR, this is the profit maximizing Q Determining Profits Graphically: A Firm with Profit P Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price Find profit per unit where the profit max Q intersects ATC MC D at Qprofit max P ATC Profits ATC at Qprofit max MC = MR Since P>ATC at the profit maximizing quantity, this firm is earning profits MR Qprofit max D Q 15 -11

Monopoly Determining Profits Graphically: A Firm with Zero Profit or Losses P P =ATC ATC at Qprofit max MC = MR MR Qprofit max Find output where MC = MR, this is the profit maximizing Q Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MC D at Qprofit max 15 D Q Find profit per unit where the profit max Q intersects ATC Since P=ATC at the profit maximizing quantity, this firm is earning zero profit or loss 15 -12

15 Monopoly Find output where MC = MR, this is the profit maximizing Q Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price Find profit per unit where the profit max Q intersects ATC Since P<ATC at the profit maximizing quantity, this firm is earning losses Determining Profits Graphically: A Firm with Losses P ATC at Qprofit max ATC P MC ATC D at Qprofit max Losses MC = MR MR Qprofit max D Q 15 -13

15 Monopoly The Welfare Loss from a Monopoly P • The welfare loss from a monopoly is represented by the triangles B and D MC PM PPC C • The rectangle C is a transfer of surplus from the consumer to the monopolist D B A QM QPC MR D Q • The area A represents the opportunity cost of diverted resources, which is not a loss to society 15 -14

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 15 -15

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 15 -16

Monopoly 15 Barriers to Entry • 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 • Government-Created Monopolies • Patents, licenses, and franchises • If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits 15 -17

Monopoly 15 A Natural Monopoly Graph Average Cost • One firm producing Q 1 has average cost C 1 • If two firms share the market, each produces Q 0. 5 and has average cost C 0. 5 • If three firms share the market, each produces Q 0. 33 has average cost C 0. 33 C 0. 5 C 1 Q 0. 33 Q 0. 5 Q 1 ATC Q 15 -18

Monopoly 15 A Natural Monopoly Graph, Profit and Regulation • A natural monopolist produces QM and charges PM, therefore earning a profit Average Cost PM CM CC PC • 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 Profits Losses MR QM QC ATC MC D Q 15 -19

Monopoly 15 Normative Views of Monopoly • Monopolies are unjust because they restrict freedom to enter business • Monopolies transfer income from “deserving” consumers to “undeserving” monopolists • Monopolies cause potential monopolists to waste resources trying to get monopolies • Rent-seeking activities 15 -20

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. 15 -21

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 -22

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 a lower price to those with more elastic demand 15 -23

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 -24

Monopoly 15 Preview of Chapter 16: Monopolistic Competition and Oligopoly • List the four distinguishing characteristics of monopolistic competition • Demonstrate graphically the equilibrium of a monopolistic competitor • State the central element of oligopoly • 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 15 -25