Today n Begin Monopoly Monopoly Chapter 22 Four

Today n Begin Monopoly

Monopoly Chapter 22

Four Basic Models ly o p o Mon firm = One A = ly o p go i l O firms few tic s i l o p = o n n o o i M petit Com e firms Som = t n c fe titio r e P pe rms m Co ny fi Ma

Profit-Maximizing Monopolist n n n Suppose only one seller in the market. For now, assume it sells all its output at the same price (no price discrimination). Choose Q to maximize: n n profits = TR - TFC - TVC. TFC do not depend on output, so maximize TR - TVC.

Marginal Revenue Recall: for the price-taking firm, MR = P. n But: the monopolist faces the market demand curve. As he sells more, he moves down the D curve and price falls. n

Graph of Marginal Revenue P What is the MR of the 4 th unit? A B Lost 3 Gained 9 10 9 How does that compare to price? 3 4 D Q Will it ever be possible to gain the price as MR?

Monopolist’s Marginal Revenue The monopolist’s marginal revenue (MR) curve lies everywhere below the demand curve. P MR < P. MR D Q

Special Case: Straight-Line Demand The MR curve for a straight-line D curve lies 1/2 -way between the D curve and the vertical axis. P MR 5 D 10 Q

Special Case: Straight-Line Demand Recall: Price elasticity falls as we move down the straight-line D curve. P Total revenue rises then falls as we move down the straight-line the D curve. =1 MR 5 D 10 Q When = 1, revenue is at its maximum. That’s when MR = 0.

Choosing Quantity n Maximize TR - TVC TR is area under the MR curve. n TVC is area under the MC curve. n Therefore maximize the difference. n

Choosing Quantity P Profits are maximized when MR = MC. TR - TVC MC MR D Q

Monopolist’s Profit. Maximizing Rule Choose Q where MR = MC, charge the highest price possible. P MC p* Check: In SR, is P AVC? MR Q* In LR, is P ATC? D Q

Monopolist’s Profit. Maximizing Rule Will this monopolist produce in the LR? P MC In the SR? p* Can you identify profits or losses? ATC MR Q* D Q

Monopolist’s Profits P MC p* ATC MR Q* D Q

The Monopolist & A Supply Curve n n A monopolist does not have a supply curve! He chooses his best price & quantity combination on the market demand curve. He is not a price taker, so the concept of a supply curve doesn’t make sense. He is a price maker.

The Monopolist and Efficiency Productive efficiency: Some have argued that a monopolist may get “lazy” and not keep costs at a minimum. n Others argue that if it’s goal is to maximize profits, that will be incentive enough to minimize costs. n This issue remains unsettled. n

The Monopolist and Efficiency n Allocative efficiency: Look at the sum of producers’ and consumers’ surpluses.

Consumers’ Surplus CS: the area under the demand curve but above price. P MC p* MR Q* D Q

Producers’ Surplus PS = TR - TVC P PS: the area under price but above MC. MC p* MR Q* D Q

Sum of Producers’ and Consumers’ Surplus Does the monopolist produce the quantity that is allocatively efficient? P MC p* MR Q* D Q

The Allocatively Efficient Quantity More PS & CS could be gained by producing QE. P MC PM The marginal benefits of the add’l units are more than their marginal costs. D QM Q E Q

Efficiency of Monopolist If the monopolist were to produce & sell the efficient quantity, he would have to set a lower price. n We say the monopolist reduces output and raises price compared to the efficient solution. n This causes a deadweight loss of producer’s & consumers’ surplus. n

Deadweight Loss of CS & PS Represents the cost to society of not producing the efficient quantity of this good. P MC PM D QM Q E Q

Effects of Monopolies Produce less than the efficient quantity. n Charge higher prices as a result. n Consumers are hurt on both counts. n

Coming Up: Barriers to entry & the monopolist. n More price discrimination n

Group Work n n Try to complete the exercise without looking back at your notes. Identify on the graph for a Monopolist n n n the profit-maximizing level of output. the price that the monopolist will charge (assuming he charges a single price for all units). the total profits or losses of the monopolist

More things to identify consumer’s surplus n producer’s surplus n the allocatively efficient quantity n the deadweight loss associated with having a monopoly in this market n the supply curve n

Monopolist’s situation