Ch 09 monopoly micro econ4

© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.



Chapter 9 ECON4 William A. McEachern

1

Monopoly





Barriers to Entry

• Monopoly

– Sole supplier of a product with no close

substitutes

• Barrier to entry

– Any impediment that prevents new firms

• From entering an industry

• And competing on an equal basis with

existing firms

2© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as






Barriers to Entry

• Barriers to entry

– Legal restrictions

– Economies of scale

– Control of essential resources







Barriers to Entry

• Legal restrictions

– Patents and invention incentives

• Exclusive right to sell a product for 20 years

from the date the patent application is filed

• Incentive for innovation

– Licenses and other entry restrictions

• Government awarding an individual firm the

exclusive right to supply a particular good or

service

• Federal and state license







Barriers to Entry

• Economies of scale

– Natural monopoly

– Downward-sloping long-run average cost

curve

• One firm can supply market demand at a

lower average cost per unit than could two

firms





Exhibit 1

6

Economies of Scale as a Barrier to Entry

Quantity

per period

Cost

per

unit

$

Long-run

average cost

A monopoly sometimes emerges

naturally when a firm

experiences economies of scale

as reflected by a downward-

sloping long-run average cost

curve. One firm can satisfy

market demand at a lower

average cost per unit than could

two or more firms, each

operating at smaller rates of

output.





Barriers to Entry

• Control of essential resources

– Firm’s control over some resource critical

to production

– Alcoa (aluminum)

• Control the supply of bauxite

– Professional sports leagues

– China (pandas)

– DeBeers Consolidated Mines (diamonds)

7





Barriers to Entry

• Supplying something that other

producers can’t match

– Unique experience

• Monopolies

– Local, national, international

• Long-lasting monopolies

– Rare - economic profit attracts

competitors

– Technological change8





Revenue for the Monopolist

• Monopoly

– Supplies the market demand

• Downward-slopping (law of demand)

– To sell more: must lower the price on all

units sold

• Total revenue TR=pˣQ

• Average revenue AR=TR/Q

– For monopolist: p=AR

• Demand curve = average revenue curve9



Exhibit 2

10

A Monopolist’s Gain and Loss in Total Revenue from Selling

a Fourth Unit

D = Average revenue

Dolla

rs p

er

dia

mon

d

$7,0006,750

1-carat diamonds

per day3 40

Loss

Gain

If De Beers increases

quantity supplied from 3 to 4

diamonds per day, the gain in

revenue from the fourth

diamond is $6,750. But the

monopolist loses $750 from

selling the first 3 diamonds

for $6,750 each instead of

$7,000 each. Marginal

revenue from the fourth

diamond equals the gain

minus the loss, or $6,750

$750 $6,000. Thus, the

marginal revenue of $6,000 is

less than the price of $6,750.





Revenue for the Monopolist

• Marginal revenue MR=∆TR/∆Q

– For monopolist: MR<p

– Declines, can be negative

• Marginal revenue curve

– Downward sloping

– Below the demand curve (average

revenue curve)

11



Exhibit 3

12

Revenue for De Beers, a Monopolist

To sell more, the

monopolist must

lower the price on

all units sold.

Because the

revenue lost from

selling all units at a

lower price must be

subtracted from the

revenue gained

from selling another

unit, marginal

revenue is less than

the price. At some

point, marginal

revenue turns

negative, as shown

here when the price

is reduced to

$3,500.



Exhibit 4

13

Monopoly Demand, Marginal Revenue, and Total Revenue

Dolla

rs p

er

dia

mond

$3,750

0

(a) Demand and marginal revenue

(b) Total revenue

1-carat diamonds per day0 16 32

Tota

l dolla

rs

$60,000

1-carat diamonds per day16 32

D=Average revenue

Elastic

Unit elastic

Inelastic

MR

Total revenue

Where demand is price elastic,

marginal revenue is positive, so total

revenue increases as the price falls.

Where demand is price inelastic,

marginal revenue is negative, so total

revenue decreases as the price falls.

Where demand is unit elastic,

marginal revenue is zero, so total

revenue is at a maximum, neither

increasing nor decreasing.





Revenue for Monopolist

• Total revenue curve

• Reaches maximum where MR=0

• Demand curve: p=AR

• Where demand is elastic, as price falls

– Total revenue increases

– MR>0

14





Revenue for Monopolist

• Where demand is inelastic, as price falls

– Total revenue decreases

– MR<0

• Where demand is unit elastic

– Total revenue is maximized

– MR=0

15





Costs and Profit Maximization

• Monopolist

– Choose the price

– OR the quantity

– ‘Price maker’

• Price maker

– Firm with some power to set the price

– Demand curve for its output slopes

downward

– Firms with market power16





Costs and Profit Maximization

• Profit maximization

– Profit = total revenue minus total cost

– Supply the quantity where

• Total revenue exceeds total cost by the

greatest amount

• Marginal revenue equals marginal cost

17



Exhibit 5

18

Short-Run Costs and Revenue for a Monopolist



Exhibit 6

19

Monopoly Costs and Revenue

Dolla

rs p

er

dia

mond

$5,250

4,000

(a) Per-unit cost and revenue

(b) Total cost and revenue

D=Average

revenueMR

Total revenue

Diamonds per day0 16 3210

Total cost

Tota

l dolla

rs

$52,500

40,000

15,000

Average total cost

Marginal cost

Diamonds

per day16 32100

a

b

e

Profit

Maximum

profit

Profit is maximized by producing where

marginal cost equals marginal revenue, which

is point e in panel (a). A profit-maximizing

monopolist supplies 10 diamonds per day and

charges $5,250 per diamond. Total profit,

shown by the blue rectangle in panel (a), is

$12,500, the profit per unit multiplied by the

number of units sold. In panel (b), profit is

maximized by producing where total revenue

exceeds total cost by the greatest amount,

which occurs at an output rate of 10 diamonds

per day.

Maximum profit is total revenue ($52,500)

minus total cost ($40,000), or $12,500. In

panel (a) profit is measured by an area and

in panel (b) by a vertical distance. That’s

because panel (a) measures cost, revenue,

and profit per unit of output while panel (b)

measures them as totals.





Short-Run Losses

• If the price exceeds average total cost,

p>ATC

– Economic profit

• If the price is between average total cost

and average variable cost, ATC>p>AVC

– Economic loss

– Produce in short run

20





Shutdown Decision

• If the price is below the average variable

cost, p<AVC

– Average variable cost curve is above the

demand curve

– Economic loss

– Shut down in short run

21



Exhibit 7

22

The Monopolist Minimizes Losses in the Short Run

0 Q Quantity per period

pDolla

rs p

er

unit

Average total cost

Average variable cost

Marginal cost

Demand=Average revenue

Marginal revenue

a

b

c

e

Loss

Marginal revenue equals marginal cost at point e. At quantity Q, price p (at point b) is

less than average total cost (at point a), so the monopolist suffers a loss, identified by

the pink rectangle. But the monopolist continues to produce rather than shut down in the

short run because price exceeds average variable cost (at point c)





Long-Run profit Maximization

• Short-run profit

– No guarantee of long-run profit

• High barriers that block new entry

– Economic profit

• Erase a loss or increase profit

– Adjust the scale of the firm

• If unable to erase a loss

– Leave the market

23





Monopoly & Allocation of Resources

• Perfect competition

– Long run equilibrium

– Constant-cost industry

– Marginal benefit (p) = marginal cost

– Allocative efficient market

– Maximize social welfare

– Consumer surplus

24






• Monopoly

– Marginal benefit (p) > marginal cost

– Restrict quantity below what would

maximize social welfare

– Smaller consumer surplus

– Economic profit

– Deadweight loss of monopoly

– Allocative inefficiency

25






• Deadweight loss of monopoly

– Net loss to society

– When a firm with market power restricts

output and increases the price

26



Sc=MC=ATC

Exhibit 8

27

Perfect Competition and Monopoly Compared

Quantity

per periodQm Qc0

Dolla

rs p

er

unit

pm

pc

D

c

a

MRm

b

m

A perfectly competitive industry

would produce output QC,

determined by the intersection of

the market demand curve D and

the market supply curve SC. The

price would be pC. A monopoly

that could produce output at the

same minimum average cost as

a perfectly competitive industry

would produce output Qm,

determined at point b, where

marginal cost intersects marginal

revenue. The monopolist would

charge price pm. Thus, given the

same costs, output is lower and

price is higher under monopoly

than under perfect competition.





Estimating Deadweight Loss

• Deadweight loss of monopoly might be

lower

– Substantial economies of scale

• Lower cost per unit

– Keep price below the profit maximizing

value

• Public scrutiny, political pressure

• Avoid attracting competition

28





Estimating Deadweight Loss

• Deadweight loss of monopoly might be

higher

– Secure and maintain monopoly position

• Use resources; social waste

• Influence public policy (Rent seeking)

– Inefficiency

– Slow to adopt new technology

– Reluctant to develop new products

– Lack innovation

29





Price Discrimination

• Price discrimination

– Increasing profit

– Charging different groups of consumers

• Different prices

• For the same product

30





Price Discrimination

• Conditions for price discrimination

– Downward sloping demand curve

• Some market power

– At last two groups of consumers

• With different price elasticity of demand

– Ability to charge different prices

• At low cost

– Prevent reselling of the product

31





A Model of Price Discrimination

• Two groups of consumers

– One group (a): less elastic demand

– The other (b): more elastic demand

• Maximize profit

– MR=MC in each market

– Lower price for group (b)

32



Exhibit 9

33

Price Discrimination with Two Groups of Consumers

D

(a) Consumer group

with less elastic demand

LRAC, MC

(b) Consumer group

with more elastic demand

400 Quantity per period0 500 Quantity per period0

A monopolist facing two groups of consumers with different demand elasticities may be

able to practice price discrimination to increase profit or reduce loss. With marginal

cost the same in both markets, the firm charges a higher price to the group in panel

(a), which has a less elastic demand than group in panel (b).

Dolla

rs

per

unit

$3.00

1.00LRAC, MC

MR

Dolla

rs

per

unit

$1.50

1.00

D’MR’





Examples of Price Discrimination

• Airline travel

• Businesspeople (business class)

– Less elastic demand

– Higher price

• Even within the same class

– Different prices

– Discount fares

– Weekend stay

34






• IBM laser printer

• 5 pages/minute: home; cheaper

– Extra chip to insert pauses between pages

• 10 pages/minute: business; expensive

• Intel - two versions of the same

computer chip

– Cheaper version

• Same as the expensive version

• Some extra work done to reduce its speed

35






• Adobe

– Photoshop Elements

• Cheaper version of Photoshop CD

• Amusement parks

• Out-of-towners: less elastic demand

– Higher prices

• Locals: more elastic demand

– Discount coupons available at local businesses

36





Perfect Price Discrimination

• Perfectly discriminating monopolist

– Monopolist who charges a different price

– For each unit sold

– The monopolist’s dream

• Charge different price for each unit sold

– D curve becomes MR curve

– Convert consumer surplus into economic

profit

– Allocative efficiency: No deadweight loss37



Exhibit 10

38

Perfect Price Discrimination

Quantity per periodQ0

Dolla

rs p

er

unit

cLong-run average

cost = Marginal cost

D=Marginal revenue

c

a

Profit

If a monopolist can charge a different price for each unit sold, it may be able to

practice perfect price discrimination. By setting the price of each unit equal to the

maximum amount consumers are willing to pay for that unit (shown by the height of

the demand curve), the monopolist can earn a profit equal to the area of the shaded

triangle. Consumer surplus is zero. Ironically, this outcome is efficient because the

monopolist has no incentive to restrict output, so there is no deadweight loss.

Economy & Finance

Ch 09 monopoly micro econ4