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Chapter 12 Pure Monopoly

I. Characteristic:

1) One seller 2) No close substitutes for the good

3) Barriers to entry4) Many buyers

2) and 3) give the firm market power

5) Firms are price searchersOne firm producing all of the market’s ouptputControls price – the only game in town

I. The Monopoly Demand Curve

Flatter demand curve implies less market power, steeper demand curve implies

more market power.

II. Barriers to Entry (Also called sources of monopoly power)

6) Natural Barriers (leads to a natural monopoly)a) economies of scale b) Exclusive control of a resource

7) Artificial Barriers (Also called legal barriers) Leads to legal monopoly

III.Profit maximizing Output and Price for a Single-Priced Monopolist

Also Max profit where MR = MC

For a monopoly MR is not constantDemand Schedule

P in$’s

Q TR MR

8 0 0 0

7 1 7 7

6 2 12 5 $6 increase from selling one more unit, $1 loss from selling firstunit at lower price

5 3 15 3 5-2

4 4 16 1 4-3

3 5 15 -1 3-4

2 6 12 -3 2-5

1 7 7 -5 1-6

0 8 0 -7

Numbers above do not correspond to the following graph

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Slide 13-16Copyright © 2000 Pearson Education Canada Inc.

Demand and MarginalDemand and Marginal

Revenue CurvesRevenue Curves

00

1010

2020

55 1010

DD QuantityQuantity

P r i c e a n d m a r g i n a l

r e v e n u e

P r i c e a n d m a r g i n a l

r e v e n u e

– –1010

– – 2020

MR MR

ElasticElastic

Over the rangeOver the range

0 to 5, a price0 to 5, a price

cut increasescut increases

total revenue,total revenue,

so demand isso demand is

elastic.elastic.

d d

f f

TR, MR, and elasticity

Total Revenue in dollars or Total Expenditures


Total Revenue CurveTotal Revenue Curve

00 1010

1010

2020

3030

4040

5050

TR TR QuantityQuantity

55

T o t a l r e v e n u e

( d o

l l a r s

p e r h o u r )

T o t a l r e v e n u e

( d o

l l a r s

p e r h o u r )

ZeroZero

marginalmarginalrevenuerevenue

A monopolist wants to operate where MR > 0 (TR is increasing).

Profit maximizing price and output graphically:

PROFIT

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EconomicEconomic

profit $12profit $12

MC MC

MR MR

A Monopoly’s Output andA Monopoly’s Output and

PricePrice

00 11 22 33 44 55

2020

QuantityQuantity

P r i c e

a n d

c o s t ( d o l l a

r s

p e r h o u r )

P r i c e

a n d

c o s t ( d o l l a

r s

p e r h o u r )

DD

ATC ATC

Profit = $12Profit = $12($4 x 3 units)($4 x 3 units)

1010

1414

Look and TR<TC and profit on graph

The monopolist uses the same shut down rule:Shut down if P < AVC No supply curve, just a supply point (*)The monopolist can’t change the highest price possible:

Must max profit where MR = MCMust keep demand curve in mind

B. A monopolist suffering a loss:

GRAPH

C. A monopolist breaking even:

GRAPH

Can a monopolist sustain profits in the long-run?

Pros and Cons of the Monopoly Market Structure

Advantages:1) Provides incentive for innovation

If you knew you can reap a profit from an invention, there is incentive to invent.2) Take advantage of economies of scale and scope

Take advantage of being a natural monopolist with lower average costsTake advantage of producing a variety of products using the same inputs

Disadvantages:

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1) Limits options to consumers (and we pay a higher price)2) Profit and losses don’t send proper signals or send proper incentives

3) Rent seeking behavior (rent is another word for monopoly profit) spending

money to obtain a monopoly position

How much will you pay to be a monopoly?

You will pay a cost of rent seeking no greater than the amount of the monopoly profits

4) Productive inefficiency P > min ATCFor perfect comp. In long-run P = min ATC

5) Allocative inefficiency (if all eff, P = MC)P >MCIn perfect competition P = MC so perfect comp is allocatively efficient.

6) Deadweight Loss or Welfare Loss (result of allocative inefficiency)To explain this in more detail discuss consumer and producer surplus first

Consumer and Producer Surplus

Consumer surplus = amount willing to pay – amount actually must pay

(market equilibrium price)Consumer surplus and market surplus are not the same thing

Consumer surplus is benefit the consumer gets from a transaction beyond what theyactually had to pay.

GRAPH

Producer Surplus =

amount actually paid to producer (market price)

amount must be paid to be willing to provide the good.

Show graphically

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Inefficiency of MonopolyInefficiency of Monopoly

P

r i c e

P

r i c e

QuantityQuantity00

DD == MBMB

Q Q C C

P P C C

S S == MC MC

Consumer Consumer

surplussurplus

EfficientEfficient

quantityquantity

Producer Producer

surplussurplus

Monopoly’s gainMonopoly’s gain

DeadweightDeadweight

lossloss

MR MR

P P M M

Q Q M M

Allocative Efficiency and Dead Weight Loss

We can also think of the demand curve as the marginal benefit curve (MB)The supply curve is the marginal cost curve (MC).

At equilibrium

MB = MC and resources are going exactly where consumers want it to goThis is allocative efficiencyAlso all of the consumer and producer surplus is being experienced

- When we are in a perfectly competitive market, this is the level of marketexchange that occurs, so we achieve allocative efficiency.

Suppose that output is restricted (This may happen in other market structures)

- Some of the producer and consumer surplus is not experienced. (See graphabove)

- This loss in producer and consumer surplus is called deadweight loss or

welfare loss (when we have this loss we allocative inefficiency. More producer and consumer surplus could be achieved by increasing the level of exchange inthe market).

Deadweight loss in the monopoly graph:- loss in consumer surplus due to monopoly- loss in producer surplus due to monopoly- welfare loss or deadweight loss- consumer surplus that is transferred into monopoly profit

Having deadweight loss means you are allocatively inefficient.

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Price Discrimination - The practice of charging different consumers different prices for the same good or service.

This is when we call them a multi-price monopolist


A Single Price of Air A Single Price of Air TravelTravel

600600

Passengers (thousands per year)Passengers (thousands per year)

P r i c e

( d o l l a r s

p e r t r i p )

P r i c e

( d o l l a r s

p e r t r i p )

DD

00 55 88 1010 1515 2020

300300

900900

12001200

15001500

18001800

21002100

Consumer Consumer surplussurplus

$48$48millionmillion

EconomicEconomicprofitprofit

ATC ATC

MR MR

MC MC


Price DiscriminationPrice Discrimination

MR MR

600600

Passengers (thousands per year)Passengers (thousands per year)

P r i c e

( d

o l l a r s

p e r t r i p )

P r i c e

( d

o l l a r s

p e r t r i p )

DD

00 66 88 1010 1515 2020

300300

900900

12001200

14001400

18001800

21002100

ATC ATC

MC MC Increased economicIncreased economic

profit from priceprofit from price

discriminationdiscrimination

16001600

4422

Three conditions that must exist for affirm to price discriminate1) Firms must face a downward sloping demand curve2) Must be able to segment market:

3) Must be able to prevent arbitrage

Perfect price discrimination:

Charger each person a different priceExtracts all consumer surplus

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