monopoly. ●monopoly defined ●the monopolist’s supply decision ●can anything good be said...

Monopoly

● Monopoly Defined

● The Monopolist’s Supply Decision

● Can Anything Good Be Said About Monopoly?

● Price Discrimination Under Monopoly

● Monopoly Defined

● The Monopolist’s Supply Decision

● Can Anything Good Be Said About Monopoly?

● Price Discrimination Under Monopoly

ContentsContents

Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

Copyright© 2006 Southwestern/Thomson Learning All rights reserved.

Monopoly DefinedMonopoly Defined

● Only one firm in the industry

● No close substitute for the product

● Little chance of successful entry by a competitor

● Only one firm in the industry

● No close substitute for the product

● Little chance of successful entry by a competitor


● Barriers to entry:♦ Legal restrictions (USPS)♦ Patents (esp. pharmaceutical industry)♦ Control of a scarce resource (diamonds)♦ Deliberate entry barriers (advertising)♦ Large sunk costs (i.e. entry costs)

● Cost advantages♦ Technical superiority♦ Economies of scale

● Barriers to entry:♦ Legal restrictions (USPS)♦ Patents (esp. pharmaceutical industry)♦ Control of a scarce resource (diamonds)♦ Deliberate entry barriers (advertising)♦ Large sunk costs (i.e. entry costs)

● Cost advantages♦ Technical superiority♦ Economies of scale

Sources of MonopolySources of Monopoly

● When a large firm can produce and sell more cheaply than a small firm

● Technically, firm that has declining long-run average cost curve♦ So the more stuff is produced, the cheaper it is

to produce in terms of per-unit cost of production

● When a large firm can produce and sell more cheaply than a small firm

● Technically, firm that has declining long-run average cost curve♦ So the more stuff is produced, the cheaper it is

to produce in terms of per-unit cost of production

Natural MonopolyNatural Monopoly


FIGURE 1: Natural MonopolyFIGURE 1: Natural Monopoly

AC

Ave

rag

e C

ost

Quantity Supplied

2.5 2 1

2.00

2.50

$3.00 B

A


C


The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision

● Not a price taker♦ So can’t sell as much as she wants at the

market price

● Instead, faces a negatively sloped demand curve

● Previous analysis of perfectly competitive firm does not apply here

● Not a price taker♦ So can’t sell as much as she wants at the

market price

● Instead, faces a negatively sloped demand curve

● Previous analysis of perfectly competitive firm does not apply here



● Consumers are willing to buy more only at lower prices

● But if monopolist lowers price, he sells all output at new, lower price

● So profit-maximizing behavior for monopolist is not to set MC = P

● Consumers are willing to buy more only at lower prices

● But if monopolist lowers price, he sells all output at new, lower price

● So profit-maximizing behavior for monopolist is not to set MC = P



● Joint decision about price and output♦ If select price – quantity demanded is given by

market demand curve

♦ If select output – price is given by market demand curve

● Marginal revenue < selling price

● Joint decision about price and output♦ If select price – quantity demanded is given by

market demand curve

♦ If select output – price is given by market demand curve

● Marginal revenue < selling price



● Monopolist selects quantity to make

MR = MC♦ If MR > MC, extra unit of output will increase

total profit, so produce more

♦ If MR < MC, reducing output will increase total profit, so produce less

● Profit is highest when MR = MC

● Monopolist selects quantity to make

MR = MC♦ If MR > MC, extra unit of output will increase

total profit, so produce more

♦ If MR < MC, reducing output will increase total profit, so produce less

● Profit is highest when MR = MC



● Monopolist sets output where MC = MR

● Market demand then determines price for this output

● P > MR

● Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.

● Monopolist sets output where MC = MR

● Market demand then determines price for this output

● P > MR

● Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.

FIGURE 2: Profit-Maximizing Equilibrium for a Monopolist

FIGURE 2: Profit-Maximizing Equilibrium for a Monopolist

MC

MC

0

4

$9

AC

AC

Quantity

Pri

ce

pe

r U

nit

7

150

C D

D

P

MR

M


300

TABLE 1: A Monopolist’s Price-Output Decision

TABLE 1: A Monopolist’s Price-Output Decision




● Compared to perfect competition, a monopoly:♦ May enjoy a long-run profit

♦ Restricts its output to raise its selling price (both in the long and short runs)

♦ Leads to inefficient resource allocation

● Compared to perfect competition, a monopoly:♦ May enjoy a long-run profit

♦ Restricts its output to raise its selling price (both in the long and short runs)

♦ Leads to inefficient resource allocation

FIGURE 3: Compare Monopoly to Competitive Industry

FIGURE 3: Compare Monopoly to Competitive Industry

300

$9

AC

AC

Quantity

Pri

ce

pe

r U

nit

7

150

D

D

MC

MC

MR

B

P

M

C



Can Anything Good Be Said About Monopoly?Can Anything Good Be Said About Monopoly?

● Under some circumstances monopoly may:♦ Raise demand for its product, i.e. through

advertising (thus negating the inefficient reduction in output noted above)

♦ Reduce marginal and average cost (produce more efficiently)

♦ Stimulate innovation

● Under some circumstances monopoly may:♦ Raise demand for its product, i.e. through

advertising (thus negating the inefficient reduction in output noted above)

♦ Reduce marginal and average cost (produce more efficiently)

♦ Stimulate innovation

● Natural monopoly = average costs fall as output rises

● Costs of production would be higher if a natural monopoly were broken up into many smaller firms.

● Natural monopoly = average costs fall as output rises

● Costs of production would be higher if a natural monopoly were broken up into many smaller firms.

Natural Monopoly: Where Single-Firm Production Is CheapestNatural Monopoly: Where Single-Firm Production Is Cheapest


● Natural monopolies may allow lower average cost than a market with numerous competing firms.

● Must be regulated in order for consumers to receive lower prices, however

● Monopolist may have incentive to produce more innovation than firms in more competitive markets.

● Natural monopolies may allow lower average cost than a market with numerous competing firms.

● Must be regulated in order for consumers to receive lower prices, however

● Monopolist may have incentive to produce more innovation than firms in more competitive markets.

Natural Monopoly: Where Single-Firm Production Is CheapestNatural Monopoly: Where Single-Firm Production Is Cheapest



Price Discrimination Under MonopolyPrice Discrimination Under Monopoly

● Three types of price discrimination:♦ First Degree Price Discrimination

♦ Second Degree Price Discrimination

♦ Third Degree Price Discrimination

● We only study last one, drop the “Third Degree” part

● Three types of price discrimination:♦ First Degree Price Discrimination

♦ Second Degree Price Discrimination

♦ Third Degree Price Discrimination

● We only study last one, drop the “Third Degree” part



● Price discrimination = charge different prices to different groups of customers for the same good♦ or charge the same price in markets where

costs vary■Example: it costs the same to mail envelope to

Hawaii and to St. Cloud, though mailing costs are clearly different

● Allows a monopolist to maximize profits

● Price discrimination = charge different prices to different groups of customers for the same good♦ or charge the same price in markets where

costs vary■Example: it costs the same to mail envelope to

Hawaii and to St. Cloud, though mailing costs are clearly different

● Allows a monopolist to maximize profits



● Monopolist sets marginal revenue (not price) equal in each market♦ With different demands, prices will in general

be different

● Assumes equal cost conditions in each markets

● Monopolist sets marginal revenue (not price) equal in each market♦ With different demands, prices will in general

be different

● Assumes equal cost conditions in each markets

FIGURE 4: Prices and Quantities under Price Discrimination

FIGURE 4: Prices and Quantities under Price Discrimination

Db

Db MRa Qa MRb Qb

Pb

W

(b)

Customer Group B Customer Group A

Quantity

0

H H

Pri

ce

(a)

Quantity

Da

Da

0

J

Pa




● Sometimes price discrimination is not profitable♦ Two markets:

■Large with many wealthy customers■Small with few poor customers

♦ Then monopolist is better-off not servicing poor guys at all

♦ Example: luxury cars are expensive, because rich guys agree to pay a lot

● Sometimes price discrimination is not profitable♦ Two markets:

■Large with many wealthy customers■Small with few poor customers

♦ Then monopolist is better-off not servicing poor guys at all

♦ Example: luxury cars are expensive, because rich guys agree to pay a lot

● No, although sometimes justice appears to demand different prices in different markets (same mailing price example)

● In some cases, price discrimination may be necessary for a firm to survive (if costs are very different)

● In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices.

● No, although sometimes justice appears to demand different prices in different markets (same mailing price example)

● In some cases, price discrimination may be necessary for a firm to survive (if costs are very different)

● In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices.

Is Price Discrimination Always Undesirable?Is Price Discrimination Always Undesirable?



MonopsoniesMonopsonies

● Monospony – situation when there is a single buyer on the market

● Examples are hard to find but:♦ A small town with a single industrial power

plant – here the plant is almost a sole employer, i.e. buyer of human labor

♦ Even if multiple employers, but all workers are members of a single union, then union is a sole purchaser of labor

● Monospony – situation when there is a single buyer on the market

● Examples are hard to find but:♦ A small town with a single industrial power

plant – here the plant is almost a sole employer, i.e. buyer of human labor

♦ Even if multiple employers, but all workers are members of a single union, then union is a sole purchaser of labor


MonopsoniesMonopsonies

● Analysis is pretty similar to that of monopolized industry

● Sometimes have a bilateral monopoly:♦ When a single buyer meets a single seller, i.e.

power plant with a union

♦ Need more advanced tools to analyze this situation, so won’t do that in this course

● Analysis is pretty similar to that of monopolized industry

● Sometimes have a bilateral monopoly:♦ When a single buyer meets a single seller, i.e.

power plant with a union

♦ Need more advanced tools to analyze this situation, so won’t do that in this course

Some Problemson Monopoly


Problem 1Problem 1

● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?


Qty 18 16 14 12 10 4

Price 1 2 3 4 5 6

TC 44 38 32 26 20 14


Problem 1: SolutionProblem 1: Solution



● Monopoly would maximize profits

● So must compute profit:

Profit = TR − TC

● Make up two extra table rows, TR and Profit

● Monopoly would maximize profits

● So must compute profit:

Profit = TR − TC

● Make up two extra table rows, TR and Profit



● What is the profit maximizing quantity for monopoly, what profits will it earn?

● What is the profit maximizing quantity for monopoly, what profits will it earn?

Qty 18 16 14 12 10 4

Price 1 2 3 4 5 6

TC 44 38 32 26 20 14

TR 18*1=18 16*2=32 14*3=42 12*4=48 10*5=50 4*6=24

Profit18-44 =-26

32-38 =-6

42-32 =10

48-26 =22

50-20 =30

24-14 =10





● So Monopoly would sell 10 units for $5 each

● And would earn a profit of $50

● This concludes the problem!

● I hope you’ll be able to complete similar problem on the midterm if I ask you

● So Monopoly would sell 10 units for $5 each

● And would earn a profit of $50

● This concludes the problem!

● I hope you’ll be able to complete similar problem on the midterm if I ask you


Problem 2Problem 2

● Suppose that there is a monopolized industry where a monopoly firm has total cost function TC(Q) = 2Q2+5Q+10, and a marginal cost curve MC(Q) = 4Q+5

● Industry inverse demand is given by P(Q) = 105−3Q and the marginal revenue curve is MR(Q) = 105−6Q

● What is the profit maximizing (PM) output of the monopoly? What are her profits? What is the CS in this industry? And what is the TS?

● Suppose that there is a monopolized industry where a monopoly firm has total cost function TC(Q) = 2Q2+5Q+10, and a marginal cost curve MC(Q) = 4Q+5

● Industry inverse demand is given by P(Q) = 105−3Q and the marginal revenue curve is MR(Q) = 105−6Q

● What is the profit maximizing (PM) output of the monopoly? What are her profits? What is the CS in this industry? And what is the TS?



● To find PM output, we have to put MR = MC:

105−6Q = 4Q+5

100 = 10Q

Q = 10

● To find the price, we plug Q=10 into demand:

P = 105−3Q = 105−30 = 75 ● Thus monopolist sells 10 units of output and

charges $75 per unit

● To find PM output, we have to put MR = MC:

105−6Q = 4Q+5

100 = 10Q

Q = 10

● To find the price, we plug Q=10 into demand:

P = 105−3Q = 105−30 = 75 ● Thus monopolist sells 10 units of output and

charges $75 per unit



● We know that P = 75 and Q = 10

● Profits of monopolist are TR−TC♦ TR = P (Q) = 75 (10) = 750♦ TC = TC(10) = 2(10)2 + 5 (10) + 10 = 260♦ So profits are 750 − 260 = 490

● Consumer surplus is computed straightforwardly:♦ CS = ½ (105 − 75) 10 = (15) 10 = 150

● So TS = profit + CS = 490 + 150 = 640


● Profits of monopolist are TR−TC♦ TR = P (Q) = 75 (10) = 750♦ TC = TC(10) = 2(10)2 + 5 (10) + 10 = 260♦ So profits are 750 − 260 = 490

● Consumer surplus is computed straightforwardly:♦ CS = ½ (105 − 75) 10 = (15) 10 = 150

● So TS = profit + CS = 490 + 150 = 640


Problem 2: ContinuedProblem 2: Continued

● Now antitrust agency splits the monopoly into many identical competitive firms.

● So the industry is now perfectly competitive with inverse supply curve P(Q) = 2Q+5

● What is the new equilibrium? What are the CS, PS and TS in this equilibrium? Compare with the monopoly case.

● Now antitrust agency splits the monopoly into many identical competitive firms.

● So the industry is now perfectly competitive with inverse supply curve P(Q) = 2Q+5

● What is the new equilibrium? What are the CS, PS and TS in this equilibrium? Compare with the monopoly case.



● To find eq’m, we put Demand = Supply

105−3Q = 2Q+5

100 = 5Q

Q = 25

● To find the price, we plug Q = 25 into demand:

P = 105−3Q = 105−75 = 30 ● Thus in equilibrium 25 units will be sold for a

price of $30 per unit

● To find eq’m, we put Demand = Supply

105−3Q = 2Q+5

100 = 5Q

Q = 25

● To find the price, we plug Q = 25 into demand:

P = 105−3Q = 105−75 = 30 ● Thus in equilibrium 25 units will be sold for a

price of $30 per unit




● Consumer surplus is computed straightforwardly:

♦ CS = ½ (105 − 30) 25 = ½ (75) 25 = 937.5

● Producer Surplus is also straightforward to get:

♦ PS = ½ (30 − 5) 25 = ½ (25) 25 = 312.5

● So TS = PS + CS = 937.5 + 312.5 = 1250

● Under monopoly had TS = 640, P = 75, Q = 10, CS = 150 and PS (which was profit) = 490


● Consumer surplus is computed straightforwardly:

♦ CS = ½ (105 − 30) 25 = ½ (75) 25 = 937.5

● Producer Surplus is also straightforward to get:

♦ PS = ½ (30 − 5) 25 = ½ (25) 25 = 312.5

● So TS = PS + CS = 937.5 + 312.5 = 1250

● Under monopoly had TS = 640, P = 75, Q = 10, CS = 150 and PS (which was profit) = 490



● Perfectly competitive industry makes everyone except monopolist better-off

● The total welfare is also bigger under perfect competition

● That is why economists believe we should keep an eye on monopolies so that they do not cause this sort of inefficiencies

● Perfectly competitive industry makes everyone except monopolist better-off

● The total welfare is also bigger under perfect competition

● That is why economists believe we should keep an eye on monopolies so that they do not cause this sort of inefficiencies


The EndThe End

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monopoly. ●monopoly defined ●the monopolist’s supply decision ●can anything good be said...

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