Download Chapter 12 Pure Monopoly

Chapter 12 Pure Monopoly
I. Characteristic:
1) One seller
2) No close substitutes for the good
3) Barriers to entry
4) Many buyers
2) and 3) give the firm market power
5) Firms are price searchers
One firm producing all of the market’s ouptput
Controls price – the only game in town
II. The Monopoly Demand Curve
Flatter demand curve implies less market power, steeper demand curve implies
more market power.
III. Barriers to Entry (Also called sources of monopoly power)
1) Natural Barriers (leads to a natural monopoly)
a) economies of scale
b) Exclusive control of a resource
2) Artificial Barriers (Also called legal barriers) Leads to legal monopoly
IV. Profit maximizing Output and Price for a Single-Priced Monopolist
Also Max profit where MR = MC
For a monopoly MR is not constant
Demand Schedule
P in
$’s
8
7
6
Q
TR
MR
0
1
2
0
7
12
0
7
5
5
4
3
2
1
0
3
4
5
6
7
8
15
16
15
12
7
0
3
1
-1
-3
-5
-7
$6 increase from selling one more unit, $1 loss from selling first
unit at lower price
5-2
4-3
3-4
2-5
1-6
Numbers above do not correspond to the following graph
Price and marginal revenue
Demand and Marginal
Revenue Curves
20
Elastic
d
10
f
MR
0
5
D
Quantity
10
Over the range
0 to 5, a price
cut increases
total revenue,
so demand is
elastic.
–10
– 20
Slide 13-16
Copyright © 2000 Pearson Education Canada Inc.
TR, MR, and elasticity
Total Revenue in dollars or Total Expenditures
Total revenue (dollars per hour)
Total Revenue Curve
50
40
30
Zero
marginal
revenue
20
10
TR
0
5
Copyright © 2000 Pearson Education Canada Inc.
10
A monopolist wants to operate where MR > 0 (TR is increasing).
Profit maximizing price and output graphically:
PROFIT
Quantity
Slide 13-19
Price and cost (dollars per hour)
A Monopoly’s Output and
Price
MC
20
Profit = $12
($4 x 3 units)
14
10
ATC
Economic
profit $12
D
MR
0
1
2
3
4
5
Quantity
Slide 13-23
Copyright © 2000 Pearson Education Canada Inc.
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 = MC
Must 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 costs
Take advantage of producing a variety of products using the same inputs
Disadvantages:
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 ATC
For perfect comp. In long-run P = min ATC
5) Allocative inefficiency (if all eff, P = MC)
P >MC
In 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 they
actually 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
Price
Inefficiency of Monopoly
Consumer
surplus
S = MC
Deadweight
loss
PM
PC
Monopoly’s gain
D = MB
Producer
surplus
MR
0
QM
Efficient
quantity
QC
Quantity
Copyright © 2000 Pearson Education Canada Inc.
Slide 13-27
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 go
This is allocative efficiency
Also all of the consumer and producer surplus is being experienced
- When we are in a perfectly competitive market, this is the level of market
exchange 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 graph
above)
- 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 in the 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.
Price Discrimination - The practice of charging different consumers different prices for
the same good or service.
Price (dollars per trip)
This is when we call them a multi-price monopolist
A Single Price of Air
Travel
Consumer
surplus
2100
1800
MC
Economic
profit
ATC
1500
1200
900 $48
million
600
300
MR
0
5
8
D
10
15
20
Passengers (thousands per year)
Slide 13-35
Copyright © 2000 Pearson Education Canada Inc.
Price (dollars per trip)
Price Discrimination
2100
Increased economic
profit from price
discrimination
MC
1800
1600
ATC
1400
1200
900
600
300
0
MR
2
4
6
8
D
10
15
20
Passengers (thousands per year)
Copyright © 2000 Pearson Education Canada Inc.
Three conditions that must exist for affirm to price discriminate
1) Firms must face a downward sloping demand curve
2) Must be able to segment market:
3) Must be able to prevent arbitrage
Perfect price discrimination:
Charger each person a different price
Extracts all consumer surplus
Slide 13-37