Download AP Micro MONOPOLY

AP Micro
MONOPOLY
Characteristics: https://www.youtube.com/watch?v=7UWgKZsKZOc&list=PL336C870BEAD3B58B&index=31
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One producer
No close substitutes
Finn is "price maker"-market power allows price-setting ability
Barriers to entry-legal barriers (patent or exclusive license), control of key resources, or economies of scale and
other cost advantages
Monopoly demand:
Because the monopolist is the only seller of the good, the demand for the product is the market demand. In order to
sell more of the good, the monopolist must lower the price (law of demand). Because the price must be lowered for all
goods sold, the marginal revenue from selling one unit of the good is the price of the last unit minus the sum of the price
cuts that must be taken on all prior units of output.
Profit Maximization:
The monopolist will maximize profits where MR=MC, as shown in the following graph. The monopolist will operate only
along the elastic position of the demand curve, where the marginal revenue is positive. When marginal revenue is
negative, demand is inelastic, so a price decrease would bring about a reduction in total revenues. Total revenues arc at
a maximum when MR = 0.
Efficiency Analysis:
Unlike perfectly competitive markets, unregulated monopolies achieve neither allocative efficiency, where MC = MB
(MB=price), nor productive efficiency, where output is produced with the lowest possible cost (at the minimum ATC).
The monopolist's P > MC, and P > minimum ATC. The monopolist's profit-maximizing output results in an
underallocation of resources. The resulting deadweight loss is shown in the graph above; this represents the value of
mutually beneficial transactions that do not occur because of monopoly behavior. Consumer surplus is the area above
the monopolist's price and below the demand curve; producer surplus is the area below the monopoly price and above
the marginal cost curve (includes the monopolist's profits).
Regulated Monopoly:
A natural monopoly occurs when the market demand curve intersects the long-run ATC curve where ATC are still
declining. The government may decide to regulate this monopoly. To achieve a socially optimal price (allocative
efficiency), the government would establish a price ceiling equal to marginal cost at the intersection of the MC curve and
the demand curve. In the graph below, the monopolist would then operate at Qs because MR up to this point equals P,
(so MR = Ps = MC). Since this price ceiling may be set below the firm’s total costs, the government would have to
subsidize the monopolist.
If the government established a fair-return price, they would establish a price, Pf, at the point where the ATC curve
intersects the demand curve, thus allowing the monopolist to cover costs. The monopolist would operate at Qf.
Price Discrimination:
Some businesses can charge different customers different prices. The business may do this if these conditions exist:
1. The firm has monopoly pricing power.
2. The firm must be able to separate different customers with different demand elasticities.
3. The firm must be able to prevent resale of its goods to prevent those buying at the lower price from selling
at a higher price.
With perfect price discrimination, the MR equals demand. Since the perfectly price discriminating monopolist operates
where MR = MC, and MR =demand, then MC = MB (aka Qs=Qd), and allocative efficiency is achieved. There is no
deadweight loss, but consumer surplus is lower than it would be in a perfectly competitive market, because the
monopoly receives as profits everything that consumers would have received as consumer surplus in a perfectly
competitive market.
Use the monopoly graph to answer the following questions.
1. At what price will the monopoly maximize profits? ________
Explain…b/c _______________________________________________________________________________
2. What quantity will the profit-maximizing monopolist produce? _________
3. Total costs for the monopolist are represented by the area ___________
Formula for calculating total cost: _____________________________________________
4. Total revenue for the monopolist is represented by the area _________
Formula for calculating total revenue: _____________________________________________
5. Economic profits are represented by the area ________________
Formula for calculating profits: _____________________________________________
6. Consumer surplus is the area __________________
7. Deadweight loss is the area ______________________; this proves that a monopoly is/ is not allocatively
efficient.