Download Price, Output, and Efficiency: In monopoly

Output and Price Determination
Cost data:
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Assumption - a pure monopolist hires resources competitively and has the same technology
as a purely competitive firm.
MR=MC rule: A monopolist seeking to maximize total profit will employ the same rationale
as a profit-seeking firm in a competitive industry; they will produce at the point where MR =
MC.
Profit maximizing price: Find MC= MR and draw a vertical line up to the demand curve.
Draw a horizontal line. This is the price they set.
How to determine the profit-maximizing output, profit-maximizing price, & economic profit
(or minimized loss) in PM industries:
1. Find the profit-maximizing output at the point where MR = MC.
2. Draw a vertical line upward from Qpm to the demand curve.
3. Determine the economic profit using one of two methods:
Method I: Find profit/unit by subtracting ATC of Qpm from Ppm. Then multiply the difference
by Qpm to determined economic profit. (In other words, Economic Profit = (P - ATC) x
Qpm )
Method II: Find TC by multiplying ATC of Qpm by Qpm. Find TR by multiplying Qpm by
Ppm. Then subtract TC from TR to determine economic profit. (In other words, Economic
Profit = TR-TC )
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No monopoly supply curve:
No unique relationship between price and quantity supplied for a monopolist → no supply
curve
Because the monopolist does not equate marginal cost to price, it is possible for different
demand conditions to bring about different prices for the same output
Misconceptions concerning monopoly pricing:
Not Highest Price:
Misconception: Monopolists will charge highest price possible because they can
manipulate output & price
Monopolies still face consumer demand. If the price is too high, consumers won't buy their
products, and profits are decreased.
Although there are many prices above Pm, monopolists don't charge at those prices
because they would yield a smaller-than-maximum total profit. (High prices would
potentially reduce sales and total revenue too severely to offset any decrease in total cost)
Monopolists seek maximum total profit, NOT the maximum price
Total, Not Unit, Profit:
Output level may not be at maximum per-unit profit, but additional sales make up for lower
unit profit, which in turn maximizes total profit.
Possibility of losses by monopolist:
Pure monopolist’s likelihood of earning economic profit greater than that of purely
competitive firm’s (PC)
PC – long-run – destined to earn only normal profit (P = Min ATC in Long-Run PC).
PM has high barriers of entry; therefore, the concept of “entry eliminates profits” does not
apply to PM
Pure monopoly does not guarantee profit:
Monopoly is not immune from upward-shifting cost curves caused by escalating resource
prices
Monopoly is not immune from changes in tastes that reduce the demand for its product
Both of these factors can lead to losses - initially it will persist in operating at a loss and to
stop incurring loss, the firm's owners will reallocate their resources
Economic Effects of Monopoly
Price, Output, and Efficiency:
In monopoly:
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P > Minimum ATC (Not productive efficiency as was the case with Pure Competition)
P > MC (Not allocative efficiency as with Pure Competition) It is under-allocation.
Income transfer:
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transfers income from consumers to stockholders who own monopoly
monopoly charges a higher price than a PC firm with the same costs
Can be seen as a "private tax" on consumers since the higher price generates higher
economic profit that is distributed amongst shareholders of the company, who are mostly
from high-income groups
owners benefit at the expense of the consumers
Since owners have more income than the consumers, monopoly increases gap between
rich and poor
Cost Complications:
- A purely monopolistic industry will charge a higher price, produce a smaller output and
allocate economic resources less efficiently than a purely competitive industry assuming
they have equal costs. This is because of the entry barriers that characterize monopoly.
- However, costs may not be the same for purely competitive producers and monopolistic
producers: the unit cost that a monopolist has is either larger or smaller than a purely
competitive firm's costs.
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4 Reasons Why Costs May Differ:
Economics of scale:
Simultaneous consumption: a product's ability to satisfy a large number of consumers at the
same time (Ex. Computer Software and Microsoft)
Network effects are increases in the value of a product to each user the more users that
there are. This is clear with BBM, Facebook, et cetera.
A factor called "X-inefficiency": X-efficiency occurs when a firm produces output, whatever
its level, at higher than the lowest possible cost of producing it. They do this because they
might need to spend to preserve their monopoly or they get lazy without competition.
Rent-seeking behavior: firms acquire monopoly granted by government through legislation
or gain special status from the government at taxpayers’ expense (Halliburton).
If a monopoly is achieved and sustained through anticompetitive actions, it creates
substantial economic inefficiency, and if it appears to be long-lasting the government can
file charges against the monopoly under the anti-trust laws. If found guilty of monopoly
abuse, a firm can either be prohibited from engaging in certain business or be broken into
two or more competing companies (Standard Oil).
Assessment and policy options:
How should the government act towards monopolies in the real world?
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The government can break up monopolies that are seen to be abusive
If it is a natural monopoly, the government will allow it to profit since it is better for society.
Yet the government can also regulate the prices and operations of the monopoly.
If not a concern because it is failing, leave it alone.
Price Discriminating Monopolist
Definition: Price Discrimination is the practice of selling a specific product at more than one
price when the price differences are not justified by cost differences.
Ways of Price Discriminating:
1. Charge each person his or her maximum willing-to-pay price.
2. Charge more for the first set of the product, then less for each additional product bought
by the same consumer.
3. Charge different customers different prices based on factors such as race, gender, age,
abilities et cetera.
Conditions: Price discrimination is possible when the following conditions are realized:
- Monopoly Power: seller should have power to control the price - monopolist.
- Market Segregation: firms must be able to separate buyers on their willingness to pay for
the product, or their elasticity of demand.
- No Resale: The original buyers cannot be able to resell the product, or else they could
undermine the monopolist's market power.
Examples of price discrimination:
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Airlines charge more money to business travelers, whose demand for travel is inelastic.
Airlines also offer lower rates during certain days to attract vacationers whose demands are
more elastic.
Pay-per click service
Movie theaters and golf courses - on the basis of time and age
Discount coupons
Perfect Price Discrimination: to charge what each consumer is willing to pay. Although
perfect price discrimination is unlikely to be achieved, consumer surplus will be reduced
to zero.
Graphical analysis:
* As the graphs indicate, price discriminating increases a monopolist's profit
Price Determination
MR = MC Rule:
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Monopolies maximize total profit by producing at a level of output where MR = MC
This is the same as a purely competitive industry
At this level of output, the difference between TR and TC is also at its greatest
Consequences of Price Discriminating Monopolies:
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More profit
More output
Lowest price will = MC
Zero consumer surplus (when perfect)
Creates allocative efficiency
No productive efficiency because P> min ATC
MR is reunited with DARP because the firm no longer has to decrease the price of every
unit sold prior. In other words, at each quantity, the product will be sold at a different price.
A Regulated Monopoly
Because unregulated monopolies seek to maximize profits, output is restricted so that the
price is set higher than what everyone can afford. However, some monopolies control
products or services that are considered basic necessities for human survival. In order to
get companies to produce enough of a product for everyone, governments regulate a firm's
output.
Socially optimal price (which is also allocative effiency) :P=MC:
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To achieve allocative efficiency, a firm should produce so that P=MC. In order to simulate
allocative efficiency in a pure monopoly, governments set a price ceiling which causes the
monopolist's demand curve to become horizontal (meaning that it becomes perfectly
elastic). The monopoly is then forced to produce at P = MC = MR, and attempt to minimize
losses (or maximize profits).
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Sometimes this price ceiling is set so low that it does not cover the Average Total Costs of
production, and companies become bankrupt in the long run. In order to remedy this,
governments set a fair return price.
Fair-return price: P=ATC:
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Regulations to price so that monopolies do not become bankrupt. Economics profit is equal
to 0, so normal profits are covered.
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Utility owners get a "fair return" where P=ATC
Dilemma of regulation:
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When a regulated monopoly’s price is set to achieve the most efficient allocation of
resources (P = MC), the regulated monopoly is likely to suffer losses, or economic losses,
while only making normal profits.
Survival of the firm would presumably depend on permanent public subsidies out of tax
revenues, or subsidies to the firm via the government.
Although a fair return price (P = ATC) allows the monopolist to cover costs, it only partially
resolves the under-allocation of resources that the unregulated monopoly price would
foster, thus the monopoly is still deemed inefficient.