Download CHAPTER 9 – MONOPOLY (6e)

CHAPTER 9 – MONOPOLY (6e)
Features of Monopoly:
One seller
Product has no close substitutes
Barriers to entry exist
The firm is a price searcher
I.
Barriers to Entry
A monopoly exists because there are barriers to entry:
There are three kinds of barriers:
A. Legal Restrictions
B. Economies of Scale
C. Control of Essential Resources
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II. Revenue for the Monopolist
The monopoly firm = the industry. Thus, the demand
curve facing the monopolist = the market demand
curve, which is downward sloping.
A. Demand and Marginal Revenue
The monopolist is subject to the law of demand:
the price must fall in order for consumers to
increase their quantity demanded of the product.
Ex. 2
Note that for QD to increase, the price must fall.
B. Revenue Schedules
Ex. 3
As P falls, QD rises.
TR = P x Q
TR rises over the range of 0 to 15 units, levels out at
15 to 16 units, and then begins to fall after 16 units.
MR = ∆TR ÷ ∆Q of output
MR declines over the entire range of output.
Note that for a monopolist, MR is NOT = P. Instead,
MR < P and MR declines twice as fast as P. When
graphed, the MR curve will fall below the D curve
and will be twice as steep.
C.
Revenue Curves
Ex. 4, panel (a):
The monopolist’s D and MR curves are shown.
When D is elastic, MR is positive because a
decrease in P will increase TR.
When D is unit elastic, MR = zero because a
decrease in P will not change TR.
When D is inelastic, MR is negative because a
decrease in P will decrease TR.
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[The relationship between price and total revenue
for different elasticities of demand was first
presented in Chapter 5. Go back and review this
information on p. 92 and review Ex. 2 on p. 94. Also
review the homework assignment from Ch. 5 to see
how elasticity along a linear demand curve relates
to total revenue.]
Ex. 4, panel (b):
The monopolist’s TR curve is shown.
When D is elastic, a decrease in P will increase TR;
MR is positive though declining.
When D is unit elastic, a decrease in P will not
change TR; MR is zero.
When D is inelastic, a decrease in P will decrease
TR; MR is negative.
III.
The Firm’s Costs and Profit Maximization
Like other firms, the monopolist seeks to maximize
profit. Since the monopolist has some control over
what price to charge, it is a price maker and will select
the price-and-quantity combination that will maximize
its profit.
A. Profit Maximization
(1)
The “Total Approach:” Total Revenue minus
Total Cost
Total profit = TR – TC
Total profit is maximized when TR > TC by the
greatest amount.
Ex. 5, columns 1,2,3,5, and 8:
Column 8 shows the monopolist’s losses and
profits. Total profit is maximized at 10 units,
which is thus the profit-maximizing level of
output for this firm. The price at 10 units is
$5,250, meaning that if it wishes to sell 10
units, the firm will set a price of $5,250. [The
monopolist “makes” the price rather than
“takes” the price.]
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Ex. 6, panel (b):
Graphical depiction of the “total approach”
TC curve has the shape we saw in Ch. 7
TR begins at zero; it rises as long as the price
is falling and demand is elastic; it reaches a
peak when demand is unit elastic; and then it
falls as long as price is falling and demand is
inelastic.
(Notice that total profit is maximized where
TR>TC by the greatest amount, and not where
TR is at its highest level. The goal of the firm
is to maximize total profit, not maximize total
revenue.)
(2) The “Marginal Approach:” Marginal Revenue
Equals Marginal Cost
Remember RULE
#1: To maximize
profit (or minimize loss), a firm
should produce the output at
which MR=MC.
Looking at Ex. 5, columns 4,6, and 8, we see
that:
As long as MR>MC, the firm can move toward
the maximum profit by increasing its output.
When MR=MC, profit is
maximized. (This occurs at 10 units.)
The
firm should produce this level of output.
When MR<MC, the firm can move toward the
maximum profit by decreasing its output.
Ex. 6, panel (a):
Graphical depiction of the “marginal approach”
How to read this graph:
1. Find the point where MR=MC, then go down
to the horizontal axis to find the profitmaximizing quantity of output.
2. From the profit-maximizing quantity, GO UP
TO THE DEMAND CURVE AND THEN OVER
TO THE VERTICAL AXIS TO FIND THE
PROFIT-MAXIMIZING PRICE!
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3. Find the difference between the price and
the ATC at the profit-maximizing quantity to
determine the profit per unit. Then multiply
profit per unit x quantity to get total profit.
Note that since MC is always > zero, it must
always intersect MR in the positive portion of
the MR curve. This in turn corresponds to the
elastic portion of the D curve.
B. Short-Run Losses and the Shutdown Decision
If TR<TC (i.e., if P<ATC), the monopolist will suffer
a loss. Should the firm keep producing, or should it
shut down?
(1) Producing to Minimize Losses
Remember RULE
#2: If P<ATC,
produce the output at which
MR=MC only if P is > or = AVC.
Ex. 7
At the profit-maximizing level of output (where
MR=MC), P<ATC (the demand curve lies below
the ATC curve), but since P>AVC the firm will
produce and minimize its losses. The loss per
unit is shown by the vertical distance between
points a and b; the total loss is shown by the
shaded rectangle.
(2) Shutting Down to Minimize Losses
If P<AVC, the firm will minimize losses by
shutting down temporarily. The firm’s loss will
= its fixed costs.
Graphically, if the demand curve lies below the
AVC curve at the level of output at which
MR=MC, the firm should shut down temporarily,
i.e., produce zero output.
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C. Long Run Profit Maximization
(Remember that in perfect competition, SR profits
attract new firms while SR losses cause firms to
leave the industry. In the LR, perfectly competitive
firms earn zero economic profits.)
For the monopolist, there can be LR profits because
new firms are hindered from entering the market
because of barriers to entry. The monopolist will
seek to adjust the scale of the firm in the LR to
achieve the greatest profit.
Are LR profits guaranteed for a monopolist? NO,
especially if the market is contestable, meaning that
it is possible for new firms to enter the industry
because barriers to entry are relatively low.
IV. Monopoly and the Allocation of Resources
and
V. Problems Estimating the Welfare Cost of Monopoly
You will not need to know Ex. 8. From these sections,
you will only need to understand the following:
How does the efficiency of resource allocation under
monopoly compare to that under perfect competition?
Resources are not allocated as efficiently under
monopoly as under perfect competition. A perfectly
competitive industry will typically produce a larger
output at a lower price, while a monopolist will produce
a lower output and charge a higher price. Because the
monopolist’s price is higher and output lower than
under a perfectly competitive market, and because the
monopolist may be able to earn a profit in the LR
whereas perfectly competitive firms can only break
even in the LR, it is often believed that, for consumers,
a monopoly is “bad” and perfect competition is “good”.
So is a monopoly “as bad as it looks”?
NO, a monopoly is not so bad:



If economies of scale make the monopolist able
to produce at a lower average cost than
perfectly competitive firms could.
If the monopolist keeps prices and profits lower
than the profit-maximizing levels to discourage
potential rivals from entering the industry or to
avoid government scrutiny and regulation.
If the monopolist keeps profits down to avoid
public criticism.
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YES, the monopolist is “bad:”
 If the monopolist uses up scarce resources just
to secure and maintain a monopoly position.
(This is called “rent seeking.”)
 If the monopolist becomes inefficient or
wasteful or slow to innovate (if it grows “fat and
lazy”) because it is protected from competition.
VI. Price Discrimination
Up to now we have assumed that the monopolist
charges the same price to all consumers.
Sometimes monopolists practice price
discrimination:
Why would a monopolist practice price
discrimination? To increase total profit!
Conditions necessary for price discrimination to
work:
(1) The firm must have some control over price.
(2) There must be at least two classes of consumers,
each with a different price elasticity of demand.
(3) The seller must be able to distinguish among the
different classes of consumers in order to charge
them different prices.
(4) The seller must be able to prevent resale of the
product among consumers.
Examples of price discrimination:
You will not need to know Ex. 9 or Ex. 10.
END
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