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Today

Begin Monopoly
Monopoly
Chapter 22
Four Basic Models
Profit-Maximizing
Monopolist



Suppose only one seller in the market.
For now, assume it sells all its output at
the same price (no price discrimination).
Choose Q to maximize:


profits = TR - TFC - TVC.
TFC do not depend on output, so
maximize TR - TVC.
Marginal Revenue
Recall: for the price-taking firm, MR
= P.
 But: the monopolist faces the
market demand curve. As he sells
more, he moves down the D curve
and price falls.

Graph of Marginal Revenue
P
What is the MR of the 4th
unit?
Lost 3
Gained 9
10
9
How does that compare to
price?
3 4
D
Q
Will it ever be possible to
gain the price as MR?
Monopolist’s Marginal
Revenue
The monopolist’s
marginal revenue (MR)
curve lies everywhere
below the demand
curve.
P
D
MR
Q
MR < P.
Special Case: Straight-Line
Demand
P
The MR curve for a
straight-line D curve lies
1/2-way between the D
curve and the vertical
axis.
MR
5
D
10
Q
Special Case: Straight-Line
Demand
Recall: Price elasticity
falls as we move down
the straight-line D curve.
P
=1
MR
5
Total revenue rises then
falls as we move down
the straight-line the D
curve.
D
10
Q
When  = 1, revenue is
at its maximum. That’s
when MR = 0.
Choosing Quantity

Maximize TR - TVC
TR is area under the MR curve.
 TVC is area under the MC curve.
 Therefore maximize the difference.

Choosing Quantity
P
Profits are maximized
when MR = MC.
TR - TVC
MC
MR
D
Q
Monopolist’s ProfitMaximizing Rule
P
Choose Q where MR =
MC, charge the highest
price possible.
MC
p*
Check:
In SR, is P  AVC?
MR
Q*
In LR, is P  ATC?
D
Q
Monopolist’s ProfitMaximizing Rule
P
Will this monopolist
produce in the LR?
MC
In the SR?
p*
Can you identify profits
or losses?
ATC
MR
Q*
D
Q
Monopolist’s Profits
P
MC
p*
ATC
MR
Q*
D
Q
The Monopolist & A Supply
Curve




A monopolist does not have a supply
curve!
He chooses his best price & quantity
combination on the market demand
curve.
He is not a price taker, so the concept of
a supply curve doesn’t make sense.
He is a price maker.
The Monopolist and
Efficiency
Productive efficiency: Some have
argued that a monopolist may get
“lazy” and not keep costs at a
minimum.
 Others argue that if it’s goal is to
maximize profits, that will be
incentive enough to minimize costs.
 This issue remains unsettled.

The Monopolist and
Efficiency

Allocative efficiency: Look at the
sum of producers’ and consumers’
surpluses.
Consumers’ Surplus
P
CS: the area under
the demand curve but
above price.
MC
p*
MR
Q*
D
Q
Producers’ Surplus
P
PS = TR - TVC
MC
PS: the area under
price but above MC.
p*
MR
Q*
D
Q
Sum of Producers’ and
Consumers’ Surplus
P
Does the monopolist
produce the quantity
that is allocatively
efficient?
MC
p*
MR
Q*
D
Q
The Allocatively Efficient
Quantity
P
More PS & CS could
be gained by
producing QE.
MC
PM
The marginal
benefits of the add’l
units are more than
their marginal costs.
D
QM QE
Q
Efficiency of Monopolist
If the monopolist were to produce &
sell the efficient quantity, he would
have to set a lower price.
 We say the monopolist reduces
output and raises price compared to
the efficient solution.
 This causes a deadweight loss of
producer’s & consumers’ surplus.

Deadweight Loss of CS & PS
P
Represents the cost to
society of not
producing the
efficient quantity of
this good.
MC
PM
D
QM QE
Q
Effects of Monopolies
Produce less than the efficient
quantity.
 Charge higher prices as a result.
 Consumers are hurt on both counts.

Coming Up:
Barriers to entry & the monopolist.
 More price discrimination

Group Work


Try to complete the exercise without
looking back at your notes.
Identify on the graph for a Monopolist



the profit-maximizing level of output.
the price that the monopolist will charge
(assuming he charges a single price for all
units).
the total profits or losses of the monopolist
More things to identify
consumer’s surplus
 producer’s surplus
 the allocatively efficient quantity
 the deadweight loss associated with
having a monopoly in this market
 the supply curve

Monopolist’s situation
$/q
Price
50
40
MC
ATC
30
20
10
5
0
0
1
2
3
4
5
MR
6
7
8
9
10
D
Quantity