Download Monopoly Slides

Types of Market Structure
Are Products Differentiated?
Yes
No
One
How Many
Producers
Are There?
Monopoly
Oligopoly
Few
Many
Not applicable
Perfect
competition
Monopolistic
competition
This system of market
structures is based on
two dimensions:
 The number of
producers in the market
(one, few, or many)
 Whether the goods
offered are identical or
differentiated
Differentiated goods
are goods that are
different but
considered somewhat
substitutable by
consumers (think Coke
versus Pepsi).
The Meaning of Monopoly (10/24/16)
Our First Departure from Perfect Competition…
 A monopolist is a firm that is the only producer of a
good that has no close substitutes.
 The ability of a monopolist to raise its price above the
competitive level by reducing output is known as market
power.
 Very few true monopolies – why?
 Barriers to entry:
Types of monopolies
1. Natural – costs of production minimized by having
one provider – economies of scale (inc returns)
a. Example:
Increasing returns create natural monopoly
Price,
cost
Natural monopoly.
Average total cost is
falling over the relevant
output range
Natural monopolist’s
break-even price
Fixed costs required to
operate are very high 
the firm’s ATC curve
declines over the range of
output at which price is
greater than or equal to
average total cost.
ATC
D
Quantity
Relevant output range
This gives the firm economies of scale over the entire range of output at which the
firm would at least break even in the long run. As a result, a given quantity of
output is produced more cheaply by one large firm than by two or more smaller
firms.
2. Geographic – simple absence of other sellers
a. Example:
3. Technological – ownership/control of
manufacturing method/process/scientific advance
a. Patents:
4. Government – products and services that the
cannot adequately provide
public
Texas Tea Oil Co. is the only supplier of home heating oil.
In each situation, prices doubled.
Evaluate: Are the people victims of Texas Tea’s market power?
1. National shortage of heating oil  Texas Tea could procure only a
limited amount.
2. Last year, Texas Tea and several other competing local oil-supply
firms merged into a single firm.
3. The cost to Texas Tea of purchasing oil from refineries has gone
up significantly.
4. Texas Tea has acquired an exclusive government license to draw
oil from the only heating oil pipeline in the state.
What a Monopolist Does
Price
P
2. … and raises
price.
Equilibrium is at C,
where the price is
PC and the quantity
is QC. A
monopolist
reduces the
quantity supplied
to QM, and moves
up the demand
curve from C to M,
raising the price to
PM.
M
P
S
M
C
C
D
QM
QC
1. Compared to perfect
competition, a monopolist
reduces output…
Quantity
Comparing the Demand Curves of a Perfectly Competitive
Producer and a Monopolist
Price
Market
price
(a) Demand Curve of an Individual
Perfectly Competitive Producer
Price
(b) Demand Curve of a
Monopolist
D
C
D
Quantity
M
Quantity
An individual perfectly competitive firm cannot affect the market price of the good
 it faces a horizontal demand curve DC, as shown in panel (a). A monopolist, on
the other hand, can affect the price (sole supplier in the industry)  its demand
curve is the market demand curve, DM, as shown in panel (b). To sell more output
it must lower the price; by reducing output it raises the price.
Marginal revenue of a monopolist: change in total
revenue divided by change in quantity
Monopolies: MR does NOT equal price!!!!
Marginal revenue
always falls:
In order to sell one
more, you need to
lower the price of
that one AS WELL
AS the price of all the
previous ones
Example: I can’t sell
1 diamond for $950,
the 2nd for $900, and
the 3rd for $850 – if I
want to sell 3
diamonds, they ALL
must be priced at
$850

An increase in production by a monopolist has two
opposing effects on revenue:

A quantity effect. One more unit is sold, increasing total
revenue by the price at which the unit is sold.

A price effect. In order to sell the last unit, the monopolist
must cut the market price on all units sold. This
decreases total revenue.
Quantity
Demanded
Price
Total
Revenue
1
$100
2
186
3
252
4
280
5
250
Marginal
Revenue
Quantity
Price Effect
Effect
Component
Component
a. Come up with demand schedule for emeralds.
b. Fill in marginal revenue column.
c. The quantity effect component of marginal revenue per output
level (how much TR increases because of selling one more)
d. The price effect component of marginal revenue per output
level (how much TR decreases by having to decrease the
price of all sold to sell one more) Hint: MR = QE + PE
e. What additional info is needed to determine the profit
maximizing quantity of output?
How a monopolist maximizes profit
Profit-maximizing quantity of output:
MC = MR!!!!
Price per
download
Quantity
demanded
$10
0
8
1
6
3
4
6
2
10
0
15
TR
MR
(careful!!)
Bob, Bill, Ben, and
Brad are thinking
about making their
movie available for
download on the
internet. Each time
the movie is
downloaded, the ISP
charges them a fee
of $4.
b. Bob is proud of the film and wants as many people as possible to download it.
What price would he choose? How many downloads will he sell?
c. Bill wants as much total revenue as possible. Which price would he choose?
How many downloads would be sold?
d. Ben wants to maximize profit. Which price would he choose? How many
downloads would be sold?
e. Brad wants to charge the efficient price (where P=MC). What price would he
choose? How many downloads would he sell?
DeBeers: no fixed cost, marginal cost is constant $200 The optimal output rule:
per diamond
the profit maximizing level of
output for the monopolist is
at MR = MC, shown by point
A, where the MC and MR
curves cross at an output of
8 diamonds.
Price, cost,
marginal revenue
of demand
Monopolist’s
optimal point
$1,000
B
P
M
600
Perfectly competitive
industry’s optimal point
Monopoly
profit
P
C
200
0
–200
MC  ATC
A
C
D
8
Q
M
10
16
MR
Q
20
Quantity of diamonds
C
–400
The price De Beers can charge per diamond is found by going to the point on
the demand curve directly above point A, (point B here)—a price of $600 per
diamond. It makes a profit of $400 × 8 = $3,200.
Marginal revenue
always falls:
In order to sell one
more, you need to
lower the price of
that one AS WELL
AS the price of all the
previous ones
Example: I can’t sell
1 diamond for $950,
the 2nd for $900, and
the 3rd for $850 – if I
want to sell 3
diamonds, they ALL
must be priced at
$850
To summarize – monopolies…
• produce less and charge higher prices than
perfectly competitive firms
• earn profits in the short-run AND long-run – why?
The Monopolist’s Profit – the general picture
Price, cost,
marginal
revenue
Profit = TR − TC
= (PM × QM) − (ATCM ×
QM)
MC
ATC
P
B
M
Monopoly
profit
A
ATC
M
D
= (PM − ATCM) × QM
The average total cost of
QM is shown by point C.
Profit is given by the area
of the shaded rectangle.
C
MR
Q
M
Quantity
In this case, the MC curve is upward sloping and the ATC curve is Ushaped. The monopolist maximizes profit by producing the level of output
at which MR = MC, given by point A, generating quantity QM. It finds its
monopoly price, PM , from the point on the demand curve directly above
point A, point B here.
Partner practice:
Use the total revenue schedule of Emerald, Inc., a monopoly
producer of emeralds, to calculate the answers to parts a and b.
Price
Quantity
Total
Marginal
Demand Revenue Revenue
ed
1
$100
2
186
3
252
4
280
5
250
a. Price schedule
b. Marginal revenue
schedule
Now plot the demand curve, the marginal revenue curve, the
marginal cost curve at a constant $47. What is the profitmaximizing quantity of output? What price will the firm charge at this
level of output? How much profit will they make?
Skyscraper City has a subway system, for which a
one-way fare is $1.50. There is pressure on the
mayor to reduce the far by one-third, to $1.00. The
mayor is dismayed, thinking that this will mean
Skyscraper City is losing one-third of its revenue
from sales of subway tickets. Is the mayor correct
in his prediction? Explain.
Monopoly and Public Policy
 By reducing output and raising price above
marginal cost, a monopolist captures some of the
consumer surplus as profit and causes deadweight
loss. To avoid deadweight loss, government policy
attempts to prevent monopoly behavior.
 When monopolies are “created” rather than natural,
governments should act to prevent them from
forming and break up existing ones.
 The government policies used to prevent or
eliminate monopolies are known as antitrust policy.
Monopoly Causes Inefficiency
Price
, cost
Total Surplus with Perfect Competition
(a)
Consumer surplus
with perfect
competition
Price, cost,
marginal
revenue
Total Surplus with Monopoly
(b)
Consumer
surplus with
monopoly
Profit
P
M
Deadweight
loss
P
C
MC =ATC
MC =ATC
D
D
MR
Q
C
Quantity
Q
M
Quantity
Panel (b) depicts the industry under monopoly: the monopolist decreases
output to QM and charges PM. Consumer surplus (blue triangle) has shrunk
because a portion of it has been captured as profit (light blue area). Total
surplus falls: the deadweight loss (orange area) represents the value of
mutually beneficial transactions that do not occur because of monopoly
behavior.
Preventing Monopoly
 Breaking up a monopoly that isn’t natural is clearly a good
idea, but breaking up natural monopolies might lead to
higher costs.
 Yet even in the case of a natural monopoly, a profitmaximizing monopolist acts in a way that causes
inefficiency—it charges consumers a price that is higher
than marginal cost, and therefore prevents some
potentially beneficial transactions.
Dealing with Natural Monopoly
 What can public policy do about this? There are
two common answers (aside from doing nothing)…
1. One answer is public ownership, but publicly
owned companies are often poorly run.
1. A common response in the United States is
price regulation. A price ceiling imposed on a
monopolist does not create shortages as long as
it is not set too low.
Unregulated and Regulated Natural Monopoly
Price, cost,
marginal
revenue
(a) Total Surplus with an
Unregulated Natural
Monopolist
Price, cost,
marginal
revenue
Consumer
surplus
(b) Total Surplus with a
Regulated Natural
Monopolist
Consumer
surplus
Profit
P
M
P
M
P
R
ATC
ATC
P*
R
MC
MC
D
D
MR
Q
M
MR
Q
R
Quantity
Q
M
Q*
R
Quantity
Panel (b) shows what happens when the monopolist must charge a price
equal to average total cost, the price PR*. Output expands to QR*, and
consumer surplus is now the entire blue area. The monopolist makes zero
profit. This is the greatest consumer surplus possible when the
monopolist is allowed to at least break even, making PR* the best
regulated price.
DeBeers is a single-price monopolist. DeBeers has 5 potential customers: Raquel
(willing to pay $400), Jackie (willing to pay $300), Joan (willing to pay $200), Mia
(willing to pay $100), and Sophia (willing to pay $0).
Price
Quantity of Diamonds
Demanded
$500
0
400
1
300
2
200
3
100
4
0
5
a. Add columns for and calculate
total revenue and marginal
revenue.
b. The marginal cost of production
is a constant $100. What is the
profit maximizing quantity and
price?
c. How much is each person’s
individual consumer surplus?
How much is total consumer
surplus? How much is producer
surplus (profit)?
Suppose that Russian and Asian producers enter the diamond market, and the
industry becomes perfectly competitive.
d. What is the perfectly competitive price? What quantity will be sold?
e. At this new price, what is the new total consumer surplus? How large is producer
surplus?
Price Discrimination
 Up to this point we have considered only the case of a
single-price monopolist, one who charges all consumers
the same price. As the term suggests, not all monopolists do
this.
 In fact, many if not most monopolists find that they can
increase their profits by charging different customers different
prices for the same good: they engage in price
discrimination.
Two Types of Airline Customers
Price, cost of
ticket
Profit from sales to
business travelers
$550
Profit from sales to student
travelers
B
150
125
MC
S
D
0
2,000
4,000
Quantity of tickets
Price Discrimination
(a) Price Discrimination with Two Different Prices
(b) Price Discrimination with Three Different Prices
Price,
cost
Price,
cost
Profit with
two prices
Profit with
three prices
P
high
P
high
P
medium
P
low
P
low
MC
MC
D
D
Quantity
Sales to
consumers
with a high
willingness
to pay
Sales to
consumers
with a low
willingness
to pay
Quantity
Sales to
consumer
s with a
high
willingnes
s to pay
Sales to
consumers
with a
medium
willingness
to pay
Sales to
consumers
with a low
willingness
to pay
Perfect Price Discrimination
• Perfect price discrimination takes place when
a monopolist charges each consumer his or
her willingness to pay—the maximum that the
consumer is willing to pay.
Price Discrimination
Perfect Price Discrimination
Price, cost
Profit with perfect price
discrimination
MC
D
Quantity