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MONOPOLY ESSENTIALS
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One firm
Unique product: no close substitutes
Industry demand equals firm demand
Demand slopes down
Marginal Revenue is below demand
and slopes down twice as fast
Profit Maximizing of Monopolist
• If the MC > MR raise price and reduce
sales. MC will fall and MR will rise,
Profits will rise.
• If the MC < MR lower price and increase
sales. MC will rise and MR will fall.
Profits will rise.
• If MC = MR you are doing the best you
can.
Tricks and traps to using the
monopolist’s diagram
• Find the profit maximising quantity by
finding the intersection of MR and MC.
• Find the profit maximising price by finding
the highest quantity at which the firm can
sell that quantity.
• You can read the price by going up
vertically from the best quantity and finding
the best price on the demand curve.
• TRAP: giving MR as the price
Profit Maximising Price, Quantity
and Profit
Monopolists can make Losses
LOSSES
• If the ATC curve is everywhere above the
Demand curve, a profit is not possible.
• Produce where MR = MC so long as
P>AVC so loss is less than or equal to
fixed costs
• Urban transit systems are often in this
situation
LONG-RUN EQUILIBRIUM
LONG-RUN EQUILIBRIUM
• Because there is no entry in a
monopoly, profits can persist in
the long-run.
EFFICIENCY AND MONOPOLY
• Allocative efficiency is never achieved:
• P > MR = MC.
• The price, what people are willing to pay,
is always greater than the cost of one
more unit.
• We are always willing to give up more than
what must be given up to obtain one more
unit of the good
EFFICIENCY AND MONOPOLY
• Productive efficiency is achieved only by
chance.
• If price is greater than ATC, the firm may
produce at an output that causes ATC to
be greater than or less than the minimum
• Because firms do not enter or leave the
industry, the number of firms in the
industry doesn’t adjust until each firm is
the ideal size.
EQUITY AND MONOPOLY
• Monopolist can earn excessive profits at
the expense of the consumer
• Monopoly power permits these firms to be
nasty capitalists who systematically exploit
the consumer.
Regulation of Monopoly
• Economists regulate a monopoly to
achieve allocative efficiency
• The price is set where the Marginal Cost
curve intersects the Demand curve
• As a result P = MC, producing allocative
efficiency
Marginal Cost Pricing
Marginal Cost Pricing
REGULATION
• Regulating so that P=MC sometimes
results in a profit (but less than if
unregulated)
• Regulating so that P=MC sometimes
results in a loss.
• Profits should be taxed away.
• Firms must receive subsidies to cover
losses
REGULATING DRUG
COMPANIES
Unregulated Drug Companies
• Monopoly caused by government patent
• MC is very low. Manufacturing one more
unit of drug is usually fairly cheap.
• Demand is very inelastic. The price must
be very high before MR>0 and TR is at a
maximum.
• The firm is very far from allocative or
productive efficiency. Much more should
be produced.
REGULATING DRUG
COMPANIES
• Firm has very high fixed costs due to
research and development
• If price equals the cost of manufacturing
one more unit, the fixed costs are unlikely
to be covered by the price
• Firms will make a loss
• No one would develop new drugs
Average Cost Pricing
AVERAGE COST PRICING
• Setting Price so that the firm makes only a
normal return (P=ATC) is politically easier.
• Measuring costs is difficult. The firms may
know, but the firms have an incentive to
lie.
• Developing drugs is risky. What is a large
enough return to induce firms to take the
risks? The firms will tell you it is very high.
CANADA VS. THE U.S.
• Canada regulates drug companies to
restrain profits. Whether they have
reached prices that give only a fair return
is debatable. Prices are much lower than
in the U.S. where they are unregulated.
• U.S. firms have more incentive to develop
new drugs.
• The American public has a large incentive
to buy drugs in Canada.