Monopoly
● Monopoly Defined
● The Monopolist’s Supply Decision
● Can Anything Good Be Said About Monopoly?
● Price Discrimination Under Monopoly
● Monopoly Defined
● The Monopolist’s Supply Decision
● Can Anything Good Be Said About Monopoly?
● Price Discrimination Under Monopoly
ContentsContents
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Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Monopoly DefinedMonopoly Defined
● Only one firm in the industry
● No close substitute for the product
● Little chance of successful entry by a competitor
● Only one firm in the industry
● No close substitute for the product
● Little chance of successful entry by a competitor
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● Barriers to entry:♦ Legal restrictions (USPS)♦ Patents (esp. pharmaceutical industry)♦ Control of a scarce resource (diamonds)♦ Deliberate entry barriers (advertising)♦ Large sunk costs (i.e. entry costs)
● Cost advantages♦ Technical superiority♦ Economies of scale
● Barriers to entry:♦ Legal restrictions (USPS)♦ Patents (esp. pharmaceutical industry)♦ Control of a scarce resource (diamonds)♦ Deliberate entry barriers (advertising)♦ Large sunk costs (i.e. entry costs)
● Cost advantages♦ Technical superiority♦ Economies of scale
Sources of MonopolySources of Monopoly
● When a large firm can produce and sell more cheaply than a small firm
● Technically, firm that has declining long-run average cost curve♦ So the more stuff is produced, the cheaper it is
to produce in terms of per-unit cost of production
● When a large firm can produce and sell more cheaply than a small firm
● Technically, firm that has declining long-run average cost curve♦ So the more stuff is produced, the cheaper it is
to produce in terms of per-unit cost of production
Natural MonopolyNatural Monopoly
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FIGURE 1: Natural MonopolyFIGURE 1: Natural Monopoly
AC
Ave
rag
e C
ost
Quantity Supplied
2.5 2 1
2.00
2.50
$3.00 B
A
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C
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Not a price taker♦ So can’t sell as much as she wants at the
market price
● Instead, faces a negatively sloped demand curve
● Previous analysis of perfectly competitive firm does not apply here
● Not a price taker♦ So can’t sell as much as she wants at the
market price
● Instead, faces a negatively sloped demand curve
● Previous analysis of perfectly competitive firm does not apply here
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Consumers are willing to buy more only at lower prices
● But if monopolist lowers price, he sells all output at new, lower price
● So profit-maximizing behavior for monopolist is not to set MC = P
● Consumers are willing to buy more only at lower prices
● But if monopolist lowers price, he sells all output at new, lower price
● So profit-maximizing behavior for monopolist is not to set MC = P
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Joint decision about price and output♦ If select price – quantity demanded is given by
market demand curve
♦ If select output – price is given by market demand curve
● Marginal revenue < selling price
● Joint decision about price and output♦ If select price – quantity demanded is given by
market demand curve
♦ If select output – price is given by market demand curve
● Marginal revenue < selling price
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Monopolist selects quantity to make
MR = MC♦ If MR > MC, extra unit of output will increase
total profit, so produce more
♦ If MR < MC, reducing output will increase total profit, so produce less
● Profit is highest when MR = MC
● Monopolist selects quantity to make
MR = MC♦ If MR > MC, extra unit of output will increase
total profit, so produce more
♦ If MR < MC, reducing output will increase total profit, so produce less
● Profit is highest when MR = MC
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Monopolist sets output where MC = MR
● Market demand then determines price for this output
● P > MR
● Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.
● Monopolist sets output where MC = MR
● Market demand then determines price for this output
● P > MR
● Monopolist makes profits (or losses) to the extent that price is greater (less) than average cost.
FIGURE 2: Profit-Maximizing Equilibrium for a Monopolist
FIGURE 2: Profit-Maximizing Equilibrium for a Monopolist
MC
MC
0
4
$9
AC
AC
Quantity
Pri
ce
pe
r U
nit
7
150
C D
D
P
MR
M
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300
TABLE 1: A Monopolist’s Price-Output Decision
TABLE 1: A Monopolist’s Price-Output Decision
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The Monopolist’s Supply DecisionThe Monopolist’s Supply Decision
● Compared to perfect competition, a monopoly:♦ May enjoy a long-run profit
♦ Restricts its output to raise its selling price (both in the long and short runs)
♦ Leads to inefficient resource allocation
● Compared to perfect competition, a monopoly:♦ May enjoy a long-run profit
♦ Restricts its output to raise its selling price (both in the long and short runs)
♦ Leads to inefficient resource allocation
FIGURE 3: Compare Monopoly to Competitive Industry
FIGURE 3: Compare Monopoly to Competitive Industry
300
$9
AC
AC
Quantity
Pri
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pe
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nit
7
150
D
D
MC
MC
MR
B
P
M
C
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Can Anything Good Be Said About Monopoly?Can Anything Good Be Said About Monopoly?
● Under some circumstances monopoly may:♦ Raise demand for its product, i.e. through
advertising (thus negating the inefficient reduction in output noted above)
♦ Reduce marginal and average cost (produce more efficiently)
♦ Stimulate innovation
● Under some circumstances monopoly may:♦ Raise demand for its product, i.e. through
advertising (thus negating the inefficient reduction in output noted above)
♦ Reduce marginal and average cost (produce more efficiently)
♦ Stimulate innovation
● Natural monopoly = average costs fall as output rises
● Costs of production would be higher if a natural monopoly were broken up into many smaller firms.
● Natural monopoly = average costs fall as output rises
● Costs of production would be higher if a natural monopoly were broken up into many smaller firms.
Natural Monopoly: Where Single-Firm Production Is CheapestNatural Monopoly: Where Single-Firm Production Is Cheapest
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● Natural monopolies may allow lower average cost than a market with numerous competing firms.
● Must be regulated in order for consumers to receive lower prices, however
● Monopolist may have incentive to produce more innovation than firms in more competitive markets.
● Natural monopolies may allow lower average cost than a market with numerous competing firms.
● Must be regulated in order for consumers to receive lower prices, however
● Monopolist may have incentive to produce more innovation than firms in more competitive markets.
Natural Monopoly: Where Single-Firm Production Is CheapestNatural Monopoly: Where Single-Firm Production Is Cheapest
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Price Discrimination Under MonopolyPrice Discrimination Under Monopoly
● Three types of price discrimination:♦ First Degree Price Discrimination
♦ Second Degree Price Discrimination
♦ Third Degree Price Discrimination
● We only study last one, drop the “Third Degree” part
● Three types of price discrimination:♦ First Degree Price Discrimination
♦ Second Degree Price Discrimination
♦ Third Degree Price Discrimination
● We only study last one, drop the “Third Degree” part
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Price Discrimination Under MonopolyPrice Discrimination Under Monopoly
● Price discrimination = charge different prices to different groups of customers for the same good♦ or charge the same price in markets where
costs vary■Example: it costs the same to mail envelope to
Hawaii and to St. Cloud, though mailing costs are clearly different
● Allows a monopolist to maximize profits
● Price discrimination = charge different prices to different groups of customers for the same good♦ or charge the same price in markets where
costs vary■Example: it costs the same to mail envelope to
Hawaii and to St. Cloud, though mailing costs are clearly different
● Allows a monopolist to maximize profits
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Price Discrimination Under MonopolyPrice Discrimination Under Monopoly
● Monopolist sets marginal revenue (not price) equal in each market♦ With different demands, prices will in general
be different
● Assumes equal cost conditions in each markets
● Monopolist sets marginal revenue (not price) equal in each market♦ With different demands, prices will in general
be different
● Assumes equal cost conditions in each markets
FIGURE 4: Prices and Quantities under Price Discrimination
FIGURE 4: Prices and Quantities under Price Discrimination
Db
Db MRa Qa MRb Qb
Pb
W
(b)
Customer Group B Customer Group A
Quantity
0
H H
Pri
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(a)
Quantity
Da
Da
0
J
Pa
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Price Discrimination Under MonopolyPrice Discrimination Under Monopoly
● Sometimes price discrimination is not profitable♦ Two markets:
■Large with many wealthy customers■Small with few poor customers
♦ Then monopolist is better-off not servicing poor guys at all
♦ Example: luxury cars are expensive, because rich guys agree to pay a lot
● Sometimes price discrimination is not profitable♦ Two markets:
■Large with many wealthy customers■Small with few poor customers
♦ Then monopolist is better-off not servicing poor guys at all
♦ Example: luxury cars are expensive, because rich guys agree to pay a lot
● No, although sometimes justice appears to demand different prices in different markets (same mailing price example)
● In some cases, price discrimination may be necessary for a firm to survive (if costs are very different)
● In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices.
● No, although sometimes justice appears to demand different prices in different markets (same mailing price example)
● In some cases, price discrimination may be necessary for a firm to survive (if costs are very different)
● In some cases, where there are significant economies of scale, price discrimination may actually lead to lower prices.
Is Price Discrimination Always Undesirable?Is Price Discrimination Always Undesirable?
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MonopsoniesMonopsonies
● Monospony – situation when there is a single buyer on the market
● Examples are hard to find but:♦ A small town with a single industrial power
plant – here the plant is almost a sole employer, i.e. buyer of human labor
♦ Even if multiple employers, but all workers are members of a single union, then union is a sole purchaser of labor
● Monospony – situation when there is a single buyer on the market
● Examples are hard to find but:♦ A small town with a single industrial power
plant – here the plant is almost a sole employer, i.e. buyer of human labor
♦ Even if multiple employers, but all workers are members of a single union, then union is a sole purchaser of labor
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MonopsoniesMonopsonies
● Analysis is pretty similar to that of monopolized industry
● Sometimes have a bilateral monopoly:♦ When a single buyer meets a single seller, i.e.
power plant with a union
♦ Need more advanced tools to analyze this situation, so won’t do that in this course
● Analysis is pretty similar to that of monopolized industry
● Sometimes have a bilateral monopoly:♦ When a single buyer meets a single seller, i.e.
power plant with a union
♦ Need more advanced tools to analyze this situation, so won’t do that in this course
Some Problemson Monopoly
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Problem 1Problem 1
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
Qty 18 16 14 12 10 4
Price 1 2 3 4 5 6
TC 44 38 32 26 20 14
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Problem 1: SolutionProblem 1: Solution
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
● Monopoly would maximize profits
● So must compute profit:
Profit = TR − TC
● Make up two extra table rows, TR and Profit
● Monopoly would maximize profits
● So must compute profit:
Profit = TR − TC
● Make up two extra table rows, TR and Profit
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Problem 1: SolutionProblem 1: Solution
● What is the profit maximizing quantity for monopoly, what profits will it earn?
● What is the profit maximizing quantity for monopoly, what profits will it earn?
Qty 18 16 14 12 10 4
Price 1 2 3 4 5 6
TC 44 38 32 26 20 14
TR 18*1=18 16*2=32 14*3=42 12*4=48 10*5=50 4*6=24
Profit18-44 =-26
32-38 =-6
42-32 =10
48-26 =22
50-20 =30
24-14 =10
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Problem 1: SolutionProblem 1: Solution
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
● Consider the following table. What is the profit maximizing quantity for monopoly, what profits will it earn?
● So Monopoly would sell 10 units for $5 each
● And would earn a profit of $50
● This concludes the problem!
● I hope you’ll be able to complete similar problem on the midterm if I ask you
● So Monopoly would sell 10 units for $5 each
● And would earn a profit of $50
● This concludes the problem!
● I hope you’ll be able to complete similar problem on the midterm if I ask you
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Problem 2Problem 2
● Suppose that there is a monopolized industry where a monopoly firm has total cost function TC(Q) = 2Q2+5Q+10, and a marginal cost curve MC(Q) = 4Q+5
● Industry inverse demand is given by P(Q) = 105−3Q and the marginal revenue curve is MR(Q) = 105−6Q
● What is the profit maximizing (PM) output of the monopoly? What are her profits? What is the CS in this industry? And what is the TS?
● Suppose that there is a monopolized industry where a monopoly firm has total cost function TC(Q) = 2Q2+5Q+10, and a marginal cost curve MC(Q) = 4Q+5
● Industry inverse demand is given by P(Q) = 105−3Q and the marginal revenue curve is MR(Q) = 105−6Q
● What is the profit maximizing (PM) output of the monopoly? What are her profits? What is the CS in this industry? And what is the TS?
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Problem 2: SolutionProblem 2: Solution
● To find PM output, we have to put MR = MC:
105−6Q = 4Q+5
100 = 10Q
Q = 10
● To find the price, we plug Q=10 into demand:
P = 105−3Q = 105−30 = 75 ● Thus monopolist sells 10 units of output and
charges $75 per unit
● To find PM output, we have to put MR = MC:
105−6Q = 4Q+5
100 = 10Q
Q = 10
● To find the price, we plug Q=10 into demand:
P = 105−3Q = 105−30 = 75 ● Thus monopolist sells 10 units of output and
charges $75 per unit
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Problem 2: SolutionProblem 2: Solution
● We know that P = 75 and Q = 10
● Profits of monopolist are TR−TC♦ TR = P (Q) = 75 (10) = 750♦ TC = TC(10) = 2(10)2 + 5 (10) + 10 = 260♦ So profits are 750 − 260 = 490
● Consumer surplus is computed straightforwardly:♦ CS = ½ (105 − 75) 10 = (15) 10 = 150
● So TS = profit + CS = 490 + 150 = 640
● We know that P = 75 and Q = 10
● Profits of monopolist are TR−TC♦ TR = P (Q) = 75 (10) = 750♦ TC = TC(10) = 2(10)2 + 5 (10) + 10 = 260♦ So profits are 750 − 260 = 490
● Consumer surplus is computed straightforwardly:♦ CS = ½ (105 − 75) 10 = (15) 10 = 150
● So TS = profit + CS = 490 + 150 = 640
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Problem 2: ContinuedProblem 2: Continued
● Now antitrust agency splits the monopoly into many identical competitive firms.
● So the industry is now perfectly competitive with inverse supply curve P(Q) = 2Q+5
● What is the new equilibrium? What are the CS, PS and TS in this equilibrium? Compare with the monopoly case.
● Now antitrust agency splits the monopoly into many identical competitive firms.
● So the industry is now perfectly competitive with inverse supply curve P(Q) = 2Q+5
● What is the new equilibrium? What are the CS, PS and TS in this equilibrium? Compare with the monopoly case.
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Problem 2: SolutionProblem 2: Solution
● To find eq’m, we put Demand = Supply
105−3Q = 2Q+5
100 = 5Q
Q = 25
● To find the price, we plug Q = 25 into demand:
P = 105−3Q = 105−75 = 30 ● Thus in equilibrium 25 units will be sold for a
price of $30 per unit
● To find eq’m, we put Demand = Supply
105−3Q = 2Q+5
100 = 5Q
Q = 25
● To find the price, we plug Q = 25 into demand:
P = 105−3Q = 105−75 = 30 ● Thus in equilibrium 25 units will be sold for a
price of $30 per unit
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Problem 2: SolutionProblem 2: Solution
● We know that P = 30 and Q = 25
● Consumer surplus is computed straightforwardly:
♦ CS = ½ (105 − 30) 25 = ½ (75) 25 = 937.5
● Producer Surplus is also straightforward to get:
♦ PS = ½ (30 − 5) 25 = ½ (25) 25 = 312.5
● So TS = PS + CS = 937.5 + 312.5 = 1250
● Under monopoly had TS = 640, P = 75, Q = 10, CS = 150 and PS (which was profit) = 490
● We know that P = 30 and Q = 25
● Consumer surplus is computed straightforwardly:
♦ CS = ½ (105 − 30) 25 = ½ (75) 25 = 937.5
● Producer Surplus is also straightforward to get:
♦ PS = ½ (30 − 5) 25 = ½ (25) 25 = 312.5
● So TS = PS + CS = 937.5 + 312.5 = 1250
● Under monopoly had TS = 640, P = 75, Q = 10, CS = 150 and PS (which was profit) = 490
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Problem 2: SolutionProblem 2: Solution
● Perfectly competitive industry makes everyone except monopolist better-off
● The total welfare is also bigger under perfect competition
● That is why economists believe we should keep an eye on monopolies so that they do not cause this sort of inefficiencies
● Perfectly competitive industry makes everyone except monopolist better-off
● The total welfare is also bigger under perfect competition
● That is why economists believe we should keep an eye on monopolies so that they do not cause this sort of inefficiencies
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The EndThe End
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