Transcript Chapter 12 MONOPOLY - University of Minnesota

Monopoly
Contents
● Monopoly Defined
● The Monopolist’s Supply Decision
● Can Anything Good Be Said About
Monopoly?
● Price Discrimination Under Monopoly
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Monopoly Defined
● Only one firm in the industry
● No close substitute for the product
● Little chance of successful entry by a
competitor
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Sources of Monopoly
● 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
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Natural 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
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Average Cost
FIGURE
1: Natural Monopoly
B
$3.00
A
2.50
C
2.00
AC
1
2
2.5
Quantity Supplied
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The 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
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The 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
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The 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
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The 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
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The 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.
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2: Profit-Maximizing
Equilibrium for a Monopolist
FIGURE
MC
Price per Unit
D
P
$9
AC
M
7
MC
4
AC
C
D
MR
0
150
300
Quantity
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1: A Monopolist’s PriceOutput Decision
TABLE
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The 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
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3: Compare Monopoly to
Competitive Industry
FIGURE
MC
Price per Unit
D
AC
P
$9
M
B
7
MC
D
C
AC
MR
150
300
Quantity
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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
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Natural Monopoly: Where SingleFirm Production Is Cheapest
● 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.
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Natural Monopoly: Where SingleFirm Production Is Cheapest
● 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.
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Price 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
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Price 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
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Price 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
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4: Prices and Quantities
under Price Discrimination
FIGURE
Customer Group A
Customer Group B
Da
Db
Pa
Price
Pb
H
0
J
Qa
W
MRa
Da
0
Qb
H
MRb
Quantity
Quantity
(a)
(b)
Db
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Price 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
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Is Price Discrimination Always
Undesirable?
● 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.
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Monopsonies
● 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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Monopsonies
● 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
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Some Problems
on Monopoly
Problem 1
● 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: Solution
● 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
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Problem 1: Solution
● 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
Profit
18*1=18 16*2=32 14*3=42 12*4=48 10*5=50
18-44
=-26
32-38
=-6
42-32
=10
48-26
=22
50-20
=30
4*6=24
24-14
=10
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Problem 1: Solution
● 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 
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Problem 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?
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Problem 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
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Problem 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
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Problem 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.
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Problem 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
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Problem 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
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Problem 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
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The End
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