ECON649/ECON991

1. ECON649/ECON991 Lecture 7

2. Monopoly(continued…)

3. Lack of Supply Curve • In monopoly there is no supply curve.  demand  shift of firm’s MR curve  new MC = MR point BUT one price can be associated with 2 quantities OR one quantity can be associated with 2 prices

4. No unique relationship between price and quantity  there can be no supply curve Lack of Supply Curve P • Consider first possibility: (one price associated with two quantities) MC P* D2 MR2 MR1 D1 0 Q Q1 Q2

5. Lack of Supply Curve No unique relationship between price and quantity  there can be no supply curve P • Consider second possibility: (one quantity associated with two prices) MC P1 P2 D2 MR1 D1 0 Q Q* MR2

6. Common Misconceptions P At all P ≠ P* lower π or higher loss • The monopoly charges the highestprice possible. In fact, monopoly charges the price that is associated with the π max/loss min output level (Q*). MC P* D MR 0 Q* Q

7. Common Misconceptions Max of total π produce at Q*, where MR=MC If max per-unit π  produce at Q1 (where difference between P and ATC is greatest) but MR>MC P • Monopoly firm attempts to maximise per-unit profit. In fact, monopoly is assumed to maximise total profit. MC ATC D MR Q1 Q* Q

8. Common Misconceptions • The monopoly firm is always profitable. In fact, there is no theoretical or empirical foundation to this belief. Profitability is not specified in the SR or the LR.

9. Common Misconceptions • The monopoly firm has an inelastic demand curve via its sole supplier status. In fact, since the D curve is subject to law of demand elasticity varies along the length of the D curve Furthermore, π max/loss min firm will only set price in the elastic section of D curve. With positive MC = MR, Q* and P* will be in the elastic section of D curve.

10. TCnew TC Total cost & total revenue Lump sum tax= tax of so many dollars in a lump-sum (e.g. $100) This tax is just like an  in firm’s total fixed cost. TFC  TC Also ATC but MC is unchanged MC = MR is unchanged π max output is still Q* TR Q Q* $ MC ATCnew P* ATCoriginal D = AR π before tax π after tax 0 Q* Q MR

11. Specific Tax (per-unit tax) TCnew TR & TC TC1 = tax of so many dollars per unit of output(e.g. tax of $2 per unit of output) • Let TC before the tax = TC1 • TC after the tax= TC1 plus (tax per unit x Q)= TC1 plus ($2 x Q) • Average costs rise by $2 and MC rises by $2 TR Q2 Q1 Q

12. Specific Tax (per-unit tax) Producer’s burden P Consumer’s burden MCnew • Without tax ~ π max  Q1, P1 • With the tax ~ MC1 MCnew  π max Q2, P2 • Note that firm shifts part of the tax onto consumers, but with P < the per-unit tax  firm has tax burden too P2 P1 MC1 tax D MR Q2 Q1 Q

13. Comparing Monopoly and Perfect Competition • Does monopoly cause a misallocation of resources? • Need to compare LR outcome of Monopoly and Perfect Competition • Perfect Competition: in LR MR = MC = P = ATCno supernormal profit • What about Monopoly ????

14. Comparing Monopoly and Perfect Competition P MC A P* P = MC B • P > MR always, and so P > MC (allocative inefficiency) • Consumers always pay a higher price under Monopoly and a lower output is produced, compared to Perfect Competition PPC C D MR 0 Q Q* QPC

15. Comparing Monopoly and Perfect Competition Deadweight loss from Monopoly Transfer of consumer surplus to Monopoly P • Under Monopoly output is restricted to maximise profit. • P > MC and some consumer surplus is transferred to the Monopolist. Society overall is worse off (there is a deadweight social loss). • Because of barriers to entry a Monopoly can continue to earn supernormal profit in the LR. MC A P* P = MC B PPC C MC* D MR 0 Q Q* QPC

16. Comparing Monopoly and Perfect Competition Counter claims: • Innovation and technological changeEconomists such as Joseph Schumpeter have argued that Monopoly does benefit the community • Inefficiency of production in Monopoly is compensated for by greater development and implementation of technological change and innovation (e.g. new commodities, new ways of organising production)

17. Comparing Monopoly and Perfect Competition • The reward of Monopoly profit for being innovative encourages others to imitate and thus destroys the Monopoly • Only by continuous innovation can Monopoly be maintained • This process provides new products to consumers and more efficient methods of production • Empirical research on the subject is still inconclusive.

18. Govt Policy Towards Monopolies • Because monopolies reduce consumer surplus and are allocatively inefficient most governments have policies to preserve and promote competition between firms, and to regulate the behaviour of monopolies. • In Australia we have trade practices laws and the ACCC (Australian Competition and Consumer Commission) to oversee business behaviour. • See pp.237-241 for more details.

19. REQUIRED READING This week’s lecture: Monopoly • Hubbard, Garnett, Lewis & O’Brien, Essentials of Economics Chapter 8

20. REQUIRED READING Next week’s lecture: Introduction to Macroeconomics • Hubbard, Garnett, Lewis & O’Brien, Essentials of Economics Chs 12, 13 (pp. 396-404) & 14