What did you study last time?

1. CRC Microeconomics

2. What did you study last time? • What is meant by perfect competition? • How much output a (perfectly) competitive firm should produce to maximize profit? • Where do the firm’s and the market supply curves come from? • What happens in the long run in a (perfectly) competitive market? CRC Microeconomics

3. Do you know … • why monopolies arise? • what is meant by a monopoly? • how much output a monopoly should produce to maximize profit? • if monopolies are good or bad? • how governments regulate monopolies? • how a monopoly price discriminates? CRC Microeconomics

4. 1. Why do monopolies arise? Because of barriers to entry, as a result of: • A key resource owned by a single firm; • The government’s authorization; • Natural monopoly, resulted from economies of scale. CRC Microeconomics

5. 2a. Monopoly—Main characteristics • Sole seller. • No close substitute. • Barriers to entry. CRC Microeconomics

6. 2b. Monopoly—Main Ideas • The monopoly is a price maker/setter. • TR = P x Q, where P varies. • AR = TR / Q = P • MR = DTR / DQ < (AR = P) • The monopoly’s demand curve, (AR = P), is downward sloping. It is also the market demand curve. CRC Microeconomics

7. 2b. Monopoly—Main ideas • P = (P – ATC)*Q < = > 0. • The monopolistic market is inefficient. There exists a DWL, because Qm < Qc. • Regulations are necessary. • A monopoly can practice price discrimination. CRC Microeconomics

8. 3. How much should a monopoly produce to maximize profit? • To maximize profit, a monopoly produces the output Q*, where (AR = P ) > MR = MC CRC Microeconomics

9. Graphs of profit maximization • Case 1. P > 0 • Case 2. P = 0 CRC Microeconomics

10. Case 1. P > 0 The graph below shows the cost and revenue curves of a monopoly. The “equilibrium” point is Em, where MRm = MC. MC $ Pm ATC AVC Em ARm MRm Q Qm CRC Microeconomics

11. Case 1. P > 0 The firm produces Qm to maximize profit. Its TR is Pm*Qm… At Qm, the firm’s VC (= AVC x Qm) is … MC $ Pm ATC TR= Pm x Qm AVC VC = AVC x Qm Em ARm MRm Q Qm CRC Microeconomics

12. Case 1. P > 0 At Qm, the firm’s FC (= AFC x Qm) is … At Qm, the firm’s TC = VC + FC is … MC $ Pm ATC TR= Pm x Qm AVC TC FC VC = AVC x Qm Em ARm MRm Q Qm CRC Microeconomics

13. Case 1. P > 0 At Qm, the firm’s P = TR - TC is … MC $ Pm ATC P TR= Pm x Qm AVC TC FC VC = AVC x Qm Em ARm MRm Q Qm CRC Microeconomics

14. Case 2. P = 0 The graph below shows the cost and revenue curves of a monopoly. The “equilibrium” point is Em, where MRm = MC. MC $ ATC Pm AVC Em ARm MRm Q Qm CRC Microeconomics

15. Case 2. P = 0 The firm produces Qm to maximize profit. Its TR is Pm*Qm… At Qm, the firm’s VC (= AVC x Qm) is … MC $ ATC Pm AVC TR VC Em ARm MRm Q Qm CRC Microeconomics

16. Case 2. P = 0 At Qm, the firm’s FC (= AFC x Qm) is … At Qm, the firm’s TC = VC + FC is … MC $ ATC Pm AVC TC FC TR VC Em ARm MRm Q Qm CRC Microeconomics

17. Case 2. P = 0 At Qm, the firm’s P = TR - TC = 0 MC $ ATC Pm AVC TC TR FC TR VC Em ARm MRm Q Qm CRC Microeconomics

18. 4. Are monopolies good or bad? P The graph below shows a competitive market. Now suppose that it becomes a monopoly. Thus, ARm = Dc, and MCm = Sc. Ec Sc = MCm Pc Dc = ARm CRC Microeconomics Qc Q

19. 4. Are monopolies good or bad? P The monopoly has a MR curve. The monopoly’s Em is where MRm=MCm. Ec Sc = MCm Pc Em Dc = ARm MRm CRC Microeconomics Qc Q

20. 4. Are monopolies good or bad? P The monopoly’s output is Qm < Qc, and the monopoly’s price is Pm > Pc. The monopoly causes a DWL. Pm DWL Ec Sc = MCm Pc Em Dc = ARm MRm CRC Microeconomics Qm Qc Q

21. 4. Are monopolies good or bad? Define: • Qc = output in perfect competition, where the market if efficient. • Qm = output produced by a monopoly. • Since a monopoly produces less: - Qm < Qc, - there is a loss of production due to monopoly, - i.e. there exists a DWL. CRC Microeconomics

22. 4. Are monopolies good or bad? • Monopolies are bad, because monopolistic markets are inefficient. • A monopoly is “like” a private tax collector. • The monopoly charges a higher price than the free-market equilibrium price, reduces output below the free-market equilibrium output. The effect is like a tax on a free market. CRC Microeconomics

23. 5. How governments regulate monopolies Governments: • make monopolies more competitive • with antitrust laws (e.g. prevent mergers, break up big companies, etc.) • regulate monopolies’ behavior • with marginal-cost pricing, or • with average-cost pricing CRC Microeconomics

24. 5. How governments regulate monopolies Governments: • turn monopolies into public enterprises. • e.g. U.S Postal Service • leave monopolies alone. • e.g. Microsoft CRC Microeconomics

25. 5. Regulating monopolies’ behavior P The graph below shows a natural monopoly. Without any regulation, the monopoly’s output is Qm, where MRm = MCm, and the profit is ... Pm P ATCm MCm Em ARm MRm CRC Microeconomics Qm Q

26. 5. Regulating monopolies’ behavior P Under MC-pricing, the monopoly is required to charge a price equal to MC. It will produce Qc at MCm = Pc. The monopolistic market is efficient, DWL = 0. However, the monopoly loses and needs to be subsidized. Pm P ATCm Loss under MC-pricing = Subsidy MCm = Pc MCm Ec Em ARm MRm CRC Microeconomics Qm Qc Q

27. 5. Regulating monopolies’ behavior P Under AC-pricing, the monopoly is required to charge a price equal to ATC. It will produce Qa at P = ATCm. The monopolistic market is inefficient, DWL > 0. The monopoly breaks even, earns only normal profit. DWL Pm Ea ATCm Pa MCm = Pc MCm Ec Em ARm MRm CRC Microeconomics Qm Qa Qc Q

28. 6. How does a monopoly price discriminate? A monopoly can charge its customers: • one single price, i.e. there is no price discrimination; • two different prices or more, i.e. there is (imperfect) price discrimination; • as many different prices as the number of customers, i.e. there is perfect price discrimination. CRC Microeconomics

29. 6. How does a monopoly price discriminate? • In imperfect price discrimination, the monopoly • raise price on customers with inelastic demand, and • lower price on customers with elastic demand • e.g. bus fare, movie ticket prices, etc. CRC Microeconomics

30. 6. How does a monopoly price discriminate? • In perfect price discrimination, the monopoly charge customers their WTP, i.e. each customer would pay a different price. • Perfect discrimination results in efficiency, because there is no DWL. The monopoly would produce an output Qm = Qc. • The issue is that all consumer surplus becomes the monopolist’s profit. CRC Microeconomics

31. Perfect price discrimination by a monopoly P The graph shows a monopoly. With a single-price, the monopoly’s output is Qm, price Pm, and the profits are ... There exists a DWL. Pm P DWL MCm = ATCm Em ARm MRm CRC Microeconomics Qm Q

32. Perfect price discrimination by a monopoly P With perfect price discrimination, themonopoly’s output is Qc, price Pc. P The profits are … There is no DWL. Pm P DWL Pc = MCm = ATCm MCm = ATCm Ec Em ARm MRm CRC Microeconomics Qm Qc Q

33. Now you know … • why monopolies arise. • what is meant by a monopoly. • how much output a monopoly should produce to maximize profit. • if monopolies are good or bad. • how governments regulate monopolies. • how a monopoly price discriminates. CRC Microeconomics

34. What will you study next time? • What is meant by an oligopoly? • What is a duopoly? • What are some special issues about oligopolies? • How do governments deal with oligopolies? CRC Microeconomics

35. See You! Take Care! CRC Microeconomics