CHAPTER 8 MONOPOLY

1. Part Two: Microeconomics of Product Markets CHAPTER 8MONOPOLY

2. In this chapter you will learn: 8.1 The characteristics of a monopoly 8.2 About the profit-maximizing price and output in pure monopoly 8.3 About the economic effects of monopoly 8.4 Why a monopolist prefers to charge different prices in different markets 8.5 The choices facing governments that regulate monopolies 8.6 About the deadweight loss associated with monopoly Chapter 8

3. Monopoly Characteristics: • Single Seller • No Close Substitutes • Price-Maker • Blocked Entry Examples of Monopoly Chapter 8.1

4. D Barrier to Entry – Figure 8-1 Economies of Scale $20 15 ATC 10 If ATC declines over the entire market demand, least-cost production is realized only if there is one producer - a natural monopoly 0 50 100 200 Quantity (millions) Chapter 8.1

5. Barriers to Entry • Economies of Scale • Legal Barriers to Entry: Patents and Licences • Ownership or Control of Essential Resources • Pricing and Other Strategic Barriers to Entry Chapter 8.1

6. Monopoly Demand Three basic assumptions: • Monopoly status is secured • Firm is not governmentally regulated • Firm charges the same price for all units Chapter 8.1

7. Monopoly Demand • Marginal revenue is less than price Illustrated… Chapter 8.1

8. ] ] Notice that MR < P Table 8-1 Chapter 8.1

9. 132 Gain = $132 Figure 8-2Price and Marginal Revenue in Monopoly When price decreases from $142 to $132, one more unit is sold… P $142 D Revenue will increase by $132 with the extra unit sold Q 1 2 3 4 5 6 Chapter 8.1

10. Price and Marginal Revenue in Monopoly When price decreases from $142 to $132, one more unit is sold… P $142 Loss = $30 132 but revenue loss = $10 X 3 units D Marginal revenue = $132-30 = $102 < $132 (price) Gain = $132 Q 1 2 3 4 5 6 Chapter 8.1

11. Monopoly Demand • Marginal revenue is less than price • The monopolist is a price-maker • The monopolist sets prices in the elastic region of demand illustrated… Chapter 8.1

12. Figure 8-3 Demand, MR, and TR for a Monopolist Elastic 200 150 200 50 Dollars Inelastic MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 750 500 250 TR Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Chapter 8.1

13. Output and Price Determination • Cost Data • assume competitive resource markets • MR=MC Rule Illustrated… Chapter 8.2

14. produce? produce? produce? produce? ] ] ] ] ] ] ] ] ] ] Table 8-1 Chapter 8.2

15. ] ] ] ] Profit Maximization Choice ] ] ] ] ] ] ] ] ] ] Same results as TR – TC Rule ] ] ] ] ] ] Chapter 8.2

16. P 200 175 150 125 100 75 50 25 D MR = MC MR Q 0 1 2 3 4 5 6 7 8 9 10 Figure 8-4Profit Maximization by a Monopolist Find q MC Chapter 8.2

17. P 200 175 150 120 100 75 50 25 D MR Q 0 1 2 3 4 5 6 7 8 9 10 Profit Maximization by a Monopolist Find p MC $122= p Chapter 8.2

18. P 200 175 150 120 100 75 50 25 D MR Q 0 1 2 3 4 5 6 7 8 9 10 Profit Maximization by a Monopolist Find ATC MC Profit =(p - ATC) X q =(122-94) X 5 =140 $122= p ATC Profit $94=ATC Chapter 8.2

19. Output and Price Determination • Cost Data • assume competitive resource markets • MR=MC Rule • No Monopoly Supply Curve Chapter 8.2

20. Output and Price Determination • Misconceptions Concerning Monopoly Pricing • Not the highest price • Total, not unit, profit • Possibility of Losses by Monopolist Illustrated… Chapter 8.2

21. Loss MR = MC Figure 8-5 The Loss-Minimizing Position of a Monopolist P MC A ATC Pm AVC D V MR Q Qm Chapter 8.2

22. Economic Effects of Monopoly • Price, Output, and Efficiency • inefficient relative to a purely competitive industry • Pm > MC • Pm > minimum ATC Illustrated… Chapter 8.3

23. Pc P=MC=minimum ATC Qc Figure 8-6 Inefficiency of Monopoly P S = MC Price and output if the industry were competitive D Q Chapter 8.3

24. Pm Pc Qm Qc Inefficiency of Monopoly S = MC P Monopolist will sell fewer units at a higher price than in pure competition D MR Q Chapter 8.3

25. Economic Effects of Monopoly • Income Transfer • monopoly owners enriched at the expense of consumers • Cost Complications Economies of Scale • simultaneous consumption • network effects X-Inefficiency Illustrated… Chapter 8.3

26. X ATCX ATC1 X' ATCX' ATC2 Figure 8-7X-Inefficiency Inefficient internal operation leads to higher-than-necessary costs Average Total Cost Unit costs (dollars) Quantity Q1 Q2 Chapter 8.3

27. Economic Effects of Monopoly • Cost Complications • Economies of Scale • simultaneous consumption • network effects • X-Inefficiency • Rent-Seeking Expenditures • Technological Advance Chapter 8.3

28. Assessment and Policy Options • Legitimate concerns • Three policy options: • Charges under Canada’s anticombines laws • Regulate prices and operations of natural monopolies • Ignore monopolies which are unsustainable over the long term Chapter 8.3

29. Price Discrimination and Monopoly • Same product is sold at more than one price • Not justified by cost differences • Based on differences in “willingness to pay” Chapter 8.4

30. Price Discrimination • Necessary Conditions.… • Monopoly Power • Market Segregation • No Resale • Examples • airlines • theatres, golf courses • coupons • international trade Chapter 8.4

31. Figure 8-8Price Discrimination to Different Groups of Buyers P (a) Small Businesses Pb MC = ATC Price and Costs MR D Q Qb Chapter 8.4

32. Price Discrimination to Different Groups of Buyers P (b) Students Ps Price and Costs MC = ATC MR D Q Qs Chapter 8.4

33. Regulated Monopoly • Natural monopolies traditionally have been subject to rate (price) regulation • e.g., natural gas distributors, regional telephone companies, electricity suppliers • Trend to deregulation where possible • e.g., long distance telephone Chapter 8.5

34. Regulated Monopoly • May be desirable to maintain but regulate a natural monopoly • Types of regulation include: • Socially optimal price where P = MC • Fair-return price where P = ATC Illustrated… Chapter 8.5

35. Figure 8-9 Regulated Monopoly – Socially Optimal P Socially Optimal Price Price = MC Unregulated monopoly price M Pm Price and Costs ATC LOSS MC Pr Allocatively efficient BUT Subsidy required D MR Q Qm Qr Chapter 8.5

36. Regulated Monopoly – Fair Return Fair Return Price Price = ATC P M Pm Price and Costs f ATC Pf MC Pr r D FIRM BREAKS EVEN still some underallocation MR Q Qm Qf Qr Chapter 8.5

37. Dilemma of Regulation • Setting price at P = MC • firm earns losses • Setting price at P = ATC • still some underallocation of resources • Regulation can improve outcomes Chapter 8.5

38. Monopoly and Deadweight Loss • Net loss of consumer and producer surplus is deadweight loss • Monopolist also loses producer surplus, but gains producer surplus at the expense of consumer surplus • Consumers lose consumer surplus Chapter 8.6

39. Pc Efficient output Qc Figure 8-10 Monopoly and Deadweight Loss S = MC P Outcomes with pure competition Consumer surplus Producer surplus D=MB Q Chapter 8.6

40. Monopoly and Deadweight Loss Monopoly’s gain Pm Deadweight loss B Pc C Qm Qc P Outcomes with pure monopoly S = MC Consumer surplus Producer surplus D=MB MR Q Chapter 8.6

41. Chapter Summary • 8.1 Characteristics of Pure Monopoly • 8.2 Output and Price Determination in a Monopoly • MR = MC • 8.3 Economic Effects of Monopoly • 8.4 Price Discrimination and Monopoly • 8.5 Regulated Monopoly • Socially optimal price or fair-return price • 8.6 Monopoly and Deadweight Loss Chapter 8