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MONOPOLY

MONOPOLY. Chapter 12. Today’s lecture will :. Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms. Explain why MR = MC maximizes total profit for a monopolist.

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MONOPOLY

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  1. MONOPOLY Chapter 12

  2. Today’s lecture will: • Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms. • Explain why MR = MC maximizes total profit for a monopolist. • Determine a monopolist’s price, output, and profit graphically and numerically.

  3. Today’s lecture will: • Show graphically the welfare loss from monopoly. • Explain why a price-discriminating monopolist will earn more profit than a normal monopolist. • Explain why there would be no monopoly without barriers to entry. • Discuss three normative arguments against monopoly.

  4. Definition of Monopoly • Monopoly is a market structure in which one firm makes up the entire market. • Barriers to entry into the market prevent competition. • There are no close substitutes for the monopolist’s product.

  5. Output Price TR MR TC MC ATC Profit 0 36 0 — 47 — –47 1 33 33 33 48 1 48.00 –15 2 30 60 27 50 2 25.00 10 3 27 81 21 54 4 18.00 27 4 24 96 15 62 8 15.50 34 5 21 105 9 78 16 15.60 27 6 18 108 3 102 24 17.00 6 7 15 105 –3 142 40 20.29 –37 8 12 96 –9 196 56 24.75 –102 9 9 81 –15 278 80 30.89 –197 Determinimg Equilibrium Price and Quantity

  6. The monopolist’s price is $24 1 2 3 4 5 6 7 8 9 10 Equilibrium Price and Quantity Price MC $36 MR = MC at approximately 4 units 30 24 18 12 6 D 0 -6 Quantity MR -12

  7. Comparison of Monopoly and Pure Competition MC Price Monopolist price $24 (MR=MC) Monopoly output is lower and price is higher than in perfect competition. $36 Competitive Price $20.50 (P=MC) 24 20.50 12 D 0 1 2 3 4 6 7 8 9 10 5.17 Quantity MR

  8. A PM B QM Finding a Monopolist’s Output, Price, and Profit Profit is P-ATC (A-B) times total output, QM. MC Monopolist charges price PM from A on the demand curve. Price ATC Profit Monopolist produces output QM where MR=MC. CM D MR 0 Quantity

  9. PM QM Breaking Even MC Price ATC • Produce QM where • MR = MC • Price (PM) = ATC • Profit = 0 D MR 0 Quantity

  10. Minimizing Losses MC Price ATC • Produce QM, where • MR = MC. B CM A PM • Price (PM) < Cost (CM) Loss • Loss = CM PMBA D MR QM 0 Quantity

  11. PM C D B A QM Welfare Loss • B and D: welfare loss or • deadweight loss Price MC • C: transfer from consumer • surplus to monopolist PC • A: opportunity cost of • diverted resources MR D 0 QC Quantity

  12. Price Discrimination • Monopolist charges different prices to different individuals. • Consumers with less elastic demands are charged higher prices. • Consumers with more elastic demands are charged lower prices. • Price discrimination increases output and profits.

  13. Examples of Price Discrimination • Movie discounts to senior citizens and children. • Airline discounts for Saturday night stayovers. • Cars are seldom sold at list price. • Tracking consumer information and pricing accordingly.

  14. Barriers to Entry • Natural Ability • A firm is better at producing the good than anyone else. • Economies of Scale • Natural monopoly-a single firm can produce at a lower cost than can two or more firms. • Government-Created Monopolies • Patents, licenses, and franchises

  15. Natural Monopoly • One firm producing Q1 has average cost C1. • If two firms share the market, each produces • Q1/2 and has average cost C2. • Three firms each producing Q1/3 have • average cost C3. C3 AverageCost C2 C1 ATC 0 Q⅓ Q½ Q1 Quantity

  16. Natural Monopoly • A natural monopolist produces QM and • charges PM and earns a profit. Profit • If the government regulates a competitive • solution where P=MC, the monopolist • charges PC and produces QC for a loss.. PM CM Average Cost CC ATC Loss PC MC MR D 0 Quantity QM QC

  17. Normative Views of Monopoly • Monopolies are unjust because they restrict freedom. • Monopolies transfer income from “deserving” consumers to “undeserving” monopolists. • Monopolies cause potential monopolists to waste resources trying to get monopolies.

  18. Government Policy and Monopoly: AIDS Drugs • A few companies have patents for AIDS drugs that enable them to charge high prices because demand is inelastic. • Policy Options • Government regulation where price = marginal cost benefits society, but discourages research. • Government purchase of the patents and allowing anyone to produce the drugs so their price = marginal cost is expensive for taxpayers.

  19. Summary • Monopoly is a market structure, protected by barriers to entry, in which a single firm produces a product for which there are no close substitutes. • A monopolist maximizes profit or minimizes losses where MR=MC. • To determine a monopolist’s profit or loss: • Find output where MR=MC. • Determine price and ATC at that output. • Profit or loss = (P – ATC) * Q.

  20. Summary • Monopoly output is lower and price is higher than in competitive markets. • Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society. • A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demand.

  21. Summary • In order to discriminate a monopolist must: • Identify and separate groups of customers with different elasticities of demand. • Limit their ability to resell its product between groups. • Three important barriers to entry are: • Natural ability • Increasing returns to scale • Government restrictions

  22. Summary • Natural monopolies exist in industries with strong economies of scale, so it is more efficient for one firm to produce the entire output. • In a natural monopoly the competitive outcome where P=MC results in losses. • Normative arguments against monopoly are: • Monopolies are inconsistent with freedom. • Distributional effects of monopoly are unfair. • Monopolies encourage people to waste time and money trying to get monopolies.

  23. Review Question 12-1 Given the following demand and cost information, complete the table and find the profit-maximizing price and output. Output Price Total Marginal Marginal Average Profit Revenue Revenue Cost Total Cost 0 $20 ______ ----- ----- ----- ______ 1 18 ______ _______ $ 7 $17 ______ 2 16 ______ ______ 5 11 ______ 3 14 ______ ______ 6 9.33 ______ 4 12 ______ ______ 12 10 ______ 5 10 ______ ______ 15 11 ______ $-10 $ 0 18 18 1 32 14 10 10 14 42 48 6 8 50 2 -5

  24. Review Question 12-2Show the equilibrium output, price, and profit from question 12-1 on a graph. $20 Price MC MR = MC between 3 and 4 units, so the monopolist maximizes profit at Q = 3 and P = $14 Profit = (P-ATC)*Q Profit = (14-9.33)*3=$14 15 14 Profit = $14 ATC 10 D 9.33 5 MR Quantity 1 2 3 4 5

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