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Lecture 8

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Price taker demand curve

D

S

30

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P = MR

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Producers decision

Quantity

Rs. 30

MC

Q

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Producers maximize profit by selling the

quantity for which marginal revenue equals

marginal cost

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Long run equilibrium is attained where

MR=MC=ATC

Economic profit is zero and only normal return

is realized

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Firm and market supply

price

quantity

price

quantity

AVC

ATC Sshort run

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Monopoly

Single seller that produces a good with no close

substitutes

Sources of monopoly

What could be the causes of monopoly to

exist

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Barriers to entry

Legal barriers

Patents

Government granted franchises

Natural barriers

Economies of scale

Average cost of production is falling through the

relevant range of consumer demand

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Is at the opposite extreme of perfect

competition. Monopolist is a price maker as

against perfect competitor is who price taker

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Profit maximising under monopoly

QO

MR

AR

Rs

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QO

MC

AR

Qm

MR

AR

a

Rs

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QO

AC

MC

AR

AC

Qm

MR

AR

a

b

Rs

c

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Case StudyThe Market Value of Monopoly Profits in the New York

City Taxi Industry

NY city requires a license (medallion) to operate a taxi. These are

limited in numbers and confer a monopoly power (I.e. ability to earn

economic profits) to owners. Value of medallion is the PV of future

streams of earnings from medallion. For example the # of

medallions in NY city have remained at 11787 since 1937 till 1996. In

1996 it was increased by only 400 to 12187 medallions. The value of

medallion has risen from $ 10 in 1937 to 250000 in 1999 (18% p.a.).

The price of medallion is lower in other cities (e.g. $ 90000 in

Boston, $ 25000 in Chicago) reflecting much lower capacity in thesecities.

Proposals to increase the # in NY blocked by Taxi Unions.

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Case StudyThe Market Value of Monopoly Profits in the New York

City Taxi Industry (Contd..)

If the city authorities could give freely the medallions then the price

of medallions could fall to zero. Alternatively the Municipality has

allowed sharp increase in the radio taxis - although they are much

less flexible.

As a result the profit of NY taxi operators has come down from 32%

to only about 11% in 1999.

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Monopoly

Comparison of monopolywith perfect competition:

(a) same industry MCcurve

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QO

MC

Q1

MR

AR = D

P1

Equilibrium of industry under perfect competition and

monopoly:with the same MCcurve

Rs

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QO

MC

Q1

MR

P1

P2

Q2

Equilibrium of industry under perfect competition and

monopoly:with the same MCcurve

AR = D

Rs

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QO

MC( = supply under

perfect competition)

Q1

MR

P1

P2

Q2

Equilibrium of industry under perfect competition and

monopoly:with the same MCcurve

AR = D

Rs

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Monopoly

Comparison of monopolywith perfect competition:

(b) monopoly has lower MCcurve (i.e. itis experiencing economies of scale)

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QO Q1

MR

P1

MCmonopoly

Equilibrium of industry under perfect competition and

monopoly: with different MCcurves

AR = D

Rs

E ilib i f i d t d f t titi d l

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QO

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

AR = D

Equilibrium of industry under perfect competition and monopoly:

with different MCcurves

Rs

l b f d d f d l

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QO

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

x

AR = D

Equilibrium of industry under perfect competition and monopoly:

with different MCcurves

Rs

Equilibrium of industry under perfect competition and monopoly:

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QO

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

Q3

P3

AR = D

Equilibrium of industry under perfect competition and monopoly:

with different MCcurves

Rs

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MONOPOLY

Disadvantages of monopoly

high prices / low output: short run

high prices / low output: long run

lack of incentive to innovate

X-inefficiency

Advantages of monopoly

economies of scale

profits can be used for investment

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MONOPOLY

Disadvantages of monopoly

high prices / low output: short run

high prices / low output: long run

lack of incentive to innovate

X-inefficiency

Advantages of monopoly

economies of scale

profits can be used for investment

promise of high profits encourages risk taking

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Deadweight loss under monopoly

Deadweight loss under monopoly

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Deadweight loss under monopoly

O

Q

Ppc

Qpc

MC(= Sunder perfect competition)

AR = D

(a) Industry equilibrium under perfect competition

Consumer

surplusa

Producer

surplus

Deadweight loss under monopoly

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Deadweight loss under monopoly

O

Q

Ppc

Qpc

MC(= Sunder perfect competition)

AR = D

a

Pm

Qpc

MR

b

Consumer

surplus

Producer

surplus

Deadweight

welfare loss