Monopoly - A Single Seller

Microeconomics - Dr. D. Foster

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Monopoly Characteristics

A single seller with no “close” substitutes . . .-- means that the market demand is the firm’s demand.

Barriers to entry . . .-- means that they can earn LR econ. profit.

– legal restrictions– patents– control of resources– economies of scale

Monopoly - Finding Profit Max.

Find where MR=MC . . .

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MR = Gain - Loss

P1

Q1

P2

Q2

loss

gain

If P1=$10, P2=$9.95, Q1=100, Q2=101,

what is MR?Gain = $9.95Loss = $5.00

MR = $4.95 < Price

Monopoly - Finding Profit Max.

Find where MR=MC . . .

Will the firm earn an economic

profit?How can we tell?Q*

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MR

MC

P*

Set output at MR=MC.

Find the price to charge from the

Demand.

Monopoly - Finding Profit Max.

Economic profit = TR - TC . . .

Can a monopoly firm earn “negative”

economic profit and stay in business in the

short run?Q*Q

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MR

MC

P*ATC TC = ATC•Q

TR = P•Q

Monopoly

Can a firm can earn negative profit in the SR?Yes! As long as

P > AVC, the firm will sustain

losses in the short run.

ATC

Q*Q

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MR

MC

P*AVC

Can a monopoly earn just a zero

economic profit?

Monopoly - Earning zero profit

Zero Economic profit if TR = TC P = ATC

Under what circumstances

might we expect this to happen?

Q*Q

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MR

MC

P*

ATC

When owners of a monopoly sell it to a

new owner they should attempt to extract this

econ. profit.

Monopoly Example I

$100

$90$75

$70

$50$45$30

500 1000 1300

1200 1800MR

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ATCMC

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1. What is the profit maximizing level of output?

2. What price will the monopolist charge?

3. What is the amount of economic profit?

4. What is the amount of accounting profit?

Monopoly and Inefficiency

Allocative efficiency occurs when P=MC.

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MR

MC

P*ATC

Monopolies are allocatively

inefficient, as they price above the MC.

They produce too little. Our loss is call the “social losssocial loss” (or, deadweight cost) and measured as shown.

Monopoly and Inefficiency

“X-inefficiencyX-inefficiency” - arises from a cost structurecost structure that is higher than would be true for perfectly competitive firms.

“Social waste of resourcesSocial waste of resources” - up to the value of the firm’s economic profit if spent in “rent rent seekingseeking” activities.

Productive efficiencyProductive efficiency occurs when at min ATC.-- Monopolies are likelylikely to be inefficientinefficient.

Monopoly Example II

$100

$90$75

$70

$50$45$30

500 1000 1300

1200 1800MR

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ATCMC

P

1. What output level is allocatively efficient?

2. What is the social loss?

3. What output level is productively efficient?

Regulating Monopoly

Using price controls can promote efficiency!

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MR

MC

P*ATC

By instituting a price ceiling, the “demand” is altered, insofar as the firm’s actions are

concerned.

Pc

Regulating Monopoly

Using price controls can promote efficiency!The monopolist can be

induced to produce more (Q’) at a lower

price!!

The firm is still inefficient, but we could

set prices to achieve either allocative or

productive efficiency.Q*Q

P

D

MR

MC

P*ATC

Q’

Pc

Monopoly Example III

$100

$90$75

$70

$50$45$30

500 1000 1300

1200 1800MR

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ATCMC

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1. What would be the effect on output, price, economic profit and social cost if the government establishes a price ceiling of . . .

a. $45?

b. $50?

c. $70?

d. $75?

e. $90?

f. $100?

Monopoly Fundamentals

A single seller with no “close” substitutes.Barriers to entry.Sets output at MR=MC.Prices output based on demand.Will be allocatively inefficient as P>MC.Will likely be productively inefficient.Also suffers from “social waste” and “X-inefficiency.”Price controls can promote efficient outcomes.

Regulating Monopoly

Do regulations work?– Inflating the cost structure (X-inefficiency).

– The “capture” hypothesis.

– Antitrust legislation may promote inefficiency.

– Regulating a natural monopoly . . .

Natural Monopoly

Experiences economies of scale:

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MRQm

Pm

--Profit max. rule is still the same. --Price off of demand.--May earn positive economic profit in LR.

How do you regulate?

At P=MC, firm has negative econ. profit.

ATCMC

Q*?

P*?

Natural Monopoly

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MRQm

Pm

ATCMC

… and give the monopoly a subsidy equal to its losses!

… and the firm can earn zero econ profits, but is alloc. inefficient.

--We can set the price equal to the MC.

--Or, we can set the price equal to the ATC.

Q*?

P*?

Monopoly - Price Discrimination

When different people/customers When different people/customers are charged are charged different pricesdifferent prices

when costs are when costs are equalequal..

When different people/customers When different people/customers are charged the are charged the same pricesame price

when costs are when costs are differentdifferent..

Monopoly - Price Discrimination

33rdrd degree price discrimination (method #2) degree price discrimination (method #2)– when a firm segments the market by elasticity.– more elastic = lower price; less elastic = higher price

22ndnd degree price discrimination (method #1) degree price discrimination (method #1)– when a firm uses volume discounts to vary the price.

11stst degree price discrimination (perfect p.d.) degree price discrimination (perfect p.d.)

– when a firm can charge each individual the max. they are willing to pay.

Monopoly - Price Discrimination

Perfect price discriminationIf the firm is

collecting different prices from each customer, to sell one more unit, it need only lower the price for that unit, not for all.

Q*Q

Price

D=MR

MCPmax

Pmin

This only works if: --you prevent resale. --you can easily separate customers.

Monopoly - Segmented markets

Day/night billing . . . phone/electricMatinee/evening . . . theaterSenior menu . . . restaurantLadies night . . . barStudent price . . . restaurant/otherCoupons & club cards . . . grocery

Is it easy to separate Is it easy to separate customers?customers?

Can resale be prevented?Can resale be prevented?

Monopoly - A Single Seller

Microeconomics - Dr. D. Foster

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