Chapter 12 Pure Monopoly

I. Characteristic: 1) One seller 2) No close substitutes for the good 3) Barriers to entry 4) Many buyers 2) and 3) give the firm market power 5) Firms are price searchers One firm producing all of the markets ouptput Controls price the only game in town I. The Monopoly Demand Curve Flatter demand curve implies less market power, steeper demand curve implies more market power. II. Barriers to Entry (Also called sources of monopoly power) 6) Natural Barriers (leads to a natural monopoly) a) economies of scale b) Exclusive control of a resource 7) Artificial Barriers (Also called legal barriers) Leads to legal monopoly III. Profit maximizing Output and Price for a Single-Priced Monopolist Also Max profit where MR = MC For a monopoly MR is not constant Demand Schedule
P in $s 8 7 6 5 4 3 2 1 0 Q 0 1 2 3 4 5 6 7 8 TR 0 7 12 15 16 15 12 7 0 MR 0 7 5 3 1 -1 -3 -5 -7

$6 increase from selling one more unit, $1 loss from selling first unit at lower price 5-2 4-3 3-4 2-5 1-6

Numbers above do not correspond to the following graph

Demand and Marginal Revenue Curves

Price and marginal revenue

20

Elastic

d 10 f MR 5
Over the range 0 to 5, a price cut increases total revenue, so demand is elastic.

0 10

D 10

Quantity

20
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Slide 13-16

TR, MR, and elasticity Total Revenue in dollars or Total Expenditures

Total Revenue Curve

Total revenue (dollars per hour)

50 40 30 20 10 TR
Quantity

Zero marginal revenue

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10

Slide 13-19

A monopolist wants to operate where MR > 0 (TR is increasing). Profit maximizing price and output graphically: PROFIT

Price and cost (dollars per hour)

A Monopolys Output and Price

20 MC Profit = $12 ($4 x 3 units) 14 10
Economic profit $12

ATC D MR

0
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Quantity

5
Slide 13-23

Look and TR<TC and profit on graph The monopolist uses the same shut down rule: Shut down if P < AVC No supply curve, just a supply point (*) The monopolist cant change the highest price possible: Must max profit where MR = MC Must keep demand curve in mind B. A monopolist suffering a loss: GRAPH C. A monopolist breaking even: GRAPH Can a monopolist sustain profits in the long-run? Pros and Cons of the Monopoly Market Structure Advantages: 1) Provides incentive for innovation If you knew you can reap a profit from an invention, there is incentive to invent. 2) Take advantage of economies of scale and scope Take advantage of being a natural monopolist with lower average costs Take advantage of producing a variety of products using the same inputs Disadvantages:

1) Limits options to consumers (and we pay a higher price) 2) Profit and losses dont send proper signals or send proper incentives 3) Rent seeking behavior (rent is another word for monopoly profit) spending money to obtain a monopoly position How much will you pay to be a monopoly? You will pay a cost of rent seeking no greater than the amount of the monopoly profits 4) Productive inefficiency P > min ATC For perfect comp. In long-run P = min ATC 5) Allocative inefficiency (if all eff, P = MC) P >MC In perfect competition P = MC so perfect comp is allocatively efficient. 6) Deadweight Loss or Welfare Loss (result of allocative inefficiency) To explain this in more detail discuss consumer and producer surplus first Consumer and Producer Surplus Consumer surplus = amount willing to pay amount actually must pay (market equilibrium price) Consumer surplus and market surplus are not the same thing Consumer surplus is benefit the consumer gets from a transaction beyond what they actually had to pay. GRAPH Producer Surplus = amount actually paid to producer (market price) amount must be paid to be willing to provide the good. Show graphically

Inefficiency of Monopoly
Price
Consumer surplus

S = MC
Deadweight loss

PM PC
Monopolys gain
Producer surplus

D = MB
Efficient quantity

MR 0
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QM

QC

Quantity
Slide 13-27

Allocative Efficiency and Dead Weight Loss We can also think of the demand curve as the marginal benefit curve (MB) The supply curve is the marginal cost curve (MC). At equilibrium MB = MC and resources are going exactly where consumers want it to go This is allocative efficiency Also all of the consumer and producer surplus is being experienced - When we are in a perfectly competitive market, this is the level of market exchange that occurs, so we achieve allocative efficiency. Suppose that output is restricted (This may happen in other market structures) - Some of the producer and consumer surplus is not experienced. (See graph above) - This loss in producer and consumer surplus is called deadweight loss or welfare loss (when we have this loss we allocative inefficiency. More producer and consumer surplus could be achieved by increasing the level of exchange in the market). Deadweight loss in the monopoly graph: - loss in consumer surplus due to monopoly - loss in producer surplus due to monopoly - welfare loss or deadweight loss - consumer surplus that is transferred into monopoly profit Having deadweight loss means you are allocatively inefficient.

Price Discrimination - The practice of charging different consumers different prices for the same good or service. This is when we call them a multi-price monopolist

Price (dollars per trip)

A Single Price of Air Travel

2100 1800 1500 1200 900 $48 million 600 300 0 5 8 Consumer surplus Economic profit

MC ATC

MR

10 15 20 Passengers (thousands per year)

Slide 13-35

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Price Discrimination
Price (dollars per trip) 2100 1800 1600 1400 1200 900 600 300 0
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Increased economic profit from price discrimination

MC ATC

MR
2 4 6 8

10 15 20 Passengers (thousands per year)

Slide 13-37

Three conditions that must exist for affirm to price discriminate 1) Firms must face a downward sloping demand curve 2) Must be able to segment market: 3) Must be able to prevent arbitrage Perfect price discrimination: Charger each person a different price Extracts all consumer surplus