Firm Behavior Under Monopoly AP Econ - Micro II B Mr. Griffin MHS

Monopoly Defined Only one firm in the industry No close substitutes for the product Little chance of successful entry by a competitor

Sources of Monopoly Barriers to Entry Economies of Scale (cost advantages) Legal Barriers: Patents and Licenses Control of Essential Resources Strategic Barriers to Entry

Natural Monopoly Declining long-run average costs (economies of scale) exist over an extended output range Least-cost production can only be achieved by a single producer.

Average Total Cost Quantity $ ATC If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly. THE NATURAL MONOPOLY CASE

Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Monopoly: Single Seller No Close Substitutes Price Maker Blocked Entry Nonprice Competition

MONOPOLY DEMAND 3 Basic Assumptions: Monopoly Status is Secure No Governmental Regulation Firm Charges the Same Price for all Units Sold Market Demand Curve is the Firm’s Demand Curve

MONOPOLY DEMAND P Q $ D As price decreases from $142 to $ Loss = $30 Gain = $132 revenue will increase with the additional unit sold.

MONOPOLY DEMAND P Q $ D As price decreases from $142 to $ Loss = $30 Gain = $132 revenue will increase with the additional unit sold. Marginal Revenue $132 - $30 = $102 must be less than price $132.

MONOPOLY REVENUES & COSTS Marginal Revenue 0 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172$ 0 - $100 Average Total Cost Total Cost $100 Revenue DataCost Data x = - =

0 $172$ 0 - $100$100 MONOPOLY REVENUES & COSTS Marginal Revenue Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $ $ $162 - $ Average Total Cost $ Total Cost $ ]] Revenue DataCost Data x = MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

MONOPOLY REVENUES & COSTS Marginal Revenue Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $ $ $ $ Average Total Cost $ Total Cost $ ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data

MONOPOLY REVENUES & COSTS Marginal Revenue Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $ $ $ $ Average Total Cost $ Total Cost $ ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data Can you see profit maximization? MR > = MC

MONOPOLY REVENUES & COSTS Marginal Revenue Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $ $ $ $ Average Total Cost $ Total Cost $ ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data

MONOPOLY REVENUES & COSTS Dollars $ $ Q Q

MONOPOLY REVENUES & COSTS Dollars $ $ MR Elastic D Q TR Q

MONOPOLY REVENUES & COSTS Q Dollars $ $ TR MR D InelasticElastic Q

OUTPUT AND PRICE DETERMINATION Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions Not Highest Price Total, Not Unit, Profit Possibility of Losses Graphically…

Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q Price, costs, and revenue Remember the MR=MC Rule?

Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q Price, costs, and revenue What About Loss Minimization?

Loss Minimization Under Monopoly D MC ATC MR A PmPm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q Price, costs, and revenue AVC QmQm V Since P m exceeds AVC, the firm will produce

Loss Minimization Under Monopoly D MC ATC MR A PmPm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q Price, costs, and revenue AVC QmQm V What are the Economic Effects of Monopoly?

Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition. An industry in pure competition sells where supply and demand are equal.

Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition Monopoly pricing effectively creates an income transfer from buyers to the seller!

COST COMPLICATIONS Average total costs Quantity Average Total Costs X X’ Q1Q1 Q2Q2 ATC x ATC 1 ATC 2 ATC x’ Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency Inefficient internal operation leads to higher-than- necessary costs.

COST COMPLICATIONS Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency Rent-Seeking Expenditures Rent-Seeking Behavior Technological Advance Assessment and Policy Options Antitrust Action Regulate Natural Monopoly Ignore it, if it is Short-Lived

Conditions Monopoly Power Market Segregation No Resale Consequences More Profit More Production PRICE DISCRIMINATION Graphically…

Q D MR MC ATC P Q1Q1 Price and Costs Economic profits with a single MR=MC price PRICE DISCRIMINATION

Q D MC ATC P Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D

Q D MC ATC P Q1Q1 Price and Costs Economic profits with price discrimination PRICE DISCRIMINATION Q2Q2 MR=D

Natural Monopolies Rate Regulation Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically…

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Monopoly Price MR = MC QmQm PmPm

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Fair-Return Price Normal Profit Only QfQf PfPf

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Socially-Optimum Price P = MC QrQr PrPr

REGULATED MONOPOLY Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-Optimum Price QmQm QfQf QrQr Dilemma of Regulation Which Price? PmPm PfPf PrPr

What do I need to know about monopoly for the AP Exam?

RELATIONSHIP ECONOMIC INTERPRETATION MR = MC The firm has chosen the output that maximizes profits. P > ATC Firm is earning Economic Profits P = ATC Firm is earning NORMAL PROFIT (Break-Even Point) (EP = 0) P < ATC; P > AVC Loss Minimization P = AVC SHUTDOWN POINT (firm cannot cover its AVC P < AVC Firm does not produce

MONOPOLY P > MR The firm’s DEMAND CURVE is relatively INELASTIC (but monopolists always operate in the ELASTIC region) MR = MC MR = MC The firm maximizes profit. P > ATC P > ATC Long Run ECONOMIC PROFITS. PRODUCTIVE INEFFICIENCY PRODUCTIVE INEFFICIENCY P > min ATC Firm is not forced to operate with maximum productive efficiency. Firm is not forced to operate with maximum productive efficiency. (Least-Cost Method Production not necessary) (Least-Cost Method Production not necessary) ALLOCATIVE INEFFICIENCY ALLOCATIVE INEFFICIENCY P > MC There is an UNDERALLOCATION of resources. There is an UNDERALLOCATION of resources.

Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q Price, costs, and revenue Remember the MR=MC Rule?

Q D MC ATC P Q1Q1Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D