Simple Monopoly Lecture 22 Dr. Jennifer P. Wissink ©2017 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 24, 2017

Announcements(micro)-Spring 2017 Please note: Even though my weekly Monday office hours have been shifted to Wednesdays, my appointment got cancelled on me, so if you wish to stop today I will be around most of the afternoon. If you plan to stop by and talk about your grades, please have both exam 1 and exam 2 with you. Makes it much easier to have a look and come up with ideas. See Blackboard for message about exam 2. On the whole you held up pretty well! Keep working hard!

Recall: Rules for SR Profit Maximization Suppose we are in the short run. Rules for profit maximization are the same as before. If QSM maximizes profit, then (1) mr(at QSM) = srmc(at QSM). (2) QSM is a at a max and not a min. (3) at QSM it’s worth operating, rather than shutting down. Now apply to the simple monopolist! No real change in the looks of srmc, sratc, sravc Big change in the look of perceived demand and corresponding marginal revenue. Market Demand (D) = perceived demand (δ) Marginal revenue is below Market Demand for all Q>0 When Market Demand is linear, then marginal revenue is “same intercept and twice the slope”.

Simple Monopoly Marginal Revenue with Linear Demand $ Suppose demand curve is: QD = 10 – 1/2P or PD = 20 – 2Q Total revenue(tr) = PD∙Q Total revenue = (20 – 2Q)∙Q So tr = 20Q - 2Q2 Marginal revenue(mr) mr = ∆Total revenue/∆Quantity mr = 20 - 4Q Now compare mr with PD With a linear demand, marginal revenue will have the same vertical intercept and will be twice as steep! $20 If PD = 20 – 2Q Demand 5 10 Q mrSM Then mrsm = 20 – 4Q

Graphical Display of Simple Monopolist’s Short Run Profit Maximizing Solution (1) The monopolist sets marginal revenue equal to marginal cost to get QSM. (1a) Then goes up to the demand curve to get the price PSM. (2) Then makes sure he is at a max (and not a min). (3) Then makes sure it is worth operating in the short run. $ srmc PSM Demand QSM Q mrSM

The Author vs. Publisher Predicament $TE=P•Q Price Demand is Price elastic Demand is Price inelastic Demand Quantity Quantity your graph mrSM

Simple Monopoly with a Table: New Demand & Cost Information

Long Run Profit Maximization with Simple Monopoly Pretty much the same story as in the short run, but, use correctly calculated long run cost information. Positive economic profit invites entry, but since there are barriers to entry positive economic profit can persist. Negative economic profit encourages exit, and if the monopolist can get out he will. Monopolist might make long run adjustments to changes in the economic environment.

Graphical Display of Simple Monopolist’s Long Run Profit Maximizing Solution (1) The monopolist sets marginal revenue equal to marginal cost. (1a) Then goes up to the demand curve to get the price. (2) Then makes sure he is at a max (and not a min). (3) Then makes sure it is worth operating in the long run. $ lrmc PSM Demand QSM Q mrSM

Long Run Simple Monopoly – Performance, Efficiency & Equity Recall Efficiency Definitions: The market equilibrium quantity is Pareto/Allocatively Efficient(AE) if net social surplus (NSS) in the market is maximized. Maximizing NSS implies MBsoc = MCsoc The firm’s quantity is productively efficient(pe) if it operates at the minimum point on its long run average total cost curve. So the efficiency questions are: Is the long run equilibrium quantity, QSM, under simple monopoly AE? Is the long run equilibrium quantity, QSM, under simple monopoly pe?

Simple Monopoly Performance $ lrmc=$MCsociety PSM Demand=$MBsociety QSM QAE Q Qmes mrSM

Simple Monopoly Versus Perfect Competition Suppose we start with a market that is perfectly competitive and has 50 independent firms operating in the market for fedoras. Suppose one day Vito Corleone manages to buy out all 50 firms simultaneously and creates the monopoly, Fantastic Fedoras. Suppose nothing changes in the nature of the cost structures once the monopoly is set up. If this is the case, then the monopoly (multi-plant) marginal cost curve will look exactly like the former market short run supply curve. Note: The advantage to having a monopoly in this story is that is allows the monopolist (Vito) to totally control the number of hats that get put on the market for sale. Under conditions of perfect competition no one has any individual market power, so they all act as 50 independent price taking firms. Let’s compare the before and after.

Perfect Competition (PC) vs Simple Monopoly (SM) Before (PC) After (SM) Price Quantity Consumers' Surplus Producers’ Surplus Net Social Surplus MCsoc mcSM SRS MBsoc Demand mrSM

So: Are Monopolies Good? Bad? Ugly? Depends.... What kind of monopoly is it? From whose point of view are we asking? How did the monopoly position come about? How is the monopoly position maintained? How does the monopoly behave?

So: Should the Government Regulate Monopolies? Essentially all monopolies are regulated, in some way or another. Natural monopolies are regulated by price commissions that determine the rates the monopolies may charge. Patent, copyright and license protections are a form of ex ante regulation: firms that follow the rules for establishing the validity of their innovations receive the protection of the patent, copyright or license. Should the government do more? Good question.

Ways the Government Can Regulate Monopolies – DO/KNOW THESE! How about a per unit tax on the output of the monopolist? What would that do? How about a per unit subsidy on the output of the monopolist? What would that do? How about a tax on the economic profit of the monopolist? What would that do? How about a binding price ceiling on the monopolist? What would that do? How about breaking up the monopoly? What would that do? How about taking away the patent? What would that do?

Placing a Per Unit Tax on the Simple Monopolist’s Output mc PSM Demand QSM mrSM

Placing a Price Ceiling on the Simple Monopolist mc PSM Demand QSM mrSM