11 C H A P T E R Pure Monopoly

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

MONOPOLY EXAMPLES Pure Monopoly Regulated Monopoly Near Monopolies Dual Objectives of the Study Monopoly as a Market Structure To Better Understand Other Market Structures

BARRIERS TO ENTRY Economies of Scale Legal Barriers to Entry The Natural Monopoly Case Legal Barriers to Entry Patents Licenses Ownership or Control of Essential Resources Pricing and Other Strategic Barriers to Entry

ATC THE NATURAL MONOPOLY CASE $20 15 ATC Average Total Cost 10 If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly 50 100 200 Quantity

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 As price decreases from $142 to $132... but revenue will increase with the additional unit sold $142 132 Loss = $30 D Gain = $132 Q 1 2 3 4 5 6

MONOPOLY DEMAND Marginal Revenue $142 - $30 = $102 will necessarily be As price decreases from $142 to $132... but revenue will increase with the additional unit sold $142 132 Loss = $30 Marginal Revenue $142 - $30 = $102 will necessarily be less than price $132 D Gain = $132 Q 1 2 3 4 5 6

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

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 1 $172 $172 162 $ 0 $ 0 162 $100 190 $100 - $100 - $100 - 28 ] $162 ] 90 x = - $190.00 = MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 ] $162 142 122 102 82 62 42 22 2 - 18 ] 90 80 70 60 110 130 150 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

Can you see profit maximization? MR > = MC MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost Can you see profit maximization? 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 MR > = MC ] $162 142 122 102 82 62 42 22 2 - 18 ] 90 80 70 60 110 130 150 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

MONOPOLY REVENUES & COSTS Revenue Data Cost Data Quantity of Output Price (Average Revenue) Average Total Cost Profit + or loss - Total Revenue Marginal Revenue Total Cost Marginal Cost 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 ] $162 142 122 102 82 62 42 22 2 - 18 ] 90 80 70 60 110 130 150 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00

MONOPOLY REVENUES & COSTS $200 150 200 50 Dollars Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS Elastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

MONOPOLY REVENUES & COSTS Elastic Inelastic $200 150 200 50 Dollars MR D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

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…

Remember the MR=MC Rule? OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly Remember the MR=MC Rule? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

OUTPUT AND PRICE DETERMINATION Profit Maximization Under Monopoly What About Loss Minimization? Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Profit Per Unit MC $122 Profit ATC $94 D MR = MC MR

OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Since Pm exceeds AVC, the firm will produce Loss Per Unit MC ATC A Loss AVC Pm V D MR = MC MR Qm

OUTPUT AND PRICE DETERMINATION Loss Minimization Under Monopoly Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Loss Per Unit What are the Economic Effects of Monopoly? MC ATC A Loss AVC Pm V D MR = MC MR Qm

INEFFICIENCY OF PURE MONOPOLY An industry in pure competition sells where supply and demand are equal P S = MC At MR=MC A monopolist will sell less units at a higher price than in competition Pm Pc D MR Q Qm Qc

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

COST COMPLICATIONS Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency Inefficient internal operation leads to higher-than- necessary costs Average total costs Quantity Average Total Costs X X’ Q1 Q2 ATCx ATC1 ATC2 ATCx’

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

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

PRICE DISCRIMINATION Economic profits with a single MR=MC price MC P ATC Price and Costs D MR Q Q1

A perfectly discriminating producing more product PRICE DISCRIMINATION A perfectly discriminating monopolist has MR=D, producing more product and more profit! MC P ATC Price and Costs MR=D D Q Q1 Q2

PRICE DISCRIMINATION Economic profits with price discrimination MC P ATC Price and Costs MR=D D Q Q1 Q2

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

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

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

REGULATED MONOPOLY P Socially-Optimum Price and Costs Price P = MC ATC MR Q Qr

REGULATED MONOPOLY Dilemma of Regulation Which Price? P MR = MC Fair-Return Price Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

Chapter Conclusions REGULATED MONOPOLY Dilemma of Regulation Which Price? P MR = MC Fair-Return Price Chapter Conclusions Pm Socially-Optimum Price Price and Costs ATC Pf MC Pr D MR Q Qm Qf Qr

simultaneous consumption network effects X-inefficiency KEY TERMS pure monopoly barriers to entry simultaneous consumption network effects X-inefficiency rent-seeking behavior price discrimination socially optimal price fair-return price Copyright McGraw-Hill/Irwin 2002 BACK END

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