Warm-Up Draw a correctly-labeled graph showing a monopoly operating at a loss in the short-run.

Monopolies and Public Policy Chapter 14: Monopoly (pages 370-376)

Monopoly versus Competition Monopolists produce less: Monopolists charge higher prices Monopolists earn profit in the long-run QM < QC PM > PC p > 0

Problems with Monopoly Beneficial trades do not occur Consumer surplus is lost Deadweight loss is created

Effects of Monopoly (a) Perfect Competition ( b ) Total Surplus with Monopoly Price Price Consumer surplus with perfect competition Consumer surplus with monopoly Profit P M Deadweight loss P MC= ATC MC = ATC C Figure Caption: Figure 14-8: Monopoly Causes Inefficiency Panel (a) depicts a perfectly competitive industry: output is QC, and market price, PC, is equal to MC. Since price is exactly equal to each producer’s average total cost of production per unit, there is no producer surplus. So total surplus is equal to consumer surplus, the entire shaded area. Panel (b) depicts the industry under monopoly: the monopolist decreases output to QM and charges PM. Consumer surplus (blue area) has shrunk: a portion of it has been captured as profit (green area), and a portion of it has been lost to deadweight loss (yellow area), the value of mutually beneficial transactions that do not occur because of monopoly behavior. As a result, total surplus falls. D D MR MR Q Quantity Q Quantity C M

Effects of Monopoly Loss of consumer surplus (consumers worse off) Increase in producer surplus (producers better off) Deadweight loss created (efficiency lost)

Natural Monopolies Price, cost A natural monopoly can arise when fixed costs required to operate are very high  the firm’s ATC curve declines over the range of output at which price is greater than or equal to average total cost. Natural monopoly. Average total cost is falling over the relevant output range Natural monopolist’s break-even price A T C D Quantity Relevant output range This gives the firm economies of scale over the entire range of output at which the firm would at least break even in the long run. As a result, a given quantity of output is produced more cheaply by one large firm than by two or more smaller firms.

Examples of Natural Monopoly Gas company Electric company Cable company Water company

How Government Responds… Public Ownership Often run poorly No incentive to lower costs Regulation Set a price ceiling Use market forces to reduce losses

Effect of Regulation ( b ) Total Surplus with a Regulated Natural Monopolist (a) Total Surplus with an Unregulated Natural Monopolist Price Price Consumer surplus Consumer surplus P Profit P M M P P R A T C * R A T C MC MC D D MR MR Q Q Quantity Q Q * M R M R Quantity

Comparing Outcomes

Practice Time… Label monopoly PM and QM Identify area of p Label competitive PC and QC Label PR and QR where monopolist earns normal profit