Part Two: Microeconomics of Product Markets CHAPTER 8 MONOPOLY

In this chapter you will learn: 8.1 The characteristics of a monopoly 8.2 About the profit-maximizing price and output in pure monopoly 8.3 About the economic effects of monopoly 8.4 Why a monopolist prefers to charge different prices in different markets 8.5 The choices facing governments that regulate monopolies 8.6 About the deadweight loss associated with monopoly ©2007 McGraw-Hill Ryerson Ltd. Chapter 8

Monopoly Characteristics: Single Seller No Close Substitutes Price-Maker Blocked Entry Examples of Monopoly ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Barrier to Entry – Figure 8-1 Economies of Scale D $20 15 ATC 10 If ATC declines over the entire market demand, least-cost production is realized only if there is one producer - a natural monopoly 50 100 200 Quantity (millions) ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Barriers to Entry Economies of Scale Legal Barriers to Entry: Patents and Licences Ownership or Control of Essential Resources Pricing and Other Strategic Barriers to Entry ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Monopoly Demand Three basic assumptions: Monopoly status is secured Firm is not governmentally regulated Firm charges the same price for all units ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Monopoly Demand Marginal revenue is less than price Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Notice that MR < P MR MR MR MR Q P TR $172 $ 0 1 162 2 152 304 3 $172 $ 0 1 162 2 152 304 3 142 426 4 132 528 5 122 610 6 112 672 7 102 714 8 92 736 9 82 738 10 72 720 Q P TR $172 1 162 2 152 3 142 4 132 5 122 6 112 7 102 8 92 9 82 10 72 MR $162 142 122 102 82 62 42 22 2 -18 MR $162 142 MR $162 MR ] ] Notice that MR < P Table 8-1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Figure 8-2 Price and Marginal Revenue in Monopoly When price decreases from $142 to $132, one more unit is sold… P $142 132 Gain = $132 D Revenue will increase by $132 with the extra unit sold 1 2 3 4 5 6 Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Price and Marginal Revenue in Monopoly When price decreases from $142 to $132, one more unit is sold… P $142 Loss = $30 132 but revenue loss = $10 X 3 units D Marginal revenue = $132-30 = $102 < $132 (price) Gain = $132 1 2 3 4 5 6 Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Monopoly Demand Marginal revenue is less than price The monopolist is a price-maker The monopolist sets prices in the elastic region of demand illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Figure 8-3 Demand, MR, and TR for a Monopolist 200 150 50 Elastic Dollars Inelastic 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 TR Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.1

Output and Price Determination Cost Data assume competitive resource markets MR=MC Rule Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Q P TR $172 $ 0 1 162 2 152 304 3 142 426 4 132 528 5 122 610 6 112 672 7 102 714 8 92 736 9 82 738 10 72 720 MR $162 142 122 102 82 62 42 22 2 -18 ATC TC $100 $190 190 135 270 113 340 100 400 94 470 92 550 91 640 750 98 880 103 1030 MC $90 80 70 60 90 110 130 150 produce? ] ] produce? ] ] produce? ] ] produce? ] ] ] ] Table 8-1 ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Q P TR MR ATC TC MC Profit or loss $-100 28 +34 +86 +128 +140 +122 +74 -14 -142 -310 Q P TR $172 $ 0 1 162 2 152 304 3 142 426 4 132 528 5 122 610 6 112 672 7 102 714 8 92 736 9 82 738 10 72 720 MR $162 142 122 102 82 62 42 22 2 -18 ATC TC $100 $190 190 135 270 113 340 100 400 94 470 92 550 91 640 750 98 880 103 1030 MC $90 80 70 60 90 110 130 150 ] ] ] ] Profit Maximization Choice ] ] ] ] ] ] ] ] ] ] ] Same results as TR – TC Rule ] ] ] ] ] ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Figure 8-4 Profit Maximization by a Monopolist Q D MR 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 P Find q MC MR = MC ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Profit Maximization by a Monopolist Q D MR 200 175 150 120 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 P Find p MC $122= p ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Profit Maximization by a Monopolist Q D MR 200 175 150 120 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 P Find ATC MC Profit =(p - ATC) X q =(122-94) X 5 =140 $122= p ATC Profit $94=ATC ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Output and Price Determination Cost Data assume competitive resource markets MR=MC Rule No Monopoly Supply Curve ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Output and Price Determination Misconceptions Concerning Monopoly Pricing Not the highest price Total, not unit, profit Possibility of Losses by Monopolist Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Figure 8-5 The Loss-Minimizing Position of a Monopolist MC A ATC Loss Pm AVC V D MR = MC MR Q Qm ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.2

Economic Effects of Monopoly Price, Output, and Efficiency inefficient relative to a purely competitive industry Pm > MC Pm > minimum ATC Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Figure 8-6 Inefficiency of Monopoly S = MC Price and output if the industry were competitive Pc Qc P=MC=minimum ATC D Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Inefficiency of Monopoly S = MC Pm Qm P Monopolist will sell fewer units at a higher price than in pure competition Pc Qc D MR Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Economic Effects of Monopoly Income Transfer monopoly owners enriched at the expense of consumers Cost Complications Economies of Scale simultaneous consumption network effects X-Inefficiency Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Figure 8-7 X-Inefficiency Inefficient internal operation leads to higher-than-necessary costs X ATCX ATC1 Average Total Cost Unit costs (dollars) X' ATCX' ATC2 Quantity Q1 Q2 ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Economic Effects of Monopoly Cost Complications Economies of Scale simultaneous consumption network effects X-Inefficiency Rent-Seeking Expenditures Technological Advance ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Assessment and Policy Options Legitimate concerns Three policy options: Charges under Canada’s anticombines laws Regulate prices and operations of natural monopolies Ignore monopolies which are unsustainable over the long term ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.3

Price Discrimination and Monopoly Same product is sold at more than one price Not justified by cost differences Based on differences in “willingness to pay” ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.4

Price Discrimination Necessary Conditions.… Examples Monopoly Power Market Segregation No Resale Examples airlines theatres, golf courses coupons international trade ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.4

Figure 8-8 Price Discrimination to Different Groups of Buyers (a) Small Businesses Pb MC = ATC Price and Costs MR D Q Qb ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.4

Price Discrimination to Different Groups of Buyers (b) Students Price and Costs Ps MC = ATC MR D Q Qs ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.4

Regulated Monopoly Natural monopolies traditionally have been subject to rate (price) regulation e.g., natural gas distributors, regional telephone companies, electricity suppliers Trend to deregulation where possible e.g., long distance telephone ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.5

Regulated Monopoly May be desirable to maintain but regulate a natural monopoly Types of regulation include: Socially optimal price where P = MC Fair-return price where P = ATC Illustrated… ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.5

Figure 8-9 Regulated Monopoly – Socially Optimal Socially Optimal Price Price = MC Unregulated monopoly price M Pm Price and Costs ATC LOSS MC Pr Allocatively efficient BUT Subsidy required D MR Q Qm Qr ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.5

Regulated Monopoly – Fair Return Fair Return Price Price = ATC P M Pm Price and Costs f Pf ATC MC Pr r FIRM BREAKS EVEN still some underallocation D MR Q Qm Qf Qr ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.5

Dilemma of Regulation Setting price at P = MC firm earns losses Setting price at P = ATC still some underallocation of resources Regulation can improve outcomes ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.5

Monopoly and Deadweight Loss Net loss of consumer and producer surplus is deadweight loss Monopolist also loses producer surplus, but gains producer surplus at the expense of consumer surplus Consumers lose consumer surplus ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.6

Figure 8-10 Monopoly and Deadweight Loss S = MC P Outcomes with pure competition Consumer surplus Pc Qc Producer surplus Efficient output D=MB Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.6

Monopoly and Deadweight Loss Pm Qm Outcomes with pure monopoly S = MC Consumer surplus Monopoly’s gain B Deadweight loss Pc Qc C Producer surplus D=MB MR Q ©2007 McGraw-Hill Ryerson Ltd. Chapter 8.6

Chapter Summary 8.1 Characteristics of Pure Monopoly 8.2 Output and Price Determination in a Monopoly MR = MC 8.3 Economic Effects of Monopoly 8.4 Price Discrimination and Monopoly 8.5 Regulated Monopoly Socially optimal price or fair-return price 8.6 Monopoly and Deadweight Loss ©2007 McGraw-Hill Ryerson Ltd. Chapter 8