10/22/2014CRC Microeconomics1

10/22/2014CRC Microeconomics2 What did you study last time? 1.What is meant by perfect competition? 2.How much output a (perfectly) competitive firm should produce to maximize profit? 3.Where do the firm’s and the market supply curves come from? 4.What happens in the long run in a (perfectly) competitive market?

10/22/2014CRC Microeconomics3 Do you know … why monopolies arise? what is meant by a monopoly? how much output a monopoly should produce to maximize profit? if monopolies are good or bad? how governments regulate monopolies? how a monopoly price discriminates?

10/22/2014CRC Microeconomics4 1. Why do monopolies arise? Because of barriers to entry, as a result of: A key resource owned by a single firm; The government’s authorization; Natural monopoly, resulted from economies of scale.

10/22/2014CRC Microeconomics5 2a. Monopoly— Main characteristics Sole seller. No close substitute. Barriers to entry.

10/22/2014CRC Microeconomics6 2b. Monopoly— Main Ideas The monopoly is a price maker/setter. TR = P x Q, where P varies. AR = TR / Q = P MR =  TR /  Q < (AR = P) The monopoly’s demand curve, (AR = P), is downward sloping. It is also the market demand curve.

10/22/2014CRC Microeconomics7 2b. Monopoly— Main ideas  = (P – ATC)*Q 0. The monopolistic market is inefficient. There exists a DWL, because Qm < Qc. Regulations are necessary. A monopoly can practice price discrimination.

10/22/2014CRC Microeconomics8 3. How much should a monopoly produce to maximize profit? To maximize profit, a monopoly produces the output Q*, where (AR = P ) > MR = MC

10/22/2014CRC Microeconomics9 Graphs of profit maximization Case 1.  > 0 Case 2.  = 0

10/22/2014CRC Microeconomics10 Case 1.  > 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm The graph below shows the cost and revenue curves of a monopoly. The “equilibrium” point is E m, where MRm = MC.

10/22/2014CRC Microeconomics11 Case 1.  > 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm The firm produces Q m to maximize profit. Its TR is Pm*Qm… TR = Pm x Qm At Q m, the firm’s VC (= AVC x Qm) is … VC = AVC x Qm

10/22/2014CRC Microeconomics12 Case 1.  > 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm TR = Pm x Qm VC = AVC x Qm At Q m, the firm’s FC (= AFC x Qm) is … FC At Q m, the firm’s TC = VC + FC is … TC

10/22/2014CRC Microeconomics13 Case 1.  > 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm TR = Pm x Qm VC = AVC x Qm FC TC At Q m, the firm’s  = TR - TC is … 

10/22/2014CRC Microeconomics14 Case 2.  = 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm The graph below shows the cost and revenue curves of a monopoly. The “equilibrium” point is E m, where MRm = MC.

10/22/2014CRC Microeconomics15 Case 2.  = 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm The firm produces Q m to maximize profit. Its TR is Pm*Qm… At Q m, the firm’s VC (= AVC x Qm) is … TR VC

10/22/2014CRC Microeconomics16 Case 2.  = 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm TR VC At Q m, the firm’s FC (= AFC x Qm) is … At Q m, the firm’s TC = VC + FC is … FC TC

10/22/2014CRC Microeconomics17 Case 2.  = 0 $ Q MC ATC AVC PmPm EmEm QmQm ARm MRm TR VC FC TC At Q m, the firm’s  = TR - TC = 0 TR

10/22/2014CRC Microeconomics18 4. Are monopolies good or bad? P Q Dc Sc Qc Ec Pc The graph below shows a competitive market. Now suppose that it becomes a monopoly. = MCm = ARm Thus, ARm = Dc, and MCm = Sc.

10/22/2014CRC Microeconomics19 4. Are monopolies good or bad? P Q Dc Sc Qc Ec Pc = MCm = ARm The monopoly has a MR curve. MRm The monopoly’s Em is where MRm=MCm. Em

10/22/2014CRC Microeconomics20 4. Are monopolies good or bad? P Q Dc Sc Qc Ec Pc = MCm = ARm MRm Em The monopoly’s output is Qm < Qc, and the monopoly’s price is Pm > Pc. Qm Pm The monopoly causes a DWL. DWL

10/22/2014CRC Microeconomics21 4. Are monopolies good or bad? Define: Qc = output in perfect competition, where the market if efficient. Qm = output produced by a monopoly. Since a monopoly produces less: - Qm < Qc, - there is a loss of production due to monopoly, - i.e. there exists a DWL.

10/22/2014CRC Microeconomics22 4. Are monopolies good or bad? Monopolies are bad, because monopolistic markets are inefficient. A monopoly is “like” a private tax collector. The monopoly charges a higher price than the free-market equilibrium price, reduces output below the free-market equilibrium output. The effect is like a tax on a free market.

10/22/2014CRC Microeconomics23 5. How governments regulate monopolies Governments: make monopolies more competitive with antitrust laws (e.g. prevent mergers, break up big companies, etc.) regulate monopolies’ behavior with marginal-cost pricing, or with average-cost pricing

10/22/2014CRC Microeconomics24 5. How governments regulate monopolies Governments: turn monopolies into public enterprises. e.g. U.S Postal Service leave monopolies alone. e.g. Microsoft

10/22/2014CRC Microeconomics25 5. Regulating monopolies’ behavior P Q The graph below shows a natural monopoly. MCm ARm MRm Em Qm Pm ATCm Without any regulation, the monopoly’s output is Qm, where MRm = MCm, and the profit is... 

10/22/2014CRC Microeconomics26 5. Regulating monopolies’ behavior P Q MCm ARm MRm Em Qm Pm ATCm  Under MC-pricing, the monopoly is required to charge a price equal to MC. It will produce Qc at MCm = Pc. Qc Ec Loss under MC-pricing = Subsidy MCm = Pc The monopolistic market is efficient, DWL = 0. However, the monopoly loses and needs to be subsidized.

10/22/2014CRC Microeconomics27 5. Regulating monopolies’ behavior P Q MCm ARm MRm Em Qm Pm ATCm Under AC-pricing, the monopoly is required to charge a price equal to ATC. It will produce Qa at P = ATCm. Qc Ec MCm = Pc The monopolistic market is inefficient, DWL > 0. The monopoly breaks even, earns only normal profit. Qa Ea Pa DWL

10/22/2014CRC Microeconomics28 6. How does a monopoly price discriminate? A monopoly can charge its customers: one single price, i.e. there is no price discrimination; two different prices or more, i.e. there is (imperfect) price discrimination; as many different prices as the number of customers, i.e. there is perfect price discrimination.

10/22/2014CRC Microeconomics29 6. How does a monopoly price discriminate? In imperfect price discrimination, the monopoly raise price on customers with inelastic demand, and lower price on customers with elastic demand e.g. bus fare, movie ticket prices, etc.

10/22/2014CRC Microeconomics30 6. How does a monopoly price discriminate? In perfect price discrimination, the monopoly charge customers their WTP, i.e. each customer would pay a different price. Perfect discrimination results in efficiency, because there is no DWL. The monopoly would produce an output Qm = Qc. The issue is that all consumer surplus becomes the monopolist’s profit.

10/22/2014CRC Microeconomics31 Perfect price discrimination by a monopoly P Q The graph shows a monopoly. ARm MRm Em Qm Pm  MCm = ATCm DWL With a single-price, the monopoly’s output is Qm, price Pm, and the profits are... There exists a DWL.

10/22/2014CRC Microeconomics32 Perfect price discrimination by a monopoly P Q Qc Ec ARm MRm Em Qm Pm  MCm = ATCm DWL With perfect price discrimination, the monopoly’s output is Qc, price Pc. The profits are … There is no DWL.  Pc = MCm = ATCm

10/22/2014CRC Microeconomics33 Now you know … why monopolies arise. what is meant by a monopoly. how much output a monopoly should produce to maximize profit. if monopolies are good or bad. how governments regulate monopolies. how a monopoly price discriminates.

10/22/2014CRC Microeconomics34 What will you study next time? What is meant by an oligopoly? What is a duopoly? What are some special issues about oligopolies? How do governments deal with oligopolies?

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