Chapter 9 Monopoly © 2009 South-Western/ Cengage Learning

In Perfect Competition we found –To maximize profit SR: choose q such that P = MC so long as P > AVC LR: choose q such that P = min LRAC = LRMC profit = 0 2

Monopoly and Barriers to Entry Monopoly –1 seller –unique product –strict barriers to entry exist Barriers to entry –Any factors which prevent new firms from entering industry on an equal footing with existing firm(s) legal, economies of scale, control over vital resource, pricing behavior 3

Monopoly –Local –National –International Long-lasting monopolies –Rare –Economic profit attracts competitors –Technological change 4

Revenue for the Monopolist Monopoly –Supplies the market demand (faces the entire market demand) Downward-sloping D (law of D) To sell more: must lower P on all units sold Total revenue TR = P*Q 5

Revenue for the Monopolist Marginal revenue MR = ∆TR/∆Q –for monopolist: MR<P –declines, can be negative MR curve –downward sloping –below D curve 6

Revenue for Monopolist D curve: Price is found on Demand Where D is elastic, as price falls –TR increases –MR>0 Where D is inelastic, as price falls –TR decreases –MR<0 Where D is unit elastic –TR is maximized; MR=0 7

Firm’s Costs and Profit Maximization Monopolist –choose the price –OR the quantity –‘price maker’ or ‘price searcher’ 8

Profit Maximization in Monopoly Profit maximization –TR minus TC –Supply quantity where TR exceeds TC by the greatest amount Monopolist –chooses Q such that MR = MC –for this Q the demand curve shows the price that can be charged –profit can be positive, zero or negative depends on AC of producing Q 9

Short-Run Losses; Shutdown Decision If P>AC –Economic profit exists If AC>P>AVC –economic loss –produce in short run (to minimize loss) If P<AVC: AVC curve above D curve –economic loss –shut down in short run (to minimize loss) 10

Exhibit 7 The monopolist minimizes losses in the short run 11 0Q Quantity per period p Dollars per unit Average total cost Average variable cost Marginal cost Demand=Average revenue Marginal revenue a b c e Loss MR=MC at point e: quantity Q For Q, price=p at point b, on D curve For Q, ATC is at point a P<ATC, monopolist suffers a loss Monopolist continue to produce because p>AVC (AVC is at point c)

Long-Run Profit Maximization Short-run profit –no guarantee of long-run profit High barriers that block new entry –economic profit is possible To erase a loss or increase profit –adjust the scale of the firm If unable to erase a loss –leave the market 12

Monopoly and LR Competition If Economic Profit exists –entrepreneurs find a way to capture profit create new products to substitute find new inputs to use find alternate production techniques What can monopolist do? –get government support –make market less attractive to entrants »Limit pricing is the practice of lowering the price to discourage entry 13

Price Discrimination Charge different prices to different groups of consumers where the price differential does not reflect cost differences Necessary Conditions –must be able to distinguish different demands Different elasticities of demand –prevent reselling of the product 14

A Model of Price Discrimination Two groups of consumers –One group (A): less elastic D –The other (B): more elastic D Maximize profit –MR=MC in each market –Results in lower price for group (B) 15

Examples of Price Discrimination Airline travel Business-people (business class) –Less elastic D; Higher price Same class, different prices –Discount fares; weekend stay IBM laser printer 5 pages/minute: home; cheaper 10 pages/minute: business; expensive Amusement parks Out-of-towners: less elastic D 16

Perfect Price Discrimination The monopolist’s dream Charge consumers what they are willing to pay –Charge different prices for each unit sold D curve becomes MR curve –Convert all consumer surplus into economic profit Results in –allocative efficiency –no deadweight loss 17

Monopoly and Allocation of Resources In LR Perfect Competition we see –P = LRMC = min LRAC –Marginal benefit P = MC –Allocatively efficient market –Maximum Social welfare –Maximum Consumer Surplus 18

Monopoly and Allocation of Resources In Monopoly –Marginal benefit = P > MC –Restrict Q below what would maximize social welfare –Smaller consumer surplus –Economic profit for firm –Deadweight loss of monopoly Allocatively inefficiency 19

Problems Estimating Deadweight Loss Deadweight loss might be lower –Lower price and average cost Substantial economies of scale –Price below the profit maximizing value Public scrutiny, political pressure Avoid attracting competition 20

Problems Estimating Deadweight Loss Deadweight loss might be higher –Resources used to secure and maintain monopoly position social waste influence public policy (Rent seeking) –Inefficiency –Slow to adopt new technology –Reluctant to develop new products –Lack innovation 21