Monopoly - A Single Seller Microeconomics - Dr. D. Foster Monopoly - A Single Seller MR P D Q

Monopoly Characteristics A single seller with no “close” substitutes . . . -- means that the market demand is the firm’s demand. Barriers to entry . . . -- means that they can earn LR econ. profit. legal restrictions patents control of resources economies of scale

Monopoly - Finding Profit Max. Find where MR=MC . . . MR = Gain - Loss Q P D If P1=$10, P2=$9.95, Q1=100, Q2=101, what is MR? loss P1 Q1 P2 Q2 gain Gain = $9.95 Loss = $5.00 MR = $4.95 < Price

Monopoly - Finding Profit Max. Find where MR=MC . . . Set output at MR=MC. Q P D MR MC Find the price to charge from the Demand. P* Q* Will the firm earn an economic profit? How can we tell?

Monopoly - Finding Profit Max. Economic profit = TR - TC . . . Q* Q P D MR MC P* TR = P•Q ATC TC = ATC•Q Can a monopoly firm earn “negative” economic profit and stay in business in the short run?

Can a monopoly earn just a zero economic profit? Can a firm can earn negative profit in the SR? ATC Q* Q P D MR MC P* AVC Yes! As long as P > AVC, the firm will sustain losses in the short run. Can a monopoly earn just a zero economic profit?

Monopoly - Earning zero profit Zero Economic profit if TR = TC P = ATC Under what circumstances might we expect this to happen? Q* Q P D MR MC P* ATC When owners of a monopoly sell it to a new owner they should attempt to extract this econ. profit.

Monopoly Example I What is the profit maximizing level of output? $100 $90 $75 $70 $50 $45 $30 500 1000 1300 1200 1800 MR Q D ATC MC P What is the profit maximizing level of output? What price will the monopolist charge? What is the amount of economic profit? What is the amount of accounting profit?

Monopoly and Inefficiency Allocative efficiency occurs when P=MC. Q* Q P D MR MC P* ATC Monopolies are allocatively inefficient, as they price above the MC. They produce too little. Our loss is call the “social loss” (or, deadweight cost) and measured as shown.

Monopoly and Inefficiency Productive efficiency occurs when at min ATC. -- Monopolies are likely to be inefficient. “Social waste of resources” - up to the value of the firm’s economic profit if spent in “rent seeking” activities. “X-inefficiency” - arises from a cost structure that is higher than would be true for perfectly competitive firms.

Monopoly Example II What output level is allocatively efficient? $100 $90 $75 $70 $50 $45 $30 500 1000 1300 1200 1800 MR Q D ATC MC P What output level is allocatively efficient? What is the social loss? What output level is productively efficient?

Regulating Monopoly Using price controls can promote efficiency! P Q* Q P D MR MC P* ATC By instituting a price ceiling, the “demand” is altered, insofar as the firm’s actions are concerned. Pc

The monopolist can be induced to produce more (Q’) at a lower price!! Regulating Monopoly Using price controls can promote efficiency! Q* Q P D MR MC P* ATC The monopolist can be induced to produce more (Q’) at a lower price!! The firm is still inefficient, but we could set prices to achieve either allocative or productive efficiency. Pc Q’

Monopoly Example III $100 $90 $75 $70 $50 $45 $30 500 1000 1300 1200 1800 MR Q D ATC MC P 1. What would be the effect on output, price, economic profit and social cost if the government establishes a price ceiling of . . . a. $45? b. $50? c. $70? d. $75? e. $90? f. $100?

Monopoly Fundamentals A single seller with no “close” substitutes. Barriers to entry. Sets output at MR=MC. Prices output based on demand. Will be allocatively inefficient as P>MC. Will likely be productively inefficient. Also suffers from “social waste” and “X-inefficiency.” Price controls can promote efficient outcomes.

Regulating Monopoly Do regulations work? Inflating the cost structure (X-inefficiency). The “capture” hypothesis. Antitrust legislation may promote inefficiency. Regulating a natural monopoly . . .

How do you regulate? At P=MC, firm has negative econ. profit. Natural Monopoly Experiences economies of scale: --Profit max. rule is still the same. --Price off of demand. --May earn positive economic profit in LR. Q P D MR ATC Qm Pm MC How do you regulate? At P=MC, firm has negative econ. profit. Q*? P*?

Natural Monopoly --We can set the price equal to the MC. P D MR Qm Pm ATC MC … and give the monopoly a subsidy equal to its losses! --Or, we can set the price equal to the ATC. Q*? P*? … and the firm can earn zero econ profits, but is alloc. inefficient.

Monopoly - Price Discrimination When different people/customers are charged different prices when costs are equal. When different people/customers are charged the same price when costs are different.

Monopoly - Price Discrimination 1st degree price discrimination (perfect p.d.) when a firm can charge each individual the max. they are willing to pay. 2nd degree price discrimination (method #1) when a firm uses volume discounts to vary the price. 3rd degree price discrimination (method #2) when a firm segments the market by elasticity. more elastic = lower price; less elastic = higher price

Monopoly - Price Discrimination If the firm is collecting different prices from each customer, to sell one more unit, it need only lower the price for that unit, not for all. Perfect price discrimination Q* Q Price D=MR MC Pmax Pmin This only works if: --you prevent resale. --you can easily separate customers.

Monopoly - Segmented markets Day/night billing . . . phone/electric Matinee/evening . . . theater Senior menu . . . restaurant Ladies night . . . bar Student price . . . restaurant/other Coupons & club cards . . . grocery Is it easy to separate customers? Can resale be prevented?

Monopoly - A Single Seller Microeconomics - Dr. D. Foster Monopoly - A Single Seller MR P D Q