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Chapter Goals Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms Determine a monopolist’s price, output, and profit graphically and numerically Show graphically the welfare loss from monopoly Explain why there would be no monopoly without barriers to entry Explain how monopolistic competition differs from monopoly and perfect competition

A Monopolistic Market Monopoly is a market structure in which one firm makes up the entire market Barriers to entry into the market prevent competition Barriers to entry can be: Legal Sociological Natural Technological There are no close substitutes for the monopolist’s product

The Key Difference Between a Monopolist and a Perfect Competitor A monopolistic firm’s marginal revenue is not its price Marginal revenue is always below its price Marginal revenue changes as output changes and is not equal to the price A monopolistic firm’s output decision can affect price There is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit

Determining the Monopolist’s Price and Output Numerically The goal of the monopolistic firm is to maximize profits, the difference between total revenue and total cost The monopoly maximizes profit when marginal revenue equals marginal cost Marginal revenue (MR) is the change in total revenue associated with a change in quantity Marginal cost (MC) is the change in total cost associated with a change in quantity

Determining the Monopolist’s Price and Output Numerically The profit-maximizing condition of a monopolistic firm is: MR = MC For a monopolistic firm, MR < P A monopolistic firm maximizes total profit, not profit per unit If MR > MC, The monopoly can increase profit by increasing output If MR < MC, The monopoly can increase profit by decreasing its output

Monopolistic Profit Maximization Table The profit- maximizing condition is: MR = MR Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($) 36 33 27 21 15 9 3 -3 -9 -15 47 1 2 4 8 16 54 40 56 80 --- -47 48 48.00 30 60 50 25.00 10 81 18.00 24 96 62 15.50 34 5 105 78 15.60 6 18 108 102 17.00 7 142 20.29 -37 12 198 24.75 -102 278 30.89 -197 If MC < MR, increase production Profit maximizing quantity is where MC = MR If MC > MR, decrease production

Finding the Monopolist’s Price and Output Draw the marginal revenue, marginal cost, and demand curves P MC Monopolist Price: D at Qprofit max $36 Find the profit maximizing level of output, where MR and MC curves intersect $24 $20.50 Find how much consumers will pay where Qm intersects demand; this is the price the monopolist will charge MC = MR D MR Q Qm (profit max)

Comparing Monopoly and Perfect Competition In a monopoly, P>MR, In perfect competition, P=MR=D MR=MC is the profit max rule for both P MC First find the monopoly Q and P PM PPC Then find the perfectly competitive Q and P DPC= MRPC DM Outcome: Monopoly output is lower and price is higher than perfect competition MRM Q QM QPC

Determining Profits Graphically: A Firm with Profit Find output where MC = MR, this is the profit maximizing Q P Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MC D at Qprofit max ATC Find profit per unit where the profit max Q intersects ATC P Profits ATC ATC at Qprofit max MC = MR D Since P>ATC at the profit maximizing quantity, this firm is earning profits MR Q Qprofit max

Determining Profits Graphically: A Firm with Zero Profit or Losses Find output where MC = MR, this is the profit maximizing Q P MC Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price ATC D at Qprofit max P Find profit per unit where the profit max Q intersects ATC =ATC ATC at Qprofit max MC = MR Since P=ATC at the profit maximizing quantity, this firm is earning zero profit or loss D MR Q Qprofit max

Determining Profits Graphically: A Firm with Losses Find output where MC = MR, this is the profit maximizing Q P MC Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price ATC at Qprofit max ATC ATC Losses D at Qprofit max P Find profit per unit where the profit max Q intersects ATC MC = MR D Since P<ATC at the profit maximizing quantity, this firm is earning losses MR Q Qprofit max

Welfare Loss from a Monopoly: The Normal Monopolist The welfare loss from a monopoly is represented by the triangles B and D The rectangle C is a transfer of surplus from the consumer to the monopolist The area A represents the opportunity cost of diverted resources, which is not a loss to society P MC PM C D PPC B D A MR Q QM QPC

The Price-Discriminating Monopolist When a monopolist price discriminates, it charges different prices to different individuals or groups of individuals Consumers with less elastic demands are charged higher prices. Consumers with more elastic demands are charged lower prices Price discrimination increases output and profits

The Price-Discriminating Monopolist A price-discriminating monopolist produces the same output as the combination of all firms in a competitive market All firms in the perfectly competitive market capture only area B The price-discriminating monopolist captures all the surplus represented by areas A and B MC A PC B D QPM = QC

The Price-Discriminating Monopolist Examples of price discrimination Movie discounts to senior citizens and children Airline charge more to fly on Fridays and Sundays Tracking consumer information and pricing accordingly It might seem unfair for a monopolist to charge different people different prices, but doing so eliminates welfare loss from monopoly For a price-discriminating monopolist, because it can charge what consumers are willing to pay, all consumer surplus is captured by the monopolist

Barriers to Entry Natural Ability A firm is better at producing the good than anyone else Natural Monopolies Natural monopoly is when a single firm can produce at a lower cost than can two or more firms Government-Created Monopolies Patents If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits

Average Cost for Natural Monopolist One firm producing Q1 has average cost C1 If two firms share the market, each produces Q1/2 and has average cost C2 If three firms share the market, each produces Q1/3 has average cost C3 C3 C2 C1 ATC Q Q 1/3 Q 1/2 Q1

Profit of Natural Monopolist A natural monopolist produces QM and charges PM, therefore earning a profit Average Cost If there is government regulation and a competitive solution where P = MC is required, the monopolist produces QC and charges PC, therefore earning a loss PM Profits CM CC ATC Losses PC MR MC D Q QM QC

Government Policy and Monopoly: AIDS Drugs A few companies have patents for AIDS drugs that enable them to charge high prices because demand is inelastic Policy Options Government regulation where price = marginal cost benefits society, but discourages research Government purchase of the patents and allowing anyone to produce the drugs so their price = marginal cost. This is expensive for taxpayers.

Characteristics of Monopolistic Competition Four distinguishing characteristics: Many sellers that do not take into account rivals’ reactions Product differentiation where the goods that are sold aren’t homogenous Multiple dimensions of competition make it harder to analyze a specific industry, but these methods of competition follow the same two decision rules as price competition Ease of entry of new firms in the long run because there are no significant barriers to entry

Output, Price, and Profit of a Monopolistic Competitor Like a monopoly, The monopolistic competitive firm has some monopoly power so the firm faces a downward sloping demand curve Marginal revenue is below price At profit maximizing output, marginal cost will be less than price Like a perfect competitor, zero economic profits exist in the long run

Monopolistic Competition MC You can see that a monopolistically competitive firm prices in the same manner as a monopolist, setting quantity where marginal revenue equals marginal cost But the firm is also a competitor; competition implies zero economic profit in the long run (determined by ATC) ATC PMC D MR Q QMC

Comparing Monopolistic Competition with Monopoly It is possible for the monopolist to make economic profit in the long run because of the existence of barriers to entry No long-run economic profit is possible in monopolistic competition because there are no significant barriers to entry For a monopolistic competitor in long-run equilibrium, (P = ATC) ≥ (MC = MR)

Monopolistic Competition Compared with Perfect Competition Graph MC In monopolistic competition in the long run, P > min ATC In perfect competition in the long run, P = min ATC ATC PMC DPC PPC Outcome: Monopolistic competition output is lower and price is higher than perfect competition DMC MRMC Q QMC QPC

Advertising and Monopolistic Competition Perfectly competitive firms have no incentive to advertise, but monopolistic competitors do The goals of advertising are to increase demand and make demand more inelastic Advertising increases ATC The increase in cost of a monopolistically competitive product is the cost of “differentness”

Chapter Summary A monopolist maximizes profit or minimizes losses where MR=MC To determine a monopolist’s profit or loss: Find output where MR=MC; Determine price and ATC at that output; Profit or loss = (P – ATC) * Q Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society Monopoly output is lower and price is higher than in competitive markets Natural monopolies exist in industries with strong economies of scale

Chapter Summary A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demand Three important barriers to entry are natural ability, economies of scale, and government restrictions Monopolistic competition is characterized by many sellers, differentiated products, multiple dimensions of competition, and ease of entry for new firms A monopolistic competitor differs from a monopolist in that a monopolistic competitor makes zero economic profit in long-run equilibrium