Today Begin Monopoly

Monopoly Chapter 22

Perfect Competition = Many firms Oligopoly = A few firms Four Basic Models Monopoly = One firm Monopolistic Competition = Some firms

Profit-Maximizing Monopolist Suppose only one seller in the market. For now, assume it sells all its output at the same price (no price discrimination). Choose Q to maximize: profits = TR - TFC - TVC. TFC do not depend on output, so maximize TR - TVC.

Marginal Revenue Recall: for the price-taking firm, MR = P. But: the monopolist faces the market demand curve. As he sells more, he moves down the D curve and price falls.

Graph of Marginal Revenue Q P D A B Lost 3 Gained 9 What is the MR of the 4th unit? How does that compare to price? Will it ever be possible to gain the price as MR?

Monopolist’s Marginal Revenue P D MR Q The monopolist’s marginal revenue (MR) curve lies everywhere below the demand curve. MR < P.

Special Case: Straight-Line Demand P D MR Q The MR curve for a straight-line D curve lies 1/2-way between the D curve and the vertical axis. 10 5

Special Case: Straight-Line Demand P D MR Q Recall: Price elasticity falls as we move down the straight-line D curve. Total revenue rises then falls as we move down the straight-line the D curve. When  = 1, revenue is at its maximum. That’s when MR =  = 1

Choosing Quantity Maximize TR - TVC TR is area under the MR curve. TVC is area under the MC curve. Therefore maximize the difference.

Choosing Quantity P D MR Q Profits are maximized when MR = MC. MC TR - TVC

Monopolist’s Profit- Maximizing Rule P D MR Q Choose Q where MR = MC, charge the highest price possible. Check: In SR, is P  AVC? In LR, is P  ATC? Q* MC p*

Monopolist’s Profit- Maximizing Rule P D MR Q Will this monopolist produce in the LR? In the SR? Can you identify profits or losses? Q* MC p* ATC

Monopolist’s Profits P D MR Q Q* MC p* ATC

The Monopolist & A Supply Curve A monopolist does not have a supply curve! He chooses his best price & quantity combination on the market demand curve. He is not a price taker, so the concept of a supply curve doesn’t make sense. He is a price maker.

The Monopolist and Efficiency Productive efficiency: Some have argued that a monopolist may get “lazy” and not keep costs at a minimum. Others argue that if it’s goal is to maximize profits, that will be incentive enough to minimize costs. This issue remains unsettled.

The Monopolist and Efficiency Allocative efficiency: Look at the sum of producers’ and consumers’ surpluses.

Consumers’ Surplus P D MR Q CS: the area under the demand curve but above price. Q* MC p*

Producers’ Surplus P D MR Q PS = TR - TVC PS: the area under price but above MC. Q* MC p*

Sum of Producers’ and Consumers’ Surplus P D MR Q Does the monopolist produce the quantity that is allocatively efficient? Q* MC p*

The Allocatively Efficient Quantity More PS & CS could be gained by producing Q E. The marginal benefits of the add’l units are more than their marginal costs. P D Q QMQM MC PMPM QEQE

Efficiency of Monopolist If the monopolist were to produce & sell the efficient quantity, he would have to set a lower price. We say the monopolist reduces output and raises price compared to the efficient solution. This causes a deadweight loss of producer’s & consumers’ surplus.

Deadweight Loss of CS & PS Represents the cost to society of not producing the efficient quantity of this good. P D Q QMQM MC PMPM QEQE

Effects of Monopolies Produce less than the efficient quantity. Charge higher prices as a result. Consumers are hurt on both counts.

Coming Up: Barriers to entry & the monopolist. More price discrimination

Group Work Try to complete the exercise without looking back at your notes. Identify on the graph for a Monopolist the profit-maximizing level of output. the price that the monopolist will charge (assuming he charges a single price for all units). the total profits or losses of the monopolist

More things to identify consumer’s surplus producer’s surplus the allocatively efficient quantity the deadweight loss associated with having a monopoly in this market the supply curve

Monopolist’s situation