1. One Seller 2. One Product 3. Blocked Entry (and exit?) 4. Non-Price competition 5. LR profits/losses 6. Price Maker (to maximize profits)

Barriers to Entry economies of scale government licensing Patents 4. control over an essential resource

Price and Output A profit-maximizing firm will expand output as long as marginal revenue exceeds marginal cost. Price will be lowered and output expanded until MR = MC The price charged will be greater than its marginal cost.

A Natural Monopoly Graph Average Cost One firm producing Q1 has average cost C1 If two firms share the market, each produces Q0.5 and has average cost C0.5 If three firms share the market, each produces Q0.33 has average cost C0.33 C0.33 C0.5 C1 ATC Q Q0.33 Q0.5 Q1

Marginal Revenue of a Monopolist Initial price P1 & output q1. Total revenue (TR) = P1 * q1. Price Reduction in Total Revenue 1. As price falls from P1 to P2, output increases from q1 to q2, two conflicting influences on TR. Increase in Total Revenue P1 1. TR will rise because of an increase in the number of units sold (q2 - q1) * P2. P2 2. TR will decline [(P1 - P2) * q1] as q1 units once sold at the higher price (P1) are now sold at the lower price (P2). d Depending on the size of the shaded regions, total revenue may increase or decrease. MR Quantity/time q1 q2

Total Cost Marginal Cost Price (AR) Output Total Revenue Marginal Revenue Quantity ATC 50 80 90 110 140 180 230 290 360 440 530 30 10 20 40 50 60 70 80 90 110 90 70 50 30 10 -10 -30 -50 -70 1 2 3 4 5 6 7 8 9 10 ___ 80 45 37 35 36 38 41 49 53 1 2 3 4 5 6 7 8 9 10 120 110 100 90 80 70 60 50 40 30 20 110 200 270 320 350 360 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

What do these curves look like? Marginal Cost Price (AR) Quantity Marginal Revenue ATC 30 10 20 40 50 60 70 80 90 110 90 70 50 30 10 -10 -30 -50 -70 80 45 37 35 36 38 41 49 53 1 2 3 4 5 6 7 8 9 10 120 110 100 90 80 70 60 50 40 30 20 How many to produce?

120 110 Cost 100 MC 90 80 70 ATC 60 50 40 30 AR 20 MR 10 1 2 3 4 5 6 7 8 9 10 Output

Monopolistic Profit Maximization Graph Marginal revenue is not constant as Q increases because: revenue increases as the monopolist sells more revenue decreases because the monopolist must lower the price to sell more P MC D at Qprofit max $24 Find output where MC = MR, this is the profit maximizing Q MC = MR Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price D MR Q 4 = Qprofit max

Monopoly Compared to Perfect Competition Graph 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

The Welfare Loss from a Monopoly 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 diagram shows demand and long-run cost conditions in an industry Price Quantity/time Explain why the industry is likely to be monopolized. Indicate the monopolist’s output level, and label it Q. Indicate the price that a profit-maximizing monopolist would charge, and label it P Indicate the maximum profits of the monopolist. Will the profits attract competitors to the industry? Yes ___ No ____ Explain why or why not MC LRATC d MR Name: ____________________

Price and Output Under Monopoly Quantity/time Expand output as long as MR > MC. (P goes down) MC Economic profits Output level q will result … with price determined by the height of the demand curve at that level of output, P. ATC A P B At q the average total cost per unit for that scale of output is C. C d MR < MC As P > C (price > ATC) the firm is making economic profits equal to the area PABC. MR > MC MR q

Price and Output Under Monopoly A monopolist will reduce price and expand output as long as MR > MC. As the monopolist reduces price and expands output, profits increase … until the point where MC > MR. Here an output of 8 a day will maximize profits. Output (per day) (1) Total revenue = (1)*(2) (3) Total costs (per day) (4) Profit = (3) - (4) (5) Marginal cost (6) Marginal revenue (7) Price (per unit) (2) ---- ----- $50.00 -$50.00 ---- ---- < 1 $25.00 $25.00 $60.00 -$35.00 $10.00 $25.00 < 2 $24.00 $48.00 $69.00 -$21.00 $9.00 $23.00 < 3 $23.00 $69.00 $77.00 -$8.00 $8.00 $21.00 < 4 $22.00 $88.00 $84.00 $4.00 $7.00 $19.00 < 5 $21.00 $105.00 $90.50 $14.50 $6.50 $17.00 < 6 $19.75 $118.50 $96.75 $21.75 $6.25 $13.50 $102.75 < 7 $18.50 $129.50 $26.75 $6.00 $11.00 < 8 $17.25 $138.00 Maximum profits $108.50 $29.50 $5.75 $8.50 $144.00 $114.75 9 $16.00 $29.25 $6.25 $6.00 10 $14.75 $147.50 $121.25 $26.25 $6.50 $3.50

Profits Under Monopoly High entry barriers protect monopolists from competitive pressures. Monopolists can earn long-run profits. However even a monopolist will not always be able to earn profit. When ATC is always above the demand curve, the monopolist will be unable to cover costs (unable to earn a profit).

When a Monopolist Incurs Losses Price Quantity/time A monopolist will set output equal to q, where MR = MC MC At this level of output, the price that the monopolist charges does not cover the average total cost of producing the output ( P < C ). ATC A C Short-run losses P B Whenever the ATC curve lies always above the demand curve, the monopolist will incur short-run losses. In this diagram the firm is making economic losses equal to the shaded area, CABP. d MR q

Regulation of a Monopolist An unregulated monopolist produces where MR = MC (Q0) and charge price P0. Price From an efficiency viewpoint, this output is too small and the price is too high. Average cost pricing Marginal cost pricing P0 average cost pricing The monopolist is forced to reduce its price to P1 the expand output to Q1. LRATC P1 MC 2. marginal cost pricing Force output to be expanded to Q2 where P = MC P = cost to produce Forces LR losses. P2 D MR Q0 Q1 Q2 Quantity/time

Allocative Efficiency Allocative efficiency is achieved when the most desired goods are produced at the lowest possible cost. The Minimum point on the ATC curve: ATC > marginal cost at the minimum point No allocative efficiency in a Monopoly.

Price Discrimination Sellers may gain from price discrimination by charging: higher prices to groups of customers with more inelastic demand lower prices to groups of customers with more elastic demand Price discrimination generally leads to more output and additional gains from trade.

The Economics of Price Discrimination Consider a hypothetical market for airline travel where the Marginal Cost per traveler is $100. If the airline charges all customers the same price, profits will be maximized where MC = MR. Here the airline charges everyone $400 and sells 100 seats. This generates Net Operating Revenue of $30,000 or (total revenues) $40,000 – (operating costs) $10,000. Price $700 Net operating revenue ($300*100) = $30,000 $600 $500 $400 $300 $200 MC $100 MR D 100 Quantity/time Single price

The Economics of Price Discrimination By charging higher prices to consumers with less elastic demand and lower prices to those with more elastic demand it will increase net operating revenue. If the airline charges $600 to business travelers (who have a highly inelastic demand) and $300 to other travelers (who have a more elastic demand), it can increase its Net Operating Revenue to $42,000. Price Price Net operating revenue from business travelers ($500*60) = $30,000 $700 Net operating revenue ($300*100) = $30,000 $700 Net operating revenue from all others ($200*60) = $12,000 $600 $600 $500 $500 $400 $400 $300 $300 $200 $200 MC MC $100 $100 MR D D 100 Quantity/time 60 120 Quantity/time Single price Price Discrim.

When economies of scale are important and an industry tends toward natural monopoly, splitting the industry into small, rival firms will a. lead to lower prices in the short run. b. cause prices to rise when demand is inelastic but fall when it is elastic. c. cause prices to fall because of the decline in producer profits. d. increase per-unit costs of production. A monopolist will maximize profits by a. setting his price as high as possible. b. setting his price at the level that will maximize per-unit profit. producing the output where marginal revenue equals marginal cost and charging the price on the demand curve at that quantity. producing the output where price equals marginal cost. Which of the following is the most accurate description of a monopolist? a firm that produces a single product a firm that is the sole producer of a narrowly defined product class, such as yellow, grade-A butter produced in Jackson County, Wisconsin a firm that is the sole producer of a product for which there are no good substitutes in a market with high barriers to entry a firm that is large relative to its competitors

Oligopolistic agreements on price tend to be unstable because although the monopoly price is the best price for all firms, oligopolists are unaware of this. although the monopoly price maximizes the joint profits of the firms, a secret price cut by any individual firm will increase the profits of that firm; hence, collusive agreements tend to break down. the demand for the products of oligopolistic industries is inherently unstable relative to the demand for the products of non-oligopolistic industries. firms in oligopolistic industries have more concern for consumers than do firms in competitive industries. When firms use resources in an attempt to secure and maintain grants of market protection from the government, it is called a. rent seeking b. franchising. c. collusion. d. resource investment The incentive for the managers of a government-operated firm (for example, a state university) to promote internal efficiency and keep costs low will be a. weak because it will be difficult for voters and their representatives to monitor and eliminate the inefficiency of such firms. b. strong because public officials will have little concern for personal gain. strong because voters can easily recognize inefficiency and penalize the public-sector managers who are responsible. weak because government employees are less competent than those who work in the private sector.

Would they be making a profit? a. yes b. no normal but not economic What price and output in the graph would an unregulated profit-maximizing monopolist choose? a. price C and output R b. price B and output R price B and output S price A and output T Would they be making a profit? a. yes b. no normal but not economic can’t tell If a regulatory agency were using the “normal return” (zero economic profit) criteria to impose a price on a monopolist with the cost and demand conditions depicted, what price would the regulators set, and what output would the monopolist produce? price A and output T price C and output R price B and output R d. price B and output S