2. Firm Behavior Under Monopoly AP Econ - Micro II B Mr. Griffin MHS

3. Monopoly Defined Only one firm in the industry No close substitutes for the product Little chance of successful entry by a competitor

4. Sources of Monopoly Barriers to Entry Economies of Scale (cost advantages) Legal Barriers: Patents and Licenses Control of Essential Resources Strategic Barriers to Entry

5. Natural Monopoly Declining long-run average costs (economies of scale) exist over an extended output range Least-cost production can only be achieved by a single producer.

6. Average Total Cost Quantity $20 15 10 050100200 ATC If ATC declines over extended output, least-cost production is realized only if there is one producer - a natural monopoly. THE NATURAL MONOPOLY CASE

7. Market Structure Continuum Pure Competition Pure Monopoly Monopolistic Competition Oligopoly FOUR MARKET MODELS Pure Monopoly: Single Seller No Close Substitutes Price Maker Blocked Entry Nonprice Competition

8. MONOPOLY DEMAND 3 Basic Assumptions: Monopoly Status is Secure No Governmental Regulation Firm Charges the Same Price for all Units Sold Market Demand Curve is the Firm’s Demand Curve

9. MONOPOLY DEMAND 1 2 3 4 5 6 P Q $142 132 D As price decreases from $142 to $132... Loss = $30 Gain = $132 revenue will increase with the additional unit sold.

10. MONOPOLY DEMAND 1 2 3 4 5 6 P Q $142 132 D As price decreases from $142 to $132... Loss = $30 Gain = $132 revenue will increase with the additional unit sold. Marginal Revenue $132 - $30 = $102 must be less than price $132.

11. MONOPOLY REVENUES & COSTS Marginal Revenue 0 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172$ 0 - $100 Average Total Cost Total Cost $100 Revenue DataCost Data x = - =

12. 0 $172$ 0 - $100$100 MONOPOLY REVENUES & COSTS Marginal Revenue 0 1 90 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172 162 $ 0 162 $162 - $100 - 28 Average Total Cost $190.00 Total Cost $100 190 ]] Revenue DataCost Data x = MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

13. MONOPOLY REVENUES & COSTS Marginal Revenue 0 1 2 3 4 5 6 7 8 9 10 90 80 70 60 70 80 90 110 130 150 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $162 142 122 102 82 62 42 22 2 - 18 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 Average Total Cost $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00 Total Cost $100 190 270 340 400 470 550 640 750 880 1030 ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data

14. MONOPOLY REVENUES & COSTS Marginal Revenue 0 1 2 3 4 5 6 7 8 9 10 90 80 70 60 70 80 90 110 130 150 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $162 142 122 102 82 62 42 22 2 - 18 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 Average Total Cost $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00 Total Cost $100 190 270 340 400 470 550 640 750 880 1030 ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data Can you see profit maximization? MR > = MC

15. MONOPOLY REVENUES & COSTS Marginal Revenue 0 1 2 3 4 5 6 7 8 9 10 90 80 70 60 70 80 90 110 130 150 Quantity of Output Price (Average Revenue) Total Revenue Marginal Cost Profit + or loss - $172 162 152 142 132 122 112 102 92 82 72 $ 0 162 304 426 528 610 672 714 736 738 720 $162 142 122 102 82 62 42 22 2 - 18 - $100 - 28 + 34 + 86 + 128 + 140 + 122 + 74 - 14 - 142 - 310 Average Total Cost $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.73 97.78 103.00 Total Cost $100 190 270 340 400 470 550 640 750 880 1030 ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Revenue DataCost Data

16. MONOPOLY REVENUES & COSTS Dollars $200 150 200 50 $750 500 250 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q Q

17. MONOPOLY REVENUES & COSTS Dollars $200 150 200 50 $750 500 250 MR Elastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 D Q TR Q

18. MONOPOLY REVENUES & COSTS Q Dollars $200 150 200 50 $750 500 250 TR MR D InelasticElastic 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q

19. OUTPUT AND PRICE DETERMINATION Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions Not Highest Price Total, Not Unit, Profit Possibility of Losses Graphically…

20. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Remember the MR=MC Rule?

21. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue What About Loss Minimization?

22. Loss Minimization Under Monopoly D MC ATC MR A PmPm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue AVC QmQm V Since P m exceeds AVC, the firm will produce

23. Loss Minimization Under Monopoly D MC ATC MR A PmPm Loss MR = MC Loss Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue AVC QmQm V What are the Economic Effects of Monopoly?

24. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition. An industry in pure competition sells where supply and demand are equal.

25. Q INEFFICIENCY OF PURE MONOPOLY P D MR S = MC PcPc PmPm QcQc QmQm At MR=MC A monopolist will sell less units at a higher price than in competition Monopoly pricing effectively creates an income transfer from buyers to the seller!

26. COST COMPLICATIONS Average total costs Quantity Average Total Costs X X’ Q1Q1 Q2Q2 ATC x ATC 1 ATC 2 ATC x’ Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency Inefficient internal operation leads to higher-than- necessary costs.

27. COST COMPLICATIONS Economies of Scale Simultaneous Consumption Network Effects X-Inefficiency Rent-Seeking Expenditures Rent-Seeking Behavior Technological Advance Assessment and Policy Options Antitrust Action Regulate Natural Monopoly Ignore it, if it is Short-Lived

28. Conditions Monopoly Power Market Segregation No Resale Consequences More Profit More Production PRICE DISCRIMINATION Graphically…

29. Q D MR MC ATC P Q1Q1 Price and Costs Economic profits with a single MR=MC price PRICE DISCRIMINATION

30. Q D MC ATC P Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D

31. Q D MC ATC P Q1Q1 Price and Costs Economic profits with price discrimination PRICE DISCRIMINATION Q2Q2 MR=D

32. Natural Monopolies Rate Regulation Socially Optimum Price P = MC Fair-Return Price P = ATC Dilemma of Regulation REGULATED MONOPOLY Graphically…

33. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Monopoly Price MR = MC QmQm PmPm

34. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Fair-Return Price Normal Profit Only QfQf PfPf

35. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs Socially-Optimum Price P = MC QrQr PrPr

36. REGULATED MONOPOLY Q D MR MC ATC P Price and Costs MR = MC Fair-Return Price Socially-Optimum Price QmQm QfQf QrQr Dilemma of Regulation Which Price? PmPm PfPf PrPr

37. What do I need to know about monopoly for the AP Exam?

38. RELATIONSHIP ECONOMIC INTERPRETATION MR = MC The firm has chosen the output that maximizes profits. P > ATC Firm is earning Economic Profits P = ATC Firm is earning NORMAL PROFIT (Break-Even Point) (EP = 0) P < ATC; P > AVC Loss Minimization P = AVC SHUTDOWN POINT (firm cannot cover its AVC P < AVC Firm does not produce

39. MONOPOLY P > MR The firm’s DEMAND CURVE is relatively INELASTIC (but monopolists always operate in the ELASTIC region) MR = MC MR = MC The firm maximizes profit. P > ATC P > ATC Long Run ECONOMIC PROFITS. PRODUCTIVE INEFFICIENCY PRODUCTIVE INEFFICIENCY P > min ATC Firm is not forced to operate with maximum productive efficiency. Firm is not forced to operate with maximum productive efficiency. (Least-Cost Method Production not necessary) (Least-Cost Method Production not necessary) ALLOCATIVE INEFFICIENCY ALLOCATIVE INEFFICIENCY P > MC There is an UNDERALLOCATION of resources. There is an UNDERALLOCATION of resources.

40. Profit Maximization Under Monopoly D MC ATC MR $94 $122 Profit MR = MC Profit Per Unit OUTPUT AND PRICE DETERMINATION Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue Remember the MR=MC Rule?

41. Q D MC ATC P Q1Q1Q1Q1 Price and Costs PRICE DISCRIMINATION Q2Q2Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! MR=D