1. Who does monopoly Area Beneath the Demand Curve Lying Above the Price: Reflects all the net benefits buyers enjoy, the consumer surplus, from purchasing and consuming the good. Consumer Surplus: The benefit each buyer enjoys from consuming the good less what each buyer must pay for the good. C 50 P C = 1.25 P M = 1.50 P Q D MR MC 75 “S” A B D E A profit maximizing monopoly will always and charge a price that lies on the market demand curve. produce a quantity Marginal Revenue (MR): The marginal revenue curve lies below the market demand curve. MR < Price Measuring the Effect of Monopoly: Consumer and Producer Surplus CompetitionMonopolyChange Consumer Surplus Producer Surplus Total Surplus A + B + CALose B & Lose C D + E + FB + D + FGain B & Lose E A + B + C + D + E + FA + B + D + FLose C & Lose E F WHAT IF the monopoly firm acts as though it were a firm in a perfectly competitive industry? Consumer Surplus: Net benefit buyers enjoy from purchasing and consuming the good. Height of Market Demand Curve: Reflects the benefit a buyer enjoys from consuming a specific unit of the good. Producer Surplus: The net benefit sellers enjoy from producing and selling the good Height of Market Supply Curve: The seller’s opportunity cost of providing a specific unit of the good. Area above the Supply Curve Lying beneath the Price: Reflects all the net benefit sellers enjoy, the producer surplus, from producing and selling the good. MC = 1.00 Producer Surplus: What each seller receives from the sale of the good less the opportunity cost each seller incurs by providing it. hurt?Consumers help?The monopoly firm What about society as a whole. Dead weight loss

2. 50 P M = 1.50 P Q D MC 75 Connecting the Pareto approach to efficiency with consumer and producer surplus MC = 1.00 Question: How did we argue that monopoly was inefficient? We chose an individual, Joe, who Did not by a hamburger when the price was $1.50, the monopoly price. But would be a hamburger at a price of $1.40, a value above Mary’s marginal cost. We then devised a special (secret) deal that made both Joe and Mary better off which did not affect anyone else. Question: Where on the market demand curve would you “place” Joe? Joe Answer: Joe is in the dead weight loss (excess burden) region. Dead weight loss Question: What were the critical aspects in choosing Joe: Price Marginal Cost The dead weight loss represent all the Joes who are around. All those who can make special deals with Mary help the two of them and do no hurt anyone else.

3. MC A = $60MC B = $30 A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 100 80 60 40 20 q A = 50q B = 25 Total Production Q = 75 Plant A produces 1 fewer unit MC = Change in total cost resulting from a one unit change in production  Plant A’s total costs decrease by $60 Plant A produces 1 more unit  Plant B’s total costs increase by $30 Firm’s total costs decrease by $30 Intuition: We can reduce the firm’s total costs without reducing the total quantity of output produced by shifting production from the high marginal cost plant to the low marginal cost plant. Question: Is it possible for the firm to produce 75 units more cheaply by transferring productions from on plant to the other? Profits will rise by $30. Question: Can this go on indefinitely?

4. MC A = $60MC B = $30 A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 100 80 60 40 20 q A = 50q B = 25 Total Production Q = 75 MC = Change in total cost resulting from a one unit change in production Intuition: We can reduce the firm’s total costs without reducing the total quantity of output produced by shifting production from the high marginal cost plant to the low marginal cost plant. Question: Is it possible for the firm to produce 75 units more cheaply by transferring productions from on plant to the other? Question: Can this go on indefinitely? As production is transferred from Plant A to Plant B  MC A decreases  MC B increases Until they are equal MC A = $40MC B = $40q A = 25q B = 50

5. A Multi-Plant Monopoly Claim: To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 100 80 60 40 20 q A + q B = Q = 75MC A = $40MC B = $40q A = 25q B = 50 10050150200 Q D MR 100 80 60 40 20 MR = $90 MC = Change in total cost resulting from a one unit change in production MR = Change in total revenue resulting from a one unit change in production Profit = TR  TC Produce 1 more unit  Up by $90  Up by $40  Up by $50 To maximize profit: MR = MC

6. A Multi-Plant Monopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 10050150200 Q D MR 100 80 60 40 20 100 80 60 40 20 q A = 50 MC A = 60 q B = 100 MC B = 60 q A + q B = = 150 MR = 60P = 90 Question: What price will the monopoly charge? Answer: A monopoly produces a quantity and charges a price that lies on the market demand curve. Claim: To maximize profit: q A = 50 and q B = 100

7.  Consumers base decisions on accurate information  Consumers base decisions on misleading information  Efficient  Inefficient Perfectly Competitive Industry  A large number of small firms  A single firm’s production decision does not significantly affect the price.  MR curve horizontal: MR = Price Monopoly  One large firm  Monopoly produces a quantity and charges a price that lies on the market demand curve.  MR curve lies beneath the market demand curve: MR < Price  MR = MC Profit Maximization Price = MR = MCPrice > MR = MC  Price = MC  Price > MC Review: Efficiency and the Two Polar Cases of Market Structure or Price = MR or Price > MR Perfectly Competitive Industry  A large number of small firms  Efficient Monopoly  One large firm  Inefficient Oligopoly  A few moderately sized firms  Question: Efficient or Inefficient?

8. Project: Explaining OPEC’s Vacillating Behavior in 1993 In late September, the members of OPEC negotiated quotas to restrict the quantity of oil produced. The agreement was applauded by OPEC oil ministers. Shortly thereafter, oil prices promptly rose. The increase in oil prices proved to be short lived, however. OPEC members violated their agreement within two weeks of consummating it. Within a few weeks, the price of oil fell. Conflicting Interests of an Oligopolies and Cartels: Collective versus Individual It is in the collective interests of the firms in an industry to establish a cartel to maximize their joint profits. It is in their collective interests to collude by reducing production below the competitive level; by do so they can act like a monopoly to maximize the joint profits of the entire industry by restricting production below the competitive level. On the other hand, if a cartel is established it may be in the individual interests of each firm to cheat on the cartel agreement to maximize its individual profit. If the cartel agreement is in place, it may be in the individual interests of a firm to produce more than the agreement allows thereby pushing production toward the competitive level. Strategy: Begin with a multi-plant monopoly and then “convert” it to an oligopoly. Oligopoly Challenge of Oligopoly: While it is straightforward to predict the price and quantity in a perfectly competitive market or a monopoly it is more difficult to do so in an oligopoly.

9. Marginal Revenue for the Monopoly A Multi-Plant Monopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 10050150200 Q D MR 100 80 60 40 20 100 80 60 40 20 q A = 50 MC A = $60 q B = 100 MC B = $60 q A + q B = = 150 MR = $60P = $90 Slope of Demand Curve = Rise Run 20 100 =  = .20

10. QuantityPriceTotal Revenue = Price  Quantity Tomorrow: Today:150 15189.80 89.80  151 89.80  (1 + 150) = 89.80+89.80  150  90.00  150 Marginal Revenue = 89.80  30.00 90.00  150 = 89.80+( .20)  150  TR tends to rise by 89.80, the price, as a consequence of the additional unit sold.  TR tends to fall by 30.00, as a consequence of the lower price.  Output Effect  Price Effect MR    90.00 = 89.80+89.80  150 QuantityPrice Tomorrow151 Today150$90.00 Slope of Demand Curve = .20 To clear the market the quantity demanded must increase by 1 unit. The price must fall by.20, from $90.00 to $89.80. $89.80 = $59.80 = 89.80+(89.80  90.00)  150  $60 Marginal Revenue for the Monopoly

11. Convert the Multi-Plant Monopoly into an Oligopoly To maximize profits, two conditions must be satisfied when a firm has two plants: Marginal costs of each plant must be equal: MC A = MC B Marginal revenue must equal each plant’s marginal cost: MR = MC A = MC B 100 80 60 40 20 1005010050150200 MC A MC B qAqA qBqB MC A MC B 10050150200 Q D MR 100 80 60 40 20 100 80 60 40 20 q A = 50 MC A = $60 q B = 100 MC B = $60 q A + q B = = 150 MR = $60P = $90 Owner retires and gives Plant A to his son Adam and Plant B to his daughter Beth Adam’s FirmBeth’s FirmTotal Production q A = 50  MC A = $60 q B = 100  MC B = $60 Q = 150 P = $90

12. Adam’sAdam’s QuantityPriceTotal Revenue = Price  Quantity Tomorrow: Today:50 5189.80 89.80  51 89.80  (1 + 50) = 89.80+89.80  50  90.00  50 Adam’s Marginal Revenue = 89.80  10.00 90.00  50 = 89.80+( .20)  50  TR tends to rise by 89.80, the price, as a consequence of the additional unit sold.  TR tends to fall by 10.00, as a consequence of the lower price.  Output Effect  Price Effect MR A = Adam’s Marginal Revenue    90.00 = 89.80+89.80  50 AdamBethJointPrice Tomorrow51100151 Today5010015090.00 Quantity Slope of Demand Curve = .20 To clear the market the quantity demanded must increase by 1 unit. The price must fall by.20, from $90.00 to $89.80. 89.80 Scenario 1: No Retaliation – Does Adam have an incentive to cheat if Beth does not retaliate? = $79.80 MC A = $60.00 Does Adam have an incentive to cheat if Beth does not retaliate? Yes = 89.80+(89.80  90.00)  50 Question: What does Adam’s marginal revenue (MR A ) equal?

13. MC = Change in total cost resulting from a one unit change in production MR = Change in total revenue resulting from a one unit change in production Adam’s Profit = TR  TC Produce 1 more unit  Up by $79.80  Up by $60.00  Up by $19.80 Adam produces one more unit of output and Beth does not retaliate: q A : 50  51q B = 100 MR A = $79.80 MC A = $60.00 P: $90.00  $89.80 Adam’s Profit Beth’s Profit P: $90.00  $89.80 Down by $.20 Beth’s Profit = TR  TC  Down by $20.00  Unchanged  Down by $20.00 $.20  100 q A : 50  51 Increased by 1 q B = 100: Unchanged Production unchanged: 100 units Question: What happens to their joint profit?Question: Down by $.20

14. MC = Change in total cost resulting from a one unit change in production MR = Change in total revenue resulting from a one unit change in production Beth’s Profit = TR  TC Produce 1 more unit  Up by $69.80  Up by $60.00  Up by $9.80 Beth produces one more unit of output and Adam does not retaliate: q B : 100  101q B = 50 MR A = $69.80 MC A = $60.00 P: $90.00  $89.80 Beth’s Profit Adam’s Profit P: $90.00  $89.80 Down by $.20 Adam’s Profit = TR  TC  Down by $10.00  Unchanged  Down by $10.00 $.20  50 q B : 50  51 Increased by 1 q A = 50: Unchanged Production unchanged: 50 units Question: What happens to their joint profit?Question: Down by $.20

15. = 89.80+89.80  50  90.00  50 Adam’s Marginal Revenue = 89.80  10.00 = 89.80+( .20)  50  TR tends to rise by 89.80, the price, as a consequence of the additional unit sold.  TR tends to fall by 10.00, as a consequence of the lower price.  Output Effect  Price Effect MR A    = 79.80 Beth:MR B = $69.80MC B = $60 Adam:MR A = $79.80MC A = $60 Question: Who has the greater incentive to cheat? = 89.80+89.80  100  90.00  100 Beth’s Marginal Revenue = 89.80  20.00 = 89.80+( .20)  100  TR tends to rise by 89.80, the price, as a consequence of the additional unit sold.  TR tends to fall by 20.00, as a consequence of the lower price.  Output Effect  Price Effect MR B    = 69.80 Summary = 89.80+(89.80  90.00)  50 = 89.80+(89.80  90.00)  100 When Adam producers 1 more unit his profit rises by approximately $19.80 When Beth producers 1 more unit her profit rises by approximately $9.80. Adam has a greater incentive to cheat. Why? Adam’s MR is greater. Why? Adam’s price effect is smaller. Why? Adam is the smaller producer. Conclusion: The smaller producer has a greater incentive to cheat.