1. Monopolistic competition
Types of Market Structure
This system of market structures is based on two dimensions:
The number of producers in the market (one, few, or many)
Whether the goods offered are identical or differentiated
Differentiated goods are goods that are different but considered somewhat substitutable by consumers (think Coke versus Pepsi).
Are Products Differentiated? No
Yes
One
Monopoly
Not applicable
How Many Producers Are There?
Oligopoly
Few
Figure Caption: Figure 14-1: Types of Market Structure
The behavior of any given firm and the market it occupies are analyzed using one of four models of market structure—monopoly, oligopoly, perfect competition, or monopolistic competition. This system for categorizing market structure is based on two dimensions: (1) whether products are differentiated or identical and (2) the number of producers in the industry—one, a few, or many.
Perfect competition
Monopolistic competition
Many

2. The Meaning of Monopoly (10/24/16)
Our First Departure from Perfect Competition…
A monopolist is a firm that is the only producer of a good that has no close substitutes.
The ability of a monopolist to raise its price above the competitive level by reducing output is known as market power.
Very few true monopolies – why?
Barriers to entry: 2

3. Types of monopolies
1. Natural – costs of production minimized by having
one provider – economies of scale (inc returns)
a. Example:

4. Increasing returns create natural monopoly
Price, cost
Fixed costs required to operate are very high  the firm’s ATC curve declines over the range of output at which price is greater than or equal to average total cost.
Natural monopoly. Average total cost is falling over the relevant output range
Natural monopolist’s break-even price A T C D
Figure Caption: Figure 14-3: Increasing Returns to Scale Create Natural Monopoly
A natural monopoly can arise when fixed costs required to operate are very high. When this occurs, the firm’s ATC curve declines over the range of output at which price is greater than or equal to average total cost. This gives the firm increasing returns to scale over the entire range of output at which the firm would at least break even in the long run. As a result, a given quantity of output is produced more cheaply by one large firm than by two or more smaller firms.
Quantity
Relevant output range
This gives the firm economies of scale over the entire range of output at which the firm would at least break even in the long run. As a result, a given quantity of output is produced more cheaply by one large firm than by two or more smaller firms.

5. 2. Geographic – simple absence of other sellers
a. Example:

6. 3. Technological – ownership/control of
3. Technological – ownership/control of manufacturing method/process/scientific advance
a. Patents:

7. 4. Government – products and services that the
4. Government – products and services that the public cannot adequately provide

8. Texas Tea Oil Co. is the only supplier of home heating oil.
In each situation, prices doubled.
Evaluate: Are the people victims of Texas Tea’s market power?
National shortage of heating oil  Texas Tea could procure only a limited amount.
Last year, Texas Tea and several other competing local oil-supply firms merged into a single firm.
The cost to Texas Tea of purchasing oil from refineries has gone up significantly.
Texas Tea has acquired an exclusive government license to draw oil from the only heating oil pipeline in the state.

9. What a Monopolist Does
Price S P M M
2. … and raises price. C P C
Equilibrium is at C, where the price is PC and the quantity is QC. A monopolist reduces the quantity supplied to QM, and moves up the demand curve from C to M, raising the price to PM. D
Figure Caption: Figure 14-2: What a Monopolist Does
Under perfect competition, the price and quantity are determined by supply and demand. Here, the equilibrium is at C, where the price is PC and the quantity is QC. A monopolist reduces the quantity supplied to QM, and moves up the demand curve from C to M, raising the price to PM. Q M Q C
Quantity
1. Compared to perfect competition, a monopolist reduces output…

10. Comparing the Demand Curves of a Perfectly Competitive Producer and a Monopolist
Demand Curve of an Individual Perfectly Competitive Producer
(b)
Demand Curve of a Monopolist
Price
Price
Market price D C D M
Quantity
Quantity
Figure Caption: Figure 14-4: Comparing the Demand Curves of a Perfectly Competitive Producer and a Monopolist
Because an individual perfectly competitive producer cannot affect the market price of the good, it faces a horizontal demand curve DC, as shown in panel (a). A monopolist, on the other hand, can affect the price. Because it is the sole supplier in the industry, its demand curve is the market demand curve DM, as shown in panel (b). To sell more output, it must lower the price; by reducing output, it raises the price.
An individual perfectly competitive firm cannot affect the market price of the good  it faces a horizontal demand curve DC, as shown in panel (a). A monopolist, on the other hand, can affect the price (sole supplier in the industry)  its demand curve is the market demand curve, DM, as shown in panel (b). To sell more output it must lower the price; by reducing output it raises the price.

11. Marginal revenue of a monopolist: change in total revenue divided by change in quantity
Monopolies: MR does NOT equal price!!!!

12. Marginal revenue always falls:
In order to sell one more, you need to lower the price of that one AS WELL AS the price of all the previous ones
Example: I can’t sell 1 diamond for $950, the 2nd for $900, and the 3rd for $850 – if I want to sell 3 diamonds, they ALL must be priced at $850

13. An increase in production by a monopolist has two opposing effects on revenue:
A quantity effect. One more unit is sold, increasing total revenue by the price at which the unit is sold.
A price effect. In order to sell the last unit, the monopolist must cut the market price on all units sold. This decreases total revenue. 13

14. Quantity Effect Component Price Effect Component
Quantity Demanded
Price
Total Revenue
Marginal Revenue
Quantity Effect Component
Price Effect Component 1
$100 2
186 3
252 4
280 5
250
Come up with demand schedule for emeralds.
Fill in marginal revenue column.
The quantity effect component of marginal revenue per output level (how much TR increases because of selling one more)
The price effect component of marginal revenue per output level (how much TR decreases by having to decrease the price of all sold to sell one more) Hint: MR = QE + PE
What additional info is needed to determine the profit maximizing quantity of output?

15. MC = MR!!!! How a monopolist maximizes profit
Profit-maximizing quantity of output:
MC = MR!!!!

16. Price per download Quantity demanded TR MR (careful!!) $10 8 1 6 3 4 28 1 6 3 4 2 10 15
Bob, Bill, Ben, and Brad are thinking about making their movie available for download on the internet. Each time the movie is downloaded, the ISP charges them a fee of $4.
b. Bob is proud of the film and wants as many people as possible to download it. What price would he choose? How many downloads will he sell?
c. Bill wants as much total revenue as possible. Which price would he choose? How many downloads would be sold?
d. Ben wants to maximize profit. Which price would he choose? How many downloads would be sold?
e. Brad wants to charge the efficient price (where P=MC). What price would he choose? How many downloads would he sell?

17. Price, cost, marginal revenue of demand
DeBeers: no fixed cost, marginal cost is constant $200
per diamond
The optimal output rule: the profit maximizing level of output for the monopolist is at MR = MC, shown by point A, where the MC and MR curves cross at an output of 8 diamonds.
Price, cost, marginal revenue of demand
$1,000
Monopolist’s optimal point B P
600 M
Perfectly competitive industry’s optimal point
Monopoly profit P
200 MC  A T C C A C D 8 10 16 20
Figure Caption: Figure 14-6: The Monopolist’s Profit-Maximizing Output and Price
This figure shows the demand, marginal revenue, and marginal cost curves. Marginal cost per diamond is constant at $200, so the marginal cost curve is horizontal at $200. According to the optimal output rule, the profit-maximizing quantity of output for the monopolist is at MR=MC, shown by point A, where the marginal cost and marginal revenue curves cross at an output of 8 diamonds. The price De Beers can charge per diamond is found by going to the point on the demand curve directly above point A, which is point B here—a price of $600 per diamond. It makes a profit of $400 ×8 =$3,200. A perfectly competitive industry produces the output level at which P=MC, given by point C, where the demand curve and marginal cost curves cross. So a competitive industry produces 16 diamonds, sells at a price of $200, and makes zero profit.
Quantity of diamonds
–200 Q Q M C MR
–400
The price De Beers can charge per diamond is found by going to the point on the demand curve directly above point A, (point B here)—a price of $600 per diamond. It makes a profit of $400 × 8 = $3,200.

18. Marginal revenue always falls:
In order to sell one more, you need to lower the price of that one AS WELL AS the price of all the previous ones
Example: I can’t sell 1 diamond for $950, the 2nd for $900, and the 3rd for $850 – if I want to sell 3 diamonds, they ALL must be priced at $850

19. To summarize – monopolies…
produce less and charge higher prices than perfectly competitive firms
earn profits in the short-run AND long-run – why?

20. Price, cost, marginal revenue
The Monopolist’s Profit – the general picture
Price, cost, marginal revenue
Profit = TR − TC
= (PM × QM) − (ATCM × QM)
= (PM − ATCM) × QM MC A T C B P M
The average total cost of QM is shown by point C. Profit is given by the area of the shaded rectangle.
Monopoly profit A D A T C M C MR
Figure Caption: Figure 14-7: The Monopolist’s Profit
In this case, the marginal cost curve has a “swoosh” shape and the average total cost curve is U-shaped. The monopolist maximizes profit by producing the level of output at which MR=MC, given by point A, generating quantity QM. It finds its monopoly price, PM, from the point on the demand curve directly above point A, point B here. The average total cost of QM is shown by point C. Profit is given by the area of the shaded rectangle. Q
Quantity M
In this case, the MC curve is upward sloping and the ATC curve is U- shaped. The monopolist maximizes profit by producing the level of output at which MR = MC, given by point A, generating quantity QM. It finds its monopoly price, PM , from the point on the demand curve directly above point A, point B here.

21. Partner practice:
Use the total revenue schedule of Emerald, Inc., a monopoly producer of emeralds, to calculate the answers to parts a and b.
Price schedule
Marginal revenue schedule
Price
Quantity Demand ed
Total Revenue
Marginal Revenue 1
$100 2
186 3
252 4
280 5
250
Now plot the demand curve, the marginal revenue curve, the marginal cost curve at a constant $47. What is the profit-maximizing quantity of output? What price will the firm charge at this level of output? How much profit will they make?

22. Skyscraper City has a subway system, for which a one-way fare is $1.50. There is pressure on the mayor to reduce the far by one-third, to $1.00. The mayor is dismayed, thinking that this will mean Skyscraper City is losing one-third of its revenue from sales of subway tickets. Is the mayor correct in his prediction? Explain.

23. Monopoly and Public Policy
By reducing output and raising price above marginal cost, a monopolist captures some of the consumer surplus as profit and causes deadweight loss. To avoid deadweight loss, government policy attempts to prevent monopoly behavior.
When monopolies are “created” rather than natural, governments should act to prevent them from forming and break up existing ones.
The government policies used to prevent or eliminate monopolies are known as antitrust policy. 23

24. Price, cost, marginal revenue
Monopoly Causes Inefficiency
Total Surplus with Perfect Competition
Total Surplus with Monopoly
(a)
(b)
Price, cost
Price, cost, marginal revenue
Consumer surplus with perfect competition
Consumer surplus with monopoly
Profit P M
Deadweight loss P
MC = A T C
MC = A T C C D D MR Q
Quantity Q
Quantity C M
Figure Caption: Figure 14-8: Monopoly Causes Inefficiency
Panel (a) depicts a perfectly competitive industry: output is QC, and market price, PC, is equal to MC. Since price is exactly equal to each producer’s average total cost of production per unit, there is no producer surplus. So total surplus is equal to consumer surplus, the entire shaded area. Panel (b) depicts the industry under monopoly: the monopolist decreases output to QM and charges PM. Consumer surplus (blue area) has shrunk: a portion of it has been captured as profit (green area), and a portion of it has been lost to deadweight loss (yellow area), the value of mutually beneficial transactions that do not occur because of monopoly behavior. As a result, total surplus falls.
Panel (b) depicts the industry under monopoly: the monopolist decreases output to QM and charges PM. Consumer surplus (blue triangle) has shrunk because a portion of it has been captured as profit (light blue area). Total surplus falls: the deadweight loss (orange area) represents the value of mutually beneficial transactions that do not occur because of monopoly behavior.

25. Preventing Monopoly
Breaking up a monopoly that isn’t natural is clearly a good idea, but breaking up natural monopolies might lead to higher costs.
Yet even in the case of a natural monopoly, a profit- maximizing monopolist acts in a way that causes inefficiency—it charges consumers a price that is higher than marginal cost, and therefore prevents some potentially beneficial transactions. 25

26. Dealing with Natural Monopoly
What can public policy do about this? There are two common answers (aside from doing nothing)…
One answer is public ownership, but publicly owned companies are often poorly run.
A common response in the United States is price regulation. A price ceiling imposed on a monopolist does not create shortages as long as it is not set too low. 26

27. Unregulated and Regulated Natural Monopoly
Total Surplus with an Unregulated Natural Monopolist ( b )
Total Surplus with a Regulated Natural Monopolist
Price, cost, marginal revenue
Price, cost, marginal revenue
Consumer surplus
Consumer surplus
Profit P P M M P R A T C P * A T C R MC MC D D MR MR
Figure Caption: Figure 14-9: Unregulated and Regulated Natural Monopoly
This figure shows the case of a natural monopolist. In panel (a), if the monopolist is allowed to charge PM, it makes a profit, shown by the green area; consumer surplus is shown by the blue area. If it is regulated and must charge the lower price PR, output increases from QM to QR and consumer surplus increases. Panel (b) shows what happens when the monopolist must charge a price equal to average total cost, the price P* R. Output expands to Q* R, and consumer surplus is now the entire blue area. The monopolist makes zero profit. This is the greatest total surplus possible when the monopolist is allowed to at least break even, making P* R the best regulated price. Q Q
Quantity Q Q * M R M R
Quantity
Panel (b) shows what happens when the monopolist must charge a price equal to average total cost, the price PR*. Output expands to QR*, and consumer surplus is now the entire blue area. The monopolist makes zero profit. This is the greatest consumer surplus possible when the monopolist is allowed to at least break even, making PR* the best regulated price.

28. Quantity of Diamonds Demanded
DeBeers is a single-price monopolist. DeBeers has 5 potential customers: Raquel (willing to pay $400), Jackie (willing to pay $300), Joan (willing to pay $200), Mia (willing to pay $100), and Sophia (willing to pay $0).
Price
Quantity of Diamonds Demanded
$500
400 1
300 2
200 3
100 4 5
Add columns for and calculate total revenue and marginal revenue.
The marginal cost of production is a constant $100. What is the profit maximizing quantity and price?
How much is each person’s individual consumer surplus? How much is total consumer surplus? How much is producer surplus (profit)?
Suppose that Russian and Asian producers enter the diamond market, and the industry becomes perfectly competitive.
What is the perfectly competitive price? What quantity will be sold?
At this new price, what is the new total consumer surplus? How large is producer surplus?

29. Price Discrimination
Up to this point we have considered only the case of a single-price monopolist, one who charges all consumers the same price. As the term suggests, not all monopolists do this.
In fact, many if not most monopolists find that they can increase their profits by charging different customers different prices for the same good: they engage in price discrimination. 29

30. Two Types of Airline Customers
Price, cost of ticket
Profit from sales to business travelers
$550 B
Profit from sales to student travelers
Figure Caption: Figure 14-10: Two Types of Airline Customers
Air Sunshine has two types of customers, business travelers willing to pay at most $550 per ticket and students willing to pay at most $150 per ticket. There are 2,000 of each kind of customer. Air Sunshine has constant marginal cost of $125 per seat. If Air Sunshine could charge these two types of customers different prices, it would maximize its profit by charging business travelers $550 and students $150 per ticket. It would capture all of the consumer surplus as profit.
150
125 MC S D
2,000
4,000
Quantity of tickets

31. Price Discrimination
(a) Price Discrimination with Two Different Prices
(b) Price Discrimination with Three Different Prices
Price, cost
Price, cost
Profit with two prices
Profit with three prices P
high P
high P
medium P
low P
low MC MC D D
Figure Caption: Figure 14-11: Price Discrimination
Panel (a) shows a monopolist that charges two different prices; its profit is shown by the shaded area. Panel (b) shows a monopolist that charges three different prices; its profit, too, is shown by the shaded area. It is able to capture more of the consumer surplus and to increase its profit. That is, by increasing the number of different prices charged, the monopolist captures more of the consumer surplus and makes a larger profit.
Quantity
Quantity
Sales to consumers with a high willingness to pay
Sales to consumers with a low willingness to pay
Sales to consumers with a high willingness to pay
Sales to consumers with a medium willingness to pay
Sales to consumers with a low willingness to pay

32. Perfect Price Discrimination
Perfect price discrimination takes place when a monopolist charges each consumer his or her willingness to pay—the maximum that the consumer is willing to pay.

33. Price Discrimination Perfect Price Discrimination Price, cost
Profit with perfect price discrimination
Figure Caption: Figure 14-11: Price Discrimination
Panel (c) shows the case of perfect price discrimination, where a monopolist charges each consumer his or her willingness to pay; the monopolist’s profit is given by the shaded triangle. MC D
Quantity