1. Monopoly

2. Monopoly Market Characteristics
One firm produces the product
No product variety
No close substitutes
Complete barriers to entry
Firm owns a key resource
Franchise rights
The costs of production make a single producer most efficient
Government gives a firm exclusive selling rights (patents)

3. Gerbil Shirt

4. Demand for the gerbil shirt…P Qd TR MR 11 10 1 9 2 8 3 7 4 6 5

5. Demand for the gerbil shirt…P Qd TR MR 11 - 10 1 9 2 18 8 3 24 6 7 4 28 5 30 -2 -4

6. Graph demand and MR for gerbil shirts
Price
$11 10 9 8 7 6 5 4 3
Demand
(average
revenue) 2 1 –1 1 2 3 4 5 6 7 8
Quantity of Gerbil Shirts –2 –3 –4
Marginal
revenue

7. The dilemma for monopolies
As a monopoly produces more, the price and revenue of their goods will fall
Because they face a downward sloping demand that is above it’s MR.

8. How do Monopolies Maximize Profits?
The same as all other firms!
Produce where MR = MC
Set the maximum prices that consumer are willing to spend (the price at the demand curve).

9. So let’s go back to the main question, how do I maximize my profits!?!?

10. Remember profit maximization is where MR = MC
- My profit maximization quantity is 5, where my MR = MC
Price
$11 10 MC 9
- But, at that quantity, the five people who will buy the shirt are willing to spend $6 8 7 6 5 4
So, the firm would sell the good for $6 3
Demand
(average
revenue) 2 1 –1 1 2 3 4 5 6 7 8
Quantity of Gerbil shirts –2 –3 –4
Marginal
revenue

11. Inefficiency of Monopolies
FIRMS
BUYERS

13. The Deadweight Loss A monopoly sets a price above its MC
Price is higher than the market price
Quantity is lower than the market quantity
This causes markets to be inefficient
Deadweight loss
Firm produces less than what the market wants

15. Figure 8 The Inefficiency of Monopoly
Price
Marginal
revenue
Demand
Marginal cost
Deadweight
loss
Monopoly
price
quantity
Efficient
quantity
Quantity

16. Review: Monopoly Key Concepts
Monopolies are able to charge a higher price because they have high market power
MR is below demand
The price that a monopoly sets is equal to the demand at the profit maximizing production level (MR=MC)
P > MC
Monopolies cause inefficient markets
Produce less at a higher price

17. Price Discrimination

18. Price Discrimination
Selling the same good at different prices to different customers

19. Price Discrimination
Selling the same good at different prices to different customers
This can be done only if a firm:
Has market power
Can separate consumers into groups
Can prevent resale between consumers

20. Let’s also assume that it costs me $5 to produce one book
Lets say I want to start selling the critically acclaimed book: 3 Blind Kraus(e): A Tale of Physics, Military and Street Law
Let’s also assume that it costs me $5 to produce one book

21. Now assume that there are two types of people who want to buy Kraus(e)
Type 1: These are the die hard readers. There are currently two type 1 people and are willing to spend $50 for the book
Type 2: These are the, “I just want to make Mr. Barber happy so I can pass” readers. There are currently five type 2 people and are willing to spend $10 for the book
I can sell the book for $50 and make a profit of $90. But, there would be 5 students who don’t have the book.
I can sell the book for $10 and make a profit of $25. Obviously, a much smaller profit.

22. Now assume I can price discriminate
Type 1: The die hard readers
I can sell them the books for $50 and make a profit of $90
Type 2: The “just want to pass” readers
I can sell them the book for $10 and make a profit of $25
So, as a firm, I make the most profit possible of $115 AND everyone who wanted the book will be able to obtain it.

23. THE BIG IDEA
Contrary to popular belief, price discrimination actually makes a market more efficient! More consumers are able to purchase the product and there is less surplus lost (deadweight loss). The monopoly firm will just share most of the surplus.

24. Final Question
If a firm can PERFECTLY price discriminate, who would obtain all of the surplus?

25. Natural Monopolies

26. All of you used a good/service today produced by a natural monopoly…

28. Natural Monopoly
Market that run most efficiently when one large firm provides all of the output
Government regulates price
The natural monopoly firm has:
Very large fixed costs
The ATC is decreasing when output increases (economics of scale)
The ATC is decreasing when providing for the entire market (D = MC)

30. Natural Monopoly MC MR

31. Regulating Natural Monopolies
The government sets the price and quantity
The regulated price is where the natural monopoly earns normal profit (price = ATC)
Still not efficient (but more efficient than the unregulated monopoly)

32. Natural Monopoly Examples
Public Water
Electricity
Cable companies!!