1. Monopoly Example 2 - Haircuts
Quantity demanded
(Q)
(haircuts per hour)
Total revenue
(TR = P x Q)
(dollars)
Marginal revenue
(MR = DTR/DQ)
(dollars)
Marginal
cost
(MC = DTC/DQ)
(dollars)
Price
(P)
(dollars per haircut)
Total cost
(TC)
(dollars)
Profit
(TR - TC)
(dollars) a b c d e f
18 14 32

2. A Monopoly’s Output and PriceMC 20 MR
ATC
Profit = $12
(P-ATC)XQ =
($4 x 3 units) 14
Price and cost (dollars per hour)
Economic
profit $12 10 D
MC=MR at Q=3 & P=$14
Quantity (haircuts per hour) 45

3. Demand and Marginal Revenue Curves and Elasticity20
Elastic
Inelastic
Over the range 5 to 10 haircuts an hour, a price cut decreases total revenue, so demand is inelastic. MR D d f
Unit elastic
Price and marginal revenue
(dollars per haircut) 10
Quantity
(haircuts
per hour)
Profit maximizing monopolies will never produce an output in the inelastic range of the demand curve.
Maximum
total revenue 5 10
–10
– 20 27

4. Monopoly: “Supply” Short Run Equilibria
There is no “supply” as we know it in monopoly
The output decision is dependant on the “demand” and there is no independent “supply”
Short Run Equilibria
Profit
Break even
Loss minimization
Shut down

5. Break Even Loss MinimizationMC
Losses
Output per Time Period
Price, Marginal Revenue,
and Cost per Unit
ATC MC D E C1 Pm Qm MR
AVC
ATC D MR Pm
Price, Marginal Revenue,
and Cost per Unit Qm
Output per Time Period
Practice by drawing the SR Shut Down for a monopolist

6. Long-Run Equilibrium For the Monopolist
In the long run:
there are two possible equilibria for the monopolist
break even
economic profit
Otherwise the monopoly will simply shut down (which generally means no market; if a monopolist can’t make money the only other option is for the government to operate at a loss)

7. Summary & Conclusions
1. MR < P, production always takes place in the elastic portion of D
2. Profit max rule MR  MC…..
3. Monopolist exercises market power, the ability to set price (ability to raise price without losing all sales).
4. Market forces constrain monopoly choices.
5. There is no “supply” as we know it.
6. Monopoly does not guarantee economic profit, but if there is economic profit, it can persist in the long run

8. Price Discrimination
To maximize profit – a producer sells a specific commodity to different buyers for different prices for reasons not associated with costs
Only makes sense for a producer with market power
Ed asks: What about those empty seats?
Return to original cost data.

9. Ed finds a way - Price Discrimination
100
1000
900
800
700
600
500
400
300
200 1 2 3 8 5 6 4 7 9 10
Tickets per Week
$ per Ticket
DFaculty&Staff
MRFS
Faculty & Staff
pay $6.50 and buy qf =325
TR $6.50x325
+ $3.50x375
= $
TC: $
Profit: $1225
DStudent
MRStudent
Students pay $3.50 and
buy qs=375

10. Price Discrimination
Summary
Find low-cost, techniques for distinguishing high-price from low-price buyers
Potential customers with elastic demands are the targets for price reductions,
Provided resale can be prevented.

11. Conclusions Price Discrimination
Price discrimination is a rational strategy for a profit maximizing monopolist facing a downward sloping demand curve
For effective price discrimination
the seller must be able to distinguish, at reasonable cost, different groups with different abilities to pay; i.e., different elasticities of demand.

12. Conclusions Price Discrimination 3. For effective price discrimination
the seller must be able to prevent resale from the low price buyers to the high price buyers.
4. Justification for price discriminations can be an important part of its success: prevents resentment.

13. Efficiency of Monopoly
Compare monopoly to “the standard”: perfect competition.
Assume:
no technological advantage for a single firm producer
constant returns to scale

14. The Social Cost of Monopolies
Efficiency of Monopoly
The Social Cost of Monopolies
Perfect
Competition
Monopoly D D MR
ATC Qm Pm
MCm
Pm > Pc
Pm > MCm
PmminATC E Pe
Marginal Revenue per Unit ($)
Price, Marginal Costs, and
Price per Unit Q2
Value to society
Pm > MCm
therefore not
enough produced
P>MinATC
inefficient resource
use
Quantity per Time Period
Quantity per Time Period

15. Comparing the Competitive Market & Monopoly Outcomes
Efficiency of Monopoly
Comparing the Competitive Market & Monopoly Outcomes
Monopolist charges a higher price, produces a lower quantity.
(could even earn an economic profit in the long run.)

16. Loss in Efficiency From Monopoly (Social Cost)
Efficiency of Monopoly
Loss in Efficiency From Monopoly (Social Cost)
Recall when P(MSB) = MC(MSC), allocative efficiency is achieved.
in monopoly the firm is under-producing P > MC,
 MSB > MSC.

17. Loss in Efficiency From Monopoly (Social Cost)
Efficiency of Monopoly
Loss in Efficiency From Monopoly (Social Cost)
Recall that productive efficiency is achieved when P=Min ATC
monopoly does not operate at min ATC (even in the case of zero economic profit)

18. Deadweight Loss: Measuring the Social Costs of Monopoly
Efficiency of Monopoly
Deadweight Loss: Measuring the Social Costs of Monopoly
The perfectly competitive equilibrium maximizes total surplus: total economic well being
In monopoly, there is a loss of surplus
”dead- weight loss”

19. Efficiency of Monopoly
Measuring the Social Costs of Monopoly: The deadweight loss of a Monopoly
Efficiency of Monopoly
MC = Supply
Price
Redistributed
surplus PM QM
Monopoly
Deadweight Loss QE
Perfectly Competitive Efficient
Quantity!
D=MSB MR
Quantity

20. Public Policy Toward Monopolies
1. Try to make monopolized industries more competitive through legislation….
2. Regulation: (Rate of Return)
used in the case of natural monopolies.
What price should the government set for such monopolies?
What about P = MC, the “allocatively” efficient price?

21. Profit Maximization Before Regulation
Economies of large-scale
production lead to a
single-firm industry:
Natural Monopoly
-Produce 5,000, where MC =MR
-Price = $8: P > MR & MC
-Inefficient allocation of resources, & productive ineffiency 8
Dollars per Unit
LATC 4 A
LMC D
5,000 MR
Quantity per Time Period

22. Regulation Through Marginal Cost Pricing
Regulatory Goal: P = MC
losses
-Set price at $4, where MC = P
-Output = 9,000
-P = MC & P < LATC
-Losses will occur
-Monopolist will go out of
business 6
LATC
Dollars per Unit 8 4
LMC D MR
7,000
9,000
Quantity per Time Period

23. Natural Monopoly Regulation
Natural monopolies have declining ATC, \ MC < ATC,
at P = MC ® firms will experience losses.
Regulators could then subsidize the monopoly or
choose P = ATC ®
average-cost pricing or
fair return pricing

24. Regulation Through Average Cost Pricing
Regulatory Goal: P = LATC
-Set price at $6, where LAC =D
-Output = 8,000
-P = LATC
--Monopolist is breaking even
8,000 8
Dollars per Unit 6
LATC 4
LMC D MR
Quantity per Time Period

25. Natural Monopoly Regulation
 choosing a price is a problem
any regulated price will result in a lack of incentive on the part of the monopolist to reduce costs: and perhaps an effort to hide “true costs”.
Capture Hypothesis
Predicts that the regulators will eventually be captured by the special interests of the industry being regulated

26. Public Policy Toward Monopolies
3. Public Ownership
private vs public ownership
loss of profit motive in public enterprise can lead to higher costs.
4. Do nothing