Today Begin Monopoly

Monopoly

Chapter 22

Perfect

Competition =

Many firms

Oligopoly = A

few firms

Four Basic Models

Monopoly = One

firm

Monopolistic

Competition =

Some firms

Profit-Maximizing Monopolist Suppose only one seller in the market. For now, assume it sells all its output at

the same price (no price discrimination). Choose Q to maximize:

profits = TR - TFC - TVC. TFC do not depend on output, so

maximize TR - TVC.

Marginal Revenue Recall: for the price-taking firm, MR

= P. But: the monopolist faces the

market demand curve. As he sells more, he moves down the D curve and price falls.

Graph of Marginal Revenue

Q

P

D

3 4

10

9

ABLost 3

Gai

ned

9What is the MR of the 4th unit?

How does that compare to price?

Will it ever be possible to gain the price as MR?

Monopolist’s Marginal Revenue

P

DMR

Q

The monopolist’s marginal revenue (MR) curve lies everywhere below the demand curve.

MR < P.

Special Case: Straight-Line Demand

P

DMR

Q

The MR curve for a straight-line D curve lies 1/2-way between the D curve and the vertical axis.

105

Special Case: Straight-Line Demand

P

DMR

Q

Recall: Price elasticity falls as we move down the straight-line D curve.

Total revenue rises then falls as we move down the straight-line the D curve.

When = 1, revenue is at its maximum. That’s when MR = 0.

105

= 1

Choosing Quantity Maximize TR - TVC

TR is area under the MR curve. TVC is area under the MC curve. Therefore maximize the difference.

Choosing QuantityP

DMR

Q

Profits are maximized when MR = MC.

MC

TR - TVC

Monopolist’s Profit-Maximizing Rule

P

DMR

Q

Choose Q where MR = MC, charge the highest price possible.

Check:

In SR, is P AVC?

In LR, is P ATC?

Q*

MC

p*

Monopolist’s Profit-Maximizing Rule

P

DMR

Q

Will this monopolist produce in the LR?

In the SR?

Can you identify profits or losses?

Q*

MC

p*ATC

Monopolist’s ProfitsP

DMR

QQ*

MC

p*ATC

The Monopolist & A Supply Curve A monopolist does not have a supply

curve! He chooses his best price & quantity

combination on the market demand curve.

He is not a price taker, so the concept of a supply curve doesn’t make sense.

He is a price maker.

The Monopolist and Efficiency Productive efficiency: Some have

argued that a monopolist may get “lazy” and not keep costs at a minimum.

Others argue that if it’s goal is to maximize profits, that will be incentive enough to minimize costs.

This issue remains unsettled.

The Monopolist and Efficiency Allocative efficiency: Look at the

sum of producers’ and consumers’ surpluses.

Consumers’ SurplusP

DMR

Q

CS: the area under the demand curve but above price.

Q*

MC

p*

Producers’ SurplusP

DMR

Q

PS = TR - TVC

PS: the area under price but above MC.

Q*

MC

p*

Sum of Producers’ and Consumers’ Surplus

P

DMR

Q

Does the monopolist produce the quantity that is allocatively efficient?

Q*

MC

p*

The Allocatively Efficient Quantity

More PS & CS could be gained by producing QE.

The marginal benefits of the add’l units are more than their marginal costs.

P

D

QQM

MC

PM

QE

Efficiency of Monopolist If the monopolist were to produce &

sell the efficient quantity, he would have to set a lower price.

We say the monopolist reduces output and raises price compared to the efficient solution.

This causes a deadweight loss of producer’s & consumers’ surplus.

Deadweight Loss of CS & PS

Represents the cost to society of not producing the efficient quantity of this good.

P

D

QQM

MC

PM

QE

Effects of Monopolies Produce less than the efficient

quantity. Charge higher prices as a result. Consumers are hurt on both counts.

Coming Up: Barriers to entry & the monopolist. More price discrimination

Group Work Try to complete the exercise without

looking back at your notes. Identify on the graph for a Monopolist

the profit-maximizing level of output. the price that the monopolist will charge

(assuming he charges a single price for all units).

the total profits or losses of the monopolist

More things to identify consumer’s surplus producer’s surplus the allocatively efficient quantity the deadweight loss associated with

having a monopoly in this market the supply curve

Monopolist’s situation

0 1 2

10

5

20

30

40

50

6543 7 8 9 10

0

Quantity

$/qPrice

DMR

MCATC