Monopoly - A Single Seller

1. P D Q MR Monopoly - A Single Seller Microeconomics - Dr. D. Foster

2. Monopoly Characteristics • A single seller with no “close” substitutes . . .-- means that the market demand is the firm’s demand. • Barriers to entry . . .-- means that they can earn LR econ. profit. • legal restrictions • patents • control of resources • economies of scale

3. P loss P1 P2 gain D Q Q1 Q2 Monopoly - Finding Profit Max. • Find where MR=MC . . . MR = Gain - Loss If P1=$10, P2=$9.95, Q1=100, Q2=101, what is MR? Gain = $9.95Loss = $5.00MR = $4.95 < Price

4. P MC P* D Q Q* MR Monopoly - Finding Profit Max. • Find where MR=MC . . . Set output at MR=MC. Find the price to charge from the Demand. Will the firm earn an economic profit?How can we tell?

5. P MC ATC P* D Q Q* MR Monopoly - Finding Profit Max. • Economic profit = TR - TC . . . TR = P•Q TC = ATC•Q Can a monopoly firm earn “negative” economic profit and stay in business in the short run?

6. P MC AVC ATC P* D Q Q* MR Monopoly • Can a firm can earn negative profit in the SR? Yes! As long as P > AVC, the firm will sustain losses in the short run. Can a monopoly earn just a zero economic profit?

7. P MC P* D Q Q* MR Monopoly - Earning zero profit P = ATC Under what circumstances might we expect this to happen? • Zero Economic profit if TR = TC ATC When owners of a monopoly sell it to a new owner they should attempt to extract this econ. profit.

8. P ATC MC $100 $90 $75 $70 $50 $45 $30 D Q 500 1000 1300 MR 1200 1800 Monopoly Example I What is the profit maximizing level of output? What price will the monopolist charge? What is the amount of economic profit? What is the amount of accounting profit?

9. P MC ATC P* D Q Q* MR Monopoly and Inefficiency • Allocative efficiency occurs when P=MC. Monopolies are allocatively inefficient, as they price above the MC. They produce too little. Our loss is call the “social loss” (or, deadweight cost) and measured as shown.

10. Monopoly and Inefficiency • Productive efficiency occurs when at min ATC.-- Monopolies are likely to be inefficient. • “X-inefficiency” - arises from a cost structure that is higher than would be true for perfectly competitive firms. • “Social waste of resources” - up to the value of the firm’s economic profit if spent in “rent seeking” activities.

11. P ATC MC $100 $90 $75 $70 $50 $45 $30 D Q 500 1000 1300 MR 1200 1800 Monopoly Example II What output level is allocatively efficient? What is the social loss? What output level is productively efficient?

12. P MC ATC P* Pc D Q Q* MR Regulating Monopoly • Using price controls can promote efficiency! By instituting a price ceiling, the “demand” is altered, insofar as the firm’s actions are concerned.

13. P MC ATC P* D Q Q* MR Regulating Monopoly • Using price controls can promote efficiency! The monopolist can be induced to produce more (Q’) at a lower price!! The firm is still inefficient, but we could set prices to achieve either allocative or productive efficiency. Pc Q’

14. P ATC MC $100 $90 $75 $70 $50 $45 $30 D Q 500 1000 1300 MR 1200 1800 Monopoly Example III 1. What would be the effect on output, price, economic profit and social cost if the government establishes a price ceiling of . . . a. $45? b. $50? c. $70? d. $75? e. $90? f. $100?

15. Monopoly Fundamentals • A single seller with no “close” substitutes. • Barriers to entry. • Sets output at MR=MC. • Prices output based on demand. • Will be allocatively inefficient as P>MC. • Will likely be productively inefficient. • Also suffers from “social waste” and “X-inefficiency.” • Price controls can promote efficient outcomes.

16. Regulating Monopoly • Do regulations work? • Inflating the cost structure (X-inefficiency). • The “capture” hypothesis. • Antitrust legislation may promote inefficiency. • Regulating a natural monopoly . . .

17. P Pm ATC MC D Q Qm MR Natural Monopoly • Experiences economies of scale: --Profit max. rule is still the same. --Price off of demand.--May earn positive economic profit in LR. How do you regulate?At P=MC, firm has negative econ. profit. P*? Q*?

18. --We can set the price equal to the MC. P Pm --Or, we can set the price equal to the ATC. ATC MC D Q Qm MR Natural Monopoly … and give the monopoly a subsidy equal to its losses! P*? … and the firm can earn zero econ profits, but is alloc. inefficient. Q*?

19. Monopoly - Price Discrimination • When different people/customers are charged different prices when costs are equal. • When different people/customers are charged the same price when costs are different.

20. Monopoly - Price Discrimination • 3rd degree price discrimination (method #2) • when a firm segments the market by elasticity. • more elastic = lower price; less elastic = higher price • 1st degree price discrimination (perfect p.d.) • when a firm can charge each individual the max. they are willing to pay. • 2nd degree price discrimination (method #1) • when a firm uses volume discounts to vary the price.

21. Price Pmax MC Pmin D=MR Q Q* Monopoly - Price Discrimination If the firm is collecting different prices from each customer, to sell one more unit, it need only lower the price for that unit, not for all. • Perfect price discrimination This only works if: --you prevent resale. --you can easily separate customers.

22. Monopoly - Segmented markets • Day/night billing . . . phone/electric • Matinee/evening . . . theater • Senior menu . . . restaurant • Ladies night . . . bar • Student price . . . restaurant/other • Coupons & club cards . . . grocery Is it easy to separate customers? Can resale be prevented?

23. P D Q MR Monopoly - A Single Seller Microeconomics - Dr. D. Foster