More Monopoly

1. More Monopoly Here I show some ideas the author of the text presents

2. $ Special MC MC Q Marginal cost is assumed to be zero before the stadium capacity is reached and then at that point the marginal cost becomes vertical. (Recall that a MC curve is like a supply curve.

3. $ Special MC MC PM D Q QM MR Even though we have a special case the monopoly firm will still want to have the level of output where MR = MC. The price that will be charged in this case is the price on the demand curve at this level of output.

4. $ Compare Monopoly to Competition MC PM D PC Q QM QC MR Because MC is really like a supply curve if the market was more like competition we would see price PC, which is lower than PM, and a higher level of output (Qc instead of QM).

5. Problems of monopoly The problems of monopoly are higher price and less output than in competition. Moreover, 1) The higher price means those who still buy have less money to spend on other things. 2) Those who no longer buy must be worse off because they get less than what they were at their liberty to purchase under competition.

6. Let’s remember back to my pizza story. We had an oven cost and costs for ingredients, electricity and labor. The marginal cost did not incorporate the fixed cost because by their very nature fixed costs do not change with changes in the level of output. We see the monopoly firm make its price and output decision based on marginal cost and marginal revenue. So, the decision about where to operate and how much to charge ignores fixed cost. Can this be? Yes, except in the one case where the firm can never overcome the fixed cost and therefore it should never produce anything! Let’s apply this story to sports, shall we?

7. When a sports team signs a free agent to a big contract, the contract is really part of fixed cost. Hopefully you can see this because no matter how many games the player plays in the player will get paid the same amount (except for incentive parts of the contract which we will not worry about for now). The amount of money paid to the player does not change with the level of output. In this regard signing a free agent should not, from a cost point of view, change the price the team charges or the level of output it provides. But, when the team signs a free agent the demand for the product may rise. If this happens the MR is also likely to rise and thus the firm will charge a higher price to see the game. We see this in the graph on the next slide.

8. $ MC PM D Q QM MR The thinking is that when a free agent is signed the demand for the teams product increases and this raises the MR as well. With a fixed MC this may mean the team will charge more for tickets.

9. So, while many say the ticket price goes up when a free agent is signed because it costs more to run the team, the economic logic suggests the reason the ticket price goes up is a demand side phenomenon! The free agent generates a buzz on the demand side and thus the firm capitalizes on the buzz on the demand side. Let’s note the higher free agent contract in itself does mean the cost goes up for the firm, but cost changing may not mean consumers will pay more. Moreover, since it is a fixed cost change it does not change the MC for the firm and its original intention does not change because the MC has not changed!