Topic 11 Monopoly

11/30/2020
N. GREGORY MANKIW NINTH EDITION
PRINCIPLES OF The Big Picture

 Chapter 13: The cost of production
 Now, we will look at firm's revenue
 But revenue depends on market structure
1. Competitive market (chapter 14)
CHAPTER 2. Monopoly (this chapter)
Monopoly
15
3. Monopolistic Competition (chapter 16)
4. Oligopoly (chapter 17)
 Are there other types of markets? Yes, see more
Interactive PowerPoint Slides by:
V. Andreea Chiritescu advance courses in IO and firm competition
Modified by Joseph Tao-yi Wang Eastern Illinois University
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1 2020/11/30 Monopoly Joseph Tao-yi Wang
IN THIS CHAPTER Why Monopolies Arise

• Why do monopolies arise? • Monopoly
• Why is MR < P for a monopolist? – A firm that is the sole seller of a product
• How do monopolies choose their P and Q? without close substitutes
• How do monopolies affect society’s well- – Has market power
being? • The ability to influence the market price of the
• What can the government do about product it sells: “price maker”
monopolies? – Arise due to barriers to entry
• What is price discrimination? • Other firms cannot enter the market to
compete with it
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Three Barriers to Entry – 1 Three Barriers to Entry – 2

1. Monopoly resources 3. The production process: natural
– A single firm owns a key resource. monopoly
• Single water provider in town – A single firm can produce the entire
• DeBeers - owns most of the world’s market Q at lower cost than could several
diamond mines firms
2. Government regulation – Arises when there are economies of
– The government gives a single firm the scale over the relevant range of output
exclusive right to produce the good. – Distribution of water, electricity, etc.
• Patent and copyright laws, rice wine
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EXAMPLE 1: Natural Monopoly Monopoly versus Competition

You live in a small town where 1,000 homes • Competitive firm
need electricity.
– Price taker
• ATC is lower if one firm services all 1,000 homes
than if two firms each service 500 homes. – Small, one of many
Electricity – Faces individual demand at P: perfectly
Cost
elastic demand
ATC slopes downward due • Monopoly firm
to huge FC and small MC
$80 – Price maker, market power
$50 ATC – Faces the entire market demand:
Q downward sloping demand
500 1000
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Demand Curves: Competitive Firm vs. Monopoly Active Learning 1: Hello Café (桌遊去) Revenue
Hello Café (桌遊去) is Q P TR AR MR
P A competitive firm’s P A monopolist’s
demand curve demand curve the only board game 0 $60
place on NTU campus. 1 55
P = MR The table shows the 2 50
D market demand for 3 45
The market game play. 4 40
demand curve D • Fill in the missing 5 35
Q Q spaces of the table. 6 30
The firm can increase To sell a larger Q, the • What is the relation 7 25
Q without lowering P, firm must reduce P. between P and AR? 8 20
so MR = P for the Thus, MR ≠ P. • Between P and MR? 9 15
competitive firm. 10 10
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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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Active Learning 1: Answers EXAMPLE 2: Hello Café MR and Demand Curve

Q P TR AR MR Q P MR P, MR
• P = AR, $60
0 $60 $0 n/a 0 $60
same as for a 55 55 50
1 55 55 55 1 55 Demand curve (P)
competitive firm. 45 45 40
2 50 100 50 2 50
35 35 30
3 45 135 45 3 45
25 25 20
4 40 160 40 4 40
15 15 10
5 35 175 35 5 35
• MR < P, whereas 5 5 0
MR
6 30 180 30 6 30
MR = P for a -5 -5 -10
Q
7 25 175 25 7 25
competitive firm. -15 -15 -20
8 20 160 20 8 20
-25 -25
9 15 135 15 9 15 -30
-35 -35 0 1 2 3 4 5 6 7 8 9 10
10 10 100 10 10 10
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A Monopolist’s Revenue Monopoly Profit Maximization

• Increasing Q has two effects on revenue: • Produce Q where MR = MC
– Output effect: higher output raises revenue • Sets the highest price consumers are
– Price effect: lower price reduces revenue willing to pay for that quantity
• Marginal revenue, MR < P • Finds this price on the D curve
– To sell a larger Q, the monopolist must • P > MR = MC
reduce the price on all the units it sells • If P > ATC, the monopoly earns a profit
– Is negative if price effect > output effect
• e.g., when Hello Café increases Q from 6 to 7
Li nhuân doanh
nghiêp ôc quyên
(vung vang)
Profit-Maximization for a Monopoly The Monopolist’s Profit

Costs and Costs and
Revenue MC Revenue MC
As with a
At this Q, find P on P P
competitive firm, ATC
the demand curve. the monopolist’s ATC
profit equals
The profit-maximizing D D
(P – ATC) x Q
Q is where MR = MC. MR MR
Q Quantity Q Quantity
Profit-maximizing output
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CASE STUDY: Monopoly vs. Generic Drugs

A Monopoly Does Not Have a S Curve
The market for
• A competitive firm takes P as given Patents on new Price a typical drug
– Has a supply curve that shows how its Q drugs give a temporary
depends on P monopoly to the seller: PM
PM, QM.
• A monopoly firm is a “price-maker”
PC = MC
– Q does not depend on P
D
– Q and P are jointly determined by MC, When the patent
MR
MR, and the demand curve expires, the market
becomes competitive, QM QC
– Hence, no supply curve for monopoly.
generics appear: PC, QC. Quantity
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The Welfare Cost of Monopolies The Deadweight Loss of Monopoly
• Competitive market equilibrium: Price Deadweight

Competitive equilibrium: loss MC
– At P = MC and maximizes total surplus
• quantity = QC
• Monopoly equilibrium: at P > MR = MC PM
• PC = MC PC = MC
– The value to buyers of an additional unit (P) • total surplus is MC
exceeds the cost of the resources needed to maximized
D
produce that unit (MC)
Monopoly equilibrium: MR
– The monopoly Q is too low – could increase
• quantity = QM
total surplus with a larger Q. QM QC Quantity
• PM > MC
– Monopoly results in a deadweight loss
• deadweight loss
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The Monopoly’s Profit: A Social Cost? Price Discrimination

• Monopoly profit is not in itself necessarily • Price discrimination:
a problem for society – Sell the same good at different prices to
– Greater producer surplus for monopoly different buyers
– Smaller consumer surplus – A firm can increase profit by charging a
– Transfer of surplus from consumers to higher price to buyers with higher
monopoly willingness to pay
• The inefficiency: – Requires the ability to separate customers
according to their willingness to pay
– Monopoly produces Q < efficient quantity
– Can raise economic welfare
– Deadweight loss
Active Learning 2: At the Movies Active Learning 2: Answers

You are the manager of the only movie theater in town. A. Single price P = $180, Q = 1,000, TC = $100,000
The price you charge is NT$180 per ticket, and in a Total revenue TR = P × Q = $180,000
given week you sell Q = 1,000 movie tickets. Assume Profit = TR – TC = $80,000
that you incur only a fixed cost of NT$100,000 in a
week. B. Single price P = $50, Q = 2,500, TC = $100,000
A. How much profit is the movie theater making?  Total revenue TR = P × Q = $125,000
B. If you are dropping the price to NT$50, you will be Profit = TR – TC = $25,000
able to sell Q = 2,500 movie tickets. Calculate the C. Price discrimination: P1 = $180 and P2 = $50.
profit. Sell Q = 1,000 at P1, so TR1 = $180,000
C. Suggest a way you can price discriminate when Sell Q = (2,500 – 1,000) at P2, so TR2 = $75,000
selling movie tickets. Calculate the profit if you price Profit = TR1 + TR2 – TC = $155,000
discriminate with P1 = NT$180 and P2 = NT$50.
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Perfect Price Discrimination Welfare With and Without Price Discrimination

Single price monopoly Perfect price discrimination
• Perfect price discrimination
Price Price
– Charge each customer a different price Consumer
surplus Monopoly
• Exactly his or her willingness to pay profit
– Monopoly firm gets the entire surplus PM
Monopoly
(Profit) profit DWL
MC MC
– No deadweight loss
D D
MR MR
QM Q
Quantity Quantity
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Price Discrimination in the Real World EXAMPLE 3: Price Discrimination – 1

A. Movie tickets
• Perfect price discrimination
– Discounts for seniors, students, and people
– Not possible in the real world who can attend during weekday afternoons.
• No firm knows every buyer’s WTP
– Lower WTP than people who pay full price
• Buyers do not reveal it to sellers on Friday night
• Price discrimination B. Airline prices
– Firms divide customers into groups – Discounts for Saturday-night stayovers
based on some observable trait – Business travelers (higher WTP) vs. more
that is likely related to willingness to pay price-sensitive leisure travelers
(WTP), such as age
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EXAMPLE 3: Price Discrimination – 2 EXAMPLE 3: Price Discrimination – 3

C. Discount coupons E. Quantity discounts
– People who have time to clip and organize – A buyer’s WTP often declines with additional
coupons are more likely to have lower units, so firms charge less per unit for large
income and lower WTP than others quantities than small ones.
D. Need-based financial aid – Example: Vieshow Cinemas charges NT$89
– Low income families have lower WTP for for a small popcorn, NT$106 for medium one
their children’s college education that’s twice as big, and NT$115 for a large
– Schools price-discriminate by offering one that’s thrice as big
need-based aid to low income families
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ASK THE EXPERTS

Public Policy Toward Monopolies – 1
Mergers
1. Increasing competition with antitrust laws
“A merger of AT&T and Time Warner would
– Sherman Antitrust Act, 1890 likely increase consumer surplus over the
– Clayton Antitrust Act, 1914 ensuing decade.”
– Prevent mergers
– Break up companies
– Prevent companies from coordinating their
activities to make markets less
competitive
Source: IGM Economic Experts Panel, August 28, 2013, November 8, 2016.
Public Policy Toward Monopolies – 2 Public Policy Toward Monopolies – 3

2. Regulation 3. Public ownership
– Set the monopolists’ price – How the ownership of the firm affects the
– Common in case of natural monopolies costs of production
• MC < ATC at all Q • Example: USPS, Taiwan CPC, TTL
• Marginal-cost pricing would result in losses – Private owners: incentive to min costs
– Regulator might subsidize the monopolist – Public owners (government)
or set P = ATC for zero economic profit • If it does a bad job, losers are the customers
– Problem: no incentive to reduce costs and taxpayers
• Public ownership is usually less efficient since
there is no profit incentive to minimize costs
Public Policy Toward Monopolies – 4 The Prevalence of Monopoly

4. Doing nothing • Pure monopoly – rare in the real world
– Some economists argue that it is often best • Many firms have market power, due to:
for the government not to try to remedy the – Selling a unique variety of a product
inefficiencies of monopoly pricing
– Having a large market share and few
• Determining the proper role of the government
significant competitors
in the economy requires judgments about
politics as well as economics • In many such cases, most of the results
5. Auction Off the Market (Harold Demsetz) from this chapter apply, including:
– Can use revenue to subsidize consumers – Markup of price over marginal cost
• Pigovian Subsidy: Correct for DWL – Deadweight loss
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Competition versus Monopoly ASK THE EXPERTS

Competition Monopoly
Mergers
Similarities
Goal of firms Maximize profits Maximize profits
“If regulators had not approved mergers in the
Rule for maximizing MR = MC MR = MC past decade between major networked
Can earn economic profits in SR? Yes Yes airlines, travelers would be better off today.”
Differences
Number of firms Many One
Marginal revenue MR = P MR < P
Price P = MC P > MC
Produces welfare-maximizing Yes No
level of output?
Entry in the LR? Yes No
Can earn economic profits in LR? No Yes
Price discrimination possible? No Yes Source: IGM Economic Experts Panel, August 28, 2013, November 8, 2016.
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THINK-PAIR-SHARE THINK-PAIR-SHARE
A consumer advocate is discussing the airline
industry on the news. He says, “There are so many A. List some of the ways airlines divide their
rates offered by airlines that it is technically possible customers according to their willingness to pay.
for a 747 to be carrying a full load of passengers B. Is it necessarily inefficient for airlines to charge
where no two of them paid the same price for their different prices to different customers? Why or why
tickets. This is clearly unfair and inefficient.” not?
He continues, “In addition, the profits of the airlines C. Is the increase in profits generated by this type of
have doubled in the last few years since they began price discrimination a social cost? Explain.
this practice, and these additional profits are clearly a
social burden. We need legislation that requires
airlines to charge all passengers on an airplane the
same price for their travel.”
CHAPTER IN A NUTSHELL CHAPTER IN A NUTSHELL

• Monopoly: the sole seller in its market. • Monopoly maximizes profit
• Monopoly arises when: – Produce Q where MR = MC, but Q is not
– A single firm owns a key resource efficient
– The government gives a firm the exclusive right – For this Q, the price is on the demand curve.
to produce a good – So P > MR = MC
– A single firm can supply the entire market at a – Causes deadweight loss
lower cost than many firms could. • Price discrimination: charge different prices for the
• Monopoly faces a downward-sloping demand same good based on a buyer’s willingness to pay.
curve for its product: MR < P – Can raise economic welfare by getting the good
to some consumers who would otherwise not
buy it.
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CHAPTER IN A NUTSHELL
• Perfect price discrimination Chapter 15: Monopoly
– No deadweight loss  MR=MC to maximize profit (still true!)
– Entire surplus goes to the monopoly producer.  But, P > MR (D - downward sloping)
• Policymakers can:  Welfare Cost of a Monopoly:
– Use the antitrust laws to try to make the industry  Profits (unfair?) vs. DWL (efficiency loss!)
more competitive.
 Cures? Do nothing?
– Regulate the prices that the monopoly charges.
 Auction off the market!
– Turn the monopolist into a government-run
enterprise.
 Homework: Mankiw, Ch.15,
– Do nothing at all.
Problem 5-11
– Or, just auction off the market. (Demsetz, 1968)
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Challenge Questions (Past Finals)

 2007 - Part 1 2008 - Essay D
 2009 - Essay A 2018 - Essay B4-B5
 2019 - Essay B9-B10
 True or False. Monopolists can achieve any
level of profit they desire because they have
unlimited market power.
 True or False. Heavy competition among
firms for a limited number of customers
leads to such devices as discounts for
students and senior citizens.
2020/11/30 Monopoly Joseph Tao-yi Wang

Topic 11 Monopoly

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11/30/2020

N. GREGORY MANKIW NINTH EDITION

PRINCIPLES OF The Big Picture

IN THIS CHAPTER Why Monopolies Arise

Three Barriers to Entry – 1 Three Barriers to Entry – 2

EXAMPLE 1: Natural Monopoly Monopoly versus Competition

Active Learning 1: Answers EXAMPLE 2: Hello Café MR and Demand Curve

A Monopolist’s Revenue Monopoly Profit Maximization

Profit-Maximization for a Monopoly The Monopolist’s Profit

CASE STUDY: Monopoly vs. Generic Drugs

The Welfare Cost of Monopolies The Deadweight Loss of Monopoly

• Competitive market equilibrium: Price Deadweight

The Monopoly’s Profit: A Social Cost? Price Discrimination

Active Learning 2: At the Movies Active Learning 2: Answers

Perfect Price Discrimination Welfare With and Without Price Discrimination

Price Discrimination in the Real World EXAMPLE 3: Price Discrimination – 1

EXAMPLE 3: Price Discrimination – 2 EXAMPLE 3: Price Discrimination – 3

ASK THE EXPERTS

Public Policy Toward Monopolies – 2 Public Policy Toward Monopolies – 3

Public Policy Toward Monopolies – 4 The Prevalence of Monopoly

Competition versus Monopoly ASK THE EXPERTS

CHAPTER IN A NUTSHELL CHAPTER IN A NUTSHELL

Challenge Questions (Past Finals)

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