Monopolies

Dr. Katherine Sauer Principles of Microeconomics ECO 2020

Overview: I. The Firms Marginal Revenue and Demand II. The Firms Output and Price III. The Firms Profits: Graphically IV. Efficiency V. Price Discrimination

Recall the characteristics of a monopoly market: one firm unique product complete barriers to entry Monopolies exist because of barriers to entry. - control the resource - government license - natural monopoly A monopoly is a price setter. That is, the firm can determine what price to charge. - charge according to demand

I. The Firms Marginal Revenue and Demand TR = P x Q AR = P MR = change in TR change in Q MR P

The demand curve for a monopoly firm is downward sloping because it is the market demand curve. - the monopoly is the only firm therefore the market demand is the same as the firm demand

The marginal revenue curve is also downward sloping. - for linear demand, marginal revenue is twice as steep Ex: demand: marginal revenue: P = 100 1/3Q MR = 100 2/3Q

demand: P = 50 Q marginal revenue: MR = 50 2Q

D MR Q

II. The Firms Level of Output and Price We learned previously that the firm will produce the level of output where marginal revenue is equal to marginal cost. P Graphically:
MC

D MR Q*

Since a monopolist is a price setter, it can charge a price as high as demand will allow.

P MC P*

D MR Q*

Notice that for a monopolist, at Q*, the price is higher than marginal cost and marginal revenue. - monopolist is not allocatively efficient
P MC P*

P = MR = MC D MR Q*

Algebraically: The Whatsa Widget Company has a monopoly in the sale of widgets. Here is the firms demand and total cost: Output 0 1 2 3 4 5 Price 15 14 13 12 11 10 TR 0 14 26 36 44 50 TC 8 11 16 26 39 57 MR --14 12 10 8 6 MC --3 5 10 13 18 Profit -8 3 10 10 5 7

This firm will produce 3 units of output. This firm will charge $12 per unit.

III. The Firms Profits Graphically Because a monopoly IS the entire market, we rarely need to worry about the shut down point. We will instead focus on the ATC and profits. if P > ATC, then profits if P = ATC, then break even if P < ATC, then loss A monopoly firm will compare P to ATC at the profit maximizing level of output to determine its profits. - at the quantity where MR = MC, compare the price to the ATC

A. At Q*, P > ATC

P profits MC

P* ATC* ATC

(P ATC)Q > 0
D MR Q* Q

B. At Q*, P = ATC
P

There is no profit area to illustrate because profits are equal to zero.

MC ATC

ATC* =

P*

(P ATC)Q = 0
D MR Q* Q

C. At Q*, P < ATC

P loss ATC* MC ATC

P*

(P ATC)Q < 0
D MR Q* Q

Recap: 1) Produce the level of output where MR = MC. 2) Charge the price according to the demand curve at Q*. 3) Compare the price to the ATC at Q* to determine profits or losses.

IV. Efficiency A monopoly firm may or may not be productively efficient. (producing at minimum of ATC) A monopoly firm is never allocatively efficient P > MC always

Monopoly Market vs Competitive Market Monopoly markets result in some deadweight loss. The demand curve represents the value that buyers place on each additional unit of a good or service. The marginal cost curve represents the additional cost of producing each unit of a good or service. The socially efficient quantity of output is found where the demand curve and the marginal cost curve intersect. This is where total surplus is maximized.

DWL MC

A monopoly market results in a lower quantity and higher price than a competitive market would have. Because the quantity is lower and the price is higher, there is deadweight loss. Total surplus is not at its maximum.

P*
Psocially optimal

D MR Q*

Qsocially optimal

Remember, there are some benefits to monopolies: - although patents create monopolies, the patent system encourages innovation - the costs of production may make a single producer more efficient due to economies of scale

V. Price Discrimination We know that people have different price elasticities of demand. We also know that a firms revenues depend on elasticity of demand. - a firm can charge a higher price to someone with an inelastic demand - to get someone with elastic demand to purchase the item, a firm would charge a lower price

price discrimination: the business practice of selling the same good at different prices to different customers - based on their price elasticity of demand

Examples Movie tickets: matinees and evening shows are different prices

Student /Senior Citizen discounts: show your ID and get a discount

Coupons: if you have a coupon, the item is cheaper

Business travel vs leisure travel: travel from a Tuesday to Thursday is more expensive than from a Friday to Sunday

Quantity discount: buy more and get a price break

In order to be able to price discriminate, a firm must: 1) have the ability to set its price 2) be able to group consumers by their willingness to pay 3) be able to keep the markets separate (prevent arbitrage) Price discrimination results in higher profits for the firm because more output is sold and consumer surplus is reduced. - lower the price in the elastic market gain sales - raise the price in the inelastic market lose few sales Some consumers are also better off.

Student Demand for Movie Tickets

P P

Professor Demand for Movie Tickets

P* P* MC D MR Q* Q Q* D MR Q MC