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Monopoly 15 Monopoly Monopoly is business at the end of its journey. — Henry Demarest Lloyd CHAPTER 15 Copyright © 2010 by the McGraw-Hill Companies, Inc.

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Presentation on theme: "Monopoly 15 Monopoly Monopoly is business at the end of its journey. — Henry Demarest Lloyd CHAPTER 15 Copyright © 2010 by the McGraw-Hill Companies, Inc."— Presentation transcript:

1 Monopoly 15 Monopoly Monopoly is business at the end of its journey. — Henry Demarest Lloyd CHAPTER 15 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2 Monopoly 15 Chapter Goals Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms Determine a monopolist’s price, output, and profit graphically and numerically Explain why MR = MC maximizes total profit for a monopolist 15-2

3 Monopoly 15 Chapter Goals Show graphically the welfare loss from monopoly Explain why a price-discriminating monopolist will earn more profit than a normal monopolist Explain why there would be no monopoly without barriers to entry Discuss three normative arguments against monopoly 15-3

4 Monopoly 15 A Monopolistic Market Barriers to entry into the market prevent competition Monopoly is a market structure in which one firm makes up the entire market There are no close substitutes for the monopolist’s product Barriers to entry can be: Legal Sociological Natural Technological 15-4

5 Monopoly 15 The Key Difference Between a Monopolist and a Perfect Competitor A monopolistic firm’s marginal revenue is not its price Marginal revenue is always below its price Marginal revenue changes as output changes and is not equal to the price A monopolistic firm’s output decision can affect price There is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit 15-5

6 Monopoly 15 Profit Maximizing Level of Output Marginal revenue (MR) is the change in total revenue associated with a change in quantity The monopoly maximizes profit when marginal revenue equals marginal cost The goal of the monopolistic firm is to maximize profits, the difference between total revenue and total cost Marginal cost (MC) is the change in total cost associated with a change in quantity 15-6

7 Monopoly 15 Profit Maximizing Level of Output If MR < MC, The monopoly can increase profit by decreasing its output If MR > MC, The monopoly can increase profit by increasing output The profit-maximizing condition of a monopolistic firm is: MR = MC For a monopolistic firm, MR < P A monopolistic firm maximizes total profit, not profit per unit 15-7

8 Monopoly 15 Monopolistic Profit Maximization Table QP ($)TR ($)MR ($)TC ($)MC ($)ATC ($)Profit ($) If MC < MR, increase production Profit maximizing quantity is where MC = MR If MC > MR, decrease production The profit- maximizing condition is: MR = MR 15-8

9 Monopoly 15 Monopolistic Profit Maximization Graph MC Q P Find output where MC = MR, this is the profit maximizing Q D MC = MR 4 = Q profit max D at Q profit max P = $24 Marginal revenue is not constant as Q increases because: revenue increases as the monopolist sells more revenue decreases because the monopolist must lower the price to sell more Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MR 15-9

10 Monopoly 15 Monopoly Compared to Perfect Competition Graph MC Q P DMDM QMQM PMPM Outcome: Monopoly output is lower and price is higher than perfect competition MR M In a monopoly, P>MR, In perfect competition, P=MR=D MR=MC is the profit max rule for both P PC Q PC First find the monopoly Q and P Then find the perfectly competitive Q and P D PC = MR PC 15-10

11 Monopoly 15 Profits Determining Profits Graphically: A Firm with Profit Q P ATC Q profit max P ATC Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects ATC Since P>ATC at the profit maximizing quantity, this firm is earning profits Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MC D MC = MR D at Q profit max MR ATC at Q profit max 15-11

12 Monopoly 15 Determining Profits Graphically: A Firm with Zero Profit or Losses Q P ATC Q profit max P =ATC Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects ATC Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MC D MC = MR D at Q profit max MR ATC at Q profit max Since P=ATC at the profit maximizing quantity, this firm is earning zero profit or loss 15-12

13 Monopoly 15 Losses Determining Profits Graphically: A Firm with Losses Q P ATC Q profit max P ATC Find output where MC = MR, this is the profit maximizing Q Find profit per unit where the profit max Q intersects ATC Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price MC D MC = MR D at Q profit max MR ATC at Q profit max Since P

14 Monopoly 15 The Welfare Loss from a Monopoly MC Q P D QMQM PMPM The welfare loss from a monopoly is represented by the triangles B and D The rectangle C is a transfer of surplus from the consumer to the monopolist The area A represents the opportunity cost of diverted resources, which is not a loss to society MR P PC Q PC A B D C 15-14

15 Monopoly 15 The Price-Discriminating Monopolist When a monopolist price discriminates, it charges different prices to different individuals or groups of individuals Consumers with less elastic demands are charged higher prices. Consumers with more elastic demands are charged lower prices Price discrimination increases output and profits 15-15

16 Monopoly 15 The Price-Discriminating Monopolist Examples of price discrimination Movie discounts to senior citizens and children Airline discounts for Saturday-night stay overs Cars are seldom sold at list price Tracking consumer information and pricing accordingly These markets are highly susceptible to price discrimination because the market demand is made up of distinguishable individuals who have different demand elasticites 15-16

17 Monopoly 15 Barriers to Entry If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits Government-Created Monopolies Patents, licenses, and franchises Natural Ability A firm is better at producing the good than anyone else Economies of Scale Natural monopoly is when a single firm can produce at a lower cost than can two or more firms 15-17

18 Monopoly 15 A Natural Monopoly Graph Q Average Cost Q 0.5 C1C1 Q1Q1 Q 0.33 C 0.5 C 0.33 ATC One firm producing Q 1 has average cost C 1 If two firms share the market, each produces Q 0.5 and has average cost C 0.5 If three firms share the market, each produces Q 0.33 has average cost C

19 Monopoly 15 A Natural Monopoly Graph, Profit and Regulation Q Average Cost C QCQC QMQM CMCM ATC A natural monopolist produces Q M and charges P M, therefore earning a profit If there is government regulation and a competitive solution where P = MC is required, the monopolist produces Q C and charges P C, therefore earning a loss D MR MC PMPM PCPC Profits Losses 15-19

20 Monopoly 15 Normative Views of Monopoly Monopolies cause potential monopolists to waste resources trying to get monopolies Rent-seeking activities Monopolies are unjust because they restrict freedom to enter business Monopolies transfer income from “deserving” consumers to “undeserving” monopolists 15-20

21 Monopoly 15 Government Policy and Monopoly: AIDS Drugs A few companies have patents for AIDS drugs that enable them to charge high prices because demand is inelastic Policy Options Government regulation where price = marginal cost benefits society, but discourages research Government purchase of the patents and allowing anyone to produce the drugs so their price = marginal cost. This is expensive for taxpayers

22 Monopoly 15 Chapter Summary Monopoly is a market structure, protected by barriers to entry, in which a single firm produces a product for which there are no close substitutes A monopolist maximizes profit or minimizes losses where MR=MC To determine a monopolist’s profit or loss: Find output where MR=MC Determine price and ATC at that output Profit or loss = (P – ATC) * Q 15-22

23 Monopoly 15 Chapter Summary Monopoly output is lower and price is higher than in competitive markets Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demand 15-23

24 Monopoly 15 Chapter Summary Natural monopolies exist in industries with strong economies of scale, so it is more efficient for one firm to produce the entire output In a natural monopoly the competitive outcome where P=MC results in losses Normative arguments against monopoly are: Monopolies are inconsistent with freedom Distributional effects of monopoly are unfair Monopolies encourage people to waste time and money trying to get monopolies 15-24

25 Monopoly 15 Preview of Chapter 16: Monopolistic Competition and Oligopoly List the four distinguishing characteristics of monopolistic competition State the central element of oligopoly Demonstrate graphically the equilibrium of a monopolistic competitor Explain why decisions in the cartel model depend on market share and decisions in the contestable market model depend on barriers to entry Describe two empirical methods of determining market structure 15-25


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