## Presentation on theme: "McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved."— Presentation transcript:

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

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

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

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

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

Profit Maximizing Level of 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 If MR > MC, The monopoly can increase profit by increasing output If MR < MC, The monopoly can increase profit by decreasing its output 15-7

Monopolistic Profit Maximization Table
The profit- maximizing condition is: MR = MR Q P (\$) TR (\$) MR (\$) TC (\$) MC (\$) ATC (\$) Profit (\$) 36 33 27 21 15 9 3 -3 -9 -15 47 1 2 4 8 16 54 40 56 80 --- -47 48 48.00 30 60 50 25.00 10 81 18.00 24 96 62 15.50 34 5 105 78 15.60 6 18 108 102 17.00 7 142 20.29 -37 12 198 24.75 -102 278 30.89 -197 If MC < MR, increase production Profit maximizing quantity is where MC = MR If MC > MR, decrease production 15-8

Monopolistic Profit Maximization Graph
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 P MC D at Qprofit max P = \$24 Find output where MC = MR, this is the profit maximizing Q MC = MR Find how much consumers will pay where the profit max Q intersects demand, this is the monopolist price D MR Q 4 = Qprofit max 15-9

Monopoly Compared to Perfect Competition Graph
In a monopoly, P>MR, In perfect competition, P=MR=D MR=MC is the profit max rule for both P MC First find the monopoly Q and P PM PPC Then find the perfectly competitive Q and P DPC= MRPC DM Outcome: Monopoly output is lower and price is higher than perfect competition MRM Q QM QPC 15-10

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

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

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

The Welfare Loss from a Monopoly
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 P MC PM C D PPC B D A MR Q QM QPC 15-14

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

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

Barriers to Entry 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 Government-Created Monopolies Patents, licenses, and franchises If there were no barriers to entry, profit-maximizing firms would always compete away monopoly profits 15-17

A Natural Monopoly Graph
Average Cost One firm producing Q1 has average cost C1 If two firms share the market, each produces Q0.5 and has average cost C0.5 If three firms share the market, each produces Q0.33 has average cost C0.33 C0.33 C0.5 C1 ATC Q Q0.33 Q0.5 Q1 15-18

A Natural Monopoly Graph, Profit and Regulation
A natural monopolist produces QM and charges PM, therefore earning a profit Average Cost If there is government regulation and a competitive solution where P = MC is required, the monopolist produces QC and charges PC, therefore earning a loss PM Profits CM CC ATC Losses PC MR MC D Q QM QC 15-19

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

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. 15-21

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

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

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

Preview of Chapter 16: Monopolistic Competition and Oligopoly
List the four distinguishing characteristics of monopolistic competition Demonstrate graphically the equilibrium of a monopolistic competitor State the central element of oligopoly 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