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CHAPTER 13 Monopoly. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which.

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Presentation on theme: "CHAPTER 13 Monopoly. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which."— Presentation transcript:

1 CHAPTER 13 Monopoly

2 TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which it arises. Distinguish between price-discriminating monopoly and single-price monopoly Explain how a single-price monopoly determines its price and output

3 TM 13-3 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit Compare the performance and efficiency of competition and monopoly Define rent seeking and explain why it arises

4 TM 13-4 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which it arises. Distinguish between price-discriminating monopoly and single-price monopoly Explain how a single-price monopoly determines its price and output

5 TM 13-5 Copyright © 1998 Addison Wesley Longman, Inc. How Monopoly Arises A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.

6 TM 13-6 Copyright © 1998 Addison Wesley Longman, Inc. How Monopoly Arises No Close Substitutes If a good has close substitutes, it faces competition from the producer of the substitute. Barriers to Entry Barriers to entry are legal or natural constraints that protect a firm from potential competitors.

7 TM 13-7 Copyright © 1998 Addison Wesley Longman, Inc. Barriers to Entry Legal Barriers to Entry In a legal monopoly competition and entry is restricted by the granting of a public franchise, government license, patent, or copyright.

8 TM 13-8 Copyright © 1998 Addison Wesley Longman, Inc. Barriers to Entry Natural Barriers to Entry A natural monopoly results from a situation in which one firm can supply the entire market at a lower price than two or more firms can. Example: Electric utility

9 TM 13-9 Copyright © 1998 Addison Wesley Longman, Inc. 5 10 15 Natural Monopoly 01234 D Quantity (millions of kilowatt-hours) Price (cents per kilowatt-hour)

10 TM 13-10 Copyright © 1998 Addison Wesley Longman, Inc. Quantity (millions of kilowatt-hours) 5 10 15 Natural Monopoly 01234 D ATC Price (cents per kilowatt-hour)

11 TM 13-11 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which it arises. Distinguish between price-discriminating monopoly and single-price monopoly Explain how a single-price monopoly determines its price and output

12 TM 13-12 Copyright © 1998 Addison Wesley Longman, Inc. Monopoly Price- Setting Strategies Price discrimination is the practice of selling different units of a good or service for different prices. (ex. pizza, airlines) A single-price monopoly is a firm that must sell each unit of its output for the same price. (ex. DeBeers)

13 TM 13-13 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which it arises. Distinguish between price-discriminating monopoly and single-price monopoly Explain how a single-price monopoly determines its price and output

14 TM 13-14 Copyright © 1998 Addison Wesley Longman, Inc. Single-Price Monopoly The firm’s demand curve is the market demand curve. Marginal revenue is not the same as the market price.

15 TM 13-15 Copyright © 1998 Addison Wesley Longman, Inc. Single-Price Monopoly Bobbie’s Barbershop, in Cairo, Nebraska is the sole supplier of haircuts in town. Let’s examine the market for haircuts in Cairo.

16 TM 13-16 Copyright © 1998 Addison Wesley Longman, Inc. Demand and Marginal Revenue QuantityMarginal PricedemandedTotalrevenue (P)(Q)revenue (dollars per(haircuts (TR=P  Q) (dollars per haircut)per hour) (dollarsadditional haircut) a200 b181 c162 d143 e124 f105

17 TM 13-17 Copyright © 1998 Addison Wesley Longman, Inc. QuantityMarginal PricedemandedTotalrevenue (P)(Q)revenue (dollars per(haircuts (TR=P  Q) (dollars per haircut)per hour) (dollarsadditional haircut) a2000 b18118 c16232 d14342 e12448 f10550 Demand and Marginal Revenue

18 TM 13-18 Copyright © 1998 Addison Wesley Longman, Inc. QuantityMarginal PricedemandedTotalrevenue (P)(Q)revenue (dollars per(haircuts (TR=P  Q) (dollars per haircut)per hour) (dollarsadditional haircut) a2000 b18118 c16232 d14342 e12448 f10550 18 14 10 6 2 Demand and Marginal Revenue

19 TM 13-19 Copyright © 1998 Addison Wesley Longman, Inc. Demand and Marginal Revenue Quantity (haircuts per hour) Price & marginal revenue (dollars per haircut)

20 TM 13-20 Copyright © 1998 Addison Wesley Longman, Inc. Demand and Marginal Revenue Quantity (haircuts per hour) Price & marginal revenue (dollars per haircut) DMR

21 TM 13-21 Copyright © 1998 Addison Wesley Longman, Inc. Demand and Marginal Revenue 10 20 16 14 DMR c d Total revenue loss $4 Total revenue gain $14 Marginal revenue $10 2 3 Quantity (haircuts per hour) Price & marginal revenue (dollars per haircut)

22 TM 13-22 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good.

23 TM 13-23 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity 5 0 –10 10 20 10 – 20 Demand and Marginal revenue curves Quantity (haircuts per hour) Price $ marginal revenue (dollars per haircut)

24 TM 13-24 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity D 5 0 10 20 10 Demand and Marginal revenue curves Quantity (haircuts per hour) Price $ marginal revenue (dollars per haircut) –10 – 20

25 TM 13-25 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity D MR 5 0 10 20 10 Demand and Marginal revenue curves Quantity (haircuts per hour) Price $ marginal revenue (dollars per haircut) –10 – 20

26 TM 13-26 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity D Elastic Unit elastic Inelastic MR 5 0 10 20 10 Demand and Marginal revenue curves Quantity (haircuts per hour) Price $ marginal revenue (dollars per haircut) –10 – 20

27 TM 13-27 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity 0 10 20 510 D MR Elastic Unit elastic Inelastic Maximum total revenue Quantity (haircuts per hour) Demand and Marginal revenue curves d f Price $ marginal revenue (dollars per haircut) –10 – 20

28 TM 13-28 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity 0 5 10 20 30 40 50 Total revenue curve Quantity (haircuts per hour) Total revenue (dollars per hour)

29 TM 13-29 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity 0 5 10 20 30 40 50 Total revenue curve Quantity (haircuts per hour) Total revenue (dollars per hour)

30 TM 13-30 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity 010 20 30 40 50 Total revenue curve TR Zero marginal revenue Quantity (haircuts per hour) 5 Total revenue (dollars per hour)

31 TM 13-31 Copyright © 1998 Addison Wesley Longman, Inc. Marginal Revenue and Elasticity Profit maximizing monopolies will never produce at an output in the inelastic range of its demand curve. It could charge a higher price, produce a smaller quantity, and earn a larger profit.

32 TM 13-32 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 200 181 162 143 124 105

33 TM 13-33 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 2000 18118 16232 14342 12448 10550

34 TM 13-34 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 2000 18118 16232 14342 12448 10550 18 14 10 6 2

35 TM 13-35 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 200020 1811821 1623224 1434230 1244840 1055055 18 14 10 6 2

36 TM 13-36 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 200020 1811821 1623224 1434230 1244840 1055055 18 14 10 6 2 1 3 6 10 15

37 TM 13-37 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price Decision Marginal PriceQuantityTotalrevenueTotalcost (P)demandedrevenuecostProfit (dollars (Q)(TR = P  Q) (dollars per (TC) (dollars per (TR – TC) per haircut)(haircuts/hour)(dollars)add. haircut)(dollars)add. haircut)(dollars) 200020-20 1811821-3 1623224+8 1434230+12 1244840+8 1055055-5 18 14 10 6 2 1 3 6 10 15

38 TM 13-38 Copyright © 1998 Addison Wesley Longman, Inc. 01234 5 10 20 30 40 50 Quantity (haircuts per hour) Total revenue and total cost (dollars per hour) A Monopoly’s Output and Price

39 TM 13-39 Copyright © 1998 Addison Wesley Longman, Inc. 01234 5 10 20 30 40 50 Quantity (haircuts per hour) Total revenue and total cost (dollars per hour) A Monopoly’s Output and Price TR

40 TM 13-40 Copyright © 1998 Addison Wesley Longman, Inc. 01234 5 10 20 30 40 50 Total revenue and total cost (dollars per hour) A Monopoly’s Output and Price TR Quantity (haircuts per hour) TC

41 TM 13-41 Copyright © 1998 Addison Wesley Longman, Inc. 01234 5 10 20 30 50 Total revenue and total cost (dollars per hour) A Monopoly’s Output and Price TR Quantity (haircuts per hour) Economic profit = $12 TC 42

42 TM 13-42 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price 01234 5 10 14 20 Quantity (haircuts per hour) Price and cost (dollars per hour)

43 TM 13-43 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price 01234 5 10 14 20 Quantity (haircuts per hour) Price and cost (dollars per hour) D MR

44 TM 13-44 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price 01234 5 10 14 20 Quantity (haircuts per hour) Price and cost (dollars per hour) D MC MR

45 TM 13-45 Copyright © 1998 Addison Wesley Longman, Inc. A Monopoly’s Output and Price 01234 5 10 14 20 Quantity (haircuts per hour) Price and cost (dollars per hour) D ATC MC MR Economic profit $12 Profit = $12 ($4 x 3 units)

46 TM 13-46 Copyright © 1998 Addison Wesley Longman, Inc. Price and Output Decision The competitive firm is a price taker, whereas the monopoly influences its price. For the monopoly, price exceeds marginal revenue, thus price exceeds marginal cost. Profit is maximized where MC = MR Monopolists can earn economic profits--firms cannot enter due to barriers to entry.

47 TM 13-47 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit Compare the performance and efficiency of competition and monopoly Define rent seeking and explain why it arises

48 TM 13-48 Copyright © 1998 Addison Wesley Longman, Inc. Price Discrimination Price discrimination usually equals bigger profits Monopolists attempt to find ways of discriminating among groups inelastic demand = higher price elastic demand = lower price How do these firms make a profit?

49 TM 13-49 Copyright © 1998 Addison Wesley Longman, Inc. Price Discrimination Consumer surplus Price discrimination attempts to capture the consumer surplus for the monopoly.

50 TM 13-50 Copyright © 1998 Addison Wesley Longman, Inc. Price Discrimination Discriminating Among Units of a Good Charging buyers different prices on each good bought (ex. bulk buying discounts) Discriminating Among Individuals Some people value additional units differently (ex. pizza)

51 TM 13-51 Copyright © 1998 Addison Wesley Longman, Inc. Price Discrimination Discriminating Between Groups Charging different prices to different groups based upon their price elasticity (ex. air fares) Let’s look at how price discrimination, when used by a monopoly, can lead to higher profits — Global Air.

52 TM 13-52 Copyright © 1998 Addison Wesley Longman, Inc. $5 mil. A Single Price of Air Travel Quantity (thousands of trips per year) Price (dollars/ trip) 51015 All travelers Business travelers Vacation travelers 500 2,000 0 1,000 1,500 2,500 Price (dollars/ trip) D MC MR $2 mil. Quantity (thousands of trips per year) 041015 500 2,000 1,000 1,500 2,500 DvDv MC $3 mil. Quantity (thousands of trips per year) 061015 Price (dollars/ trip) 500 2,000 1,000 1,500 2,500 DBDB MC

53 TM 13-53 Copyright © 1998 Addison Wesley Longman, Inc. Price Discrimination Quantity (thous. of trips per year ) $2 mil. 0 410 500 2,000 1,000 DvDv MC $3 mil. Quantity (thous. of trips per year) 0 610 Price (dollars/ trip) 500 2,000 1,000 1,500 2,500 MC Price (dollars/ trip) DBDB Business TravelersVacation Travelers 1,500

54 TM 13-54 Copyright © 1998 Addison Wesley Longman, Inc. $3.5 mil. Price Discrimination Quantity (thous. of trips per year ) $2.45 mil. 0 410 DvDv MC Quantity (thous. of trips per year) 0 610 Price (dollars/ trip) 500 2,000 1,000 1,500 2,500 DBDB MC Price (dollars/ trip) MR B 1,700 57 1,350 MR v Decrease in quantity demanded Increase in quantity demanded Business TravelersVacation Travelers 500 2,000 1,000 1,500

55 TM 13-55 Copyright © 1998 Addison Wesley Longman, Inc. More Perfect Price Discrimination Global becomes creative Places restrictions on discounts further targeting the vacationers This lowers their fare even more Creates some frills and priority reservations targeting the business travelers This allows them to charge more

56 TM 13-56 Copyright © 1998 Addison Wesley Longman, Inc. Perfect Price Discrimination Quantity (thous. of trips per year) 0 610 Price (dollars/ trip) 500 2,000 1,000 1,500 2,500 DBDB MC Price (dollars/ trip) 3 Business Travelers 0 410 DvDv Vacation Travelers 500 2,000 1,000 1,500 Quantity (thous. of trips per year ) MC 14 Profit from business travel with perfect price discrimination Profit from vacation travel with perfect price discrimination

57 TM 13-57 Copyright © 1998 Addison Wesley Longman, Inc. Limits to Price Discrimination Can only be used if the goods cannot be resold. The monopoly must be able to identify groups with different elasticities of demand.

58 TM 13-58 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit Compare the performance and efficiency of competition and monopoly Define rent seeking and explain why it arises

59 TM 13-59 Copyright © 1998 Addison Wesley Longman, Inc. Monopoly and Competition Compared Price Quantity PAPA PMPM PCPC 0 DMR S,MC QMQM QCQC Single-price monopoly restricts output, raises price Equilibrium in competitive industry

60 TM 13-60 Copyright © 1998 Addison Wesley Longman, Inc. Inefficiency of Monopoly Price Quantity PAPA 0 D QCQC PCPC S Perfect Competition Consumer surplus

61 TM 13-61 Copyright © 1998 Addison Wesley Longman, Inc. Inefficiency of Monopoly Price Quantity PAPA PMPM 0 DMR MC QMQM QCQC PCPC Consumer surplus Monopoly’s gain Deadweight loss Monopoly

62 TM 13-62 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit Compare the performance and efficiency of competition and monopoly Define rent seeking and explain why it arises

63 TM 13-63 Copyright © 1998 Addison Wesley Longman, Inc. Rent Seeking Because a monopoly creates economic profit in the long-run, people devote a lot of effort to obtain monopoly rights. This activity is called rent seeking. The firm is attempting to capture some of the consumer surplus for itself.

64 TM 13-64 Copyright © 1998 Addison Wesley Longman, Inc. Rent Seeking They attempt to do so by: Buying a monopoly (ex. taxis) does not ensure an economic profit Creating a monopoly (ex. lobbying) very costly

65 TM 13-65 Copyright © 1998 Addison Wesley Longman, Inc. Gains from Monopoly Economies of Scale and Scope Lowers average total cost and a greater range of goods produced Incentives to Innovate The attempt to apply knew knowledge in the production process and obtain a patent

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