1. Chapter 11
Monopoly

2. Objective How does a monopolist set its price and output?
What is wrong with monopoly?
What are some other pricing strategies a monopolist can use?

3. Causes of a Monopoly Barriers to entry – Legal barriers to entry.
Technical barriers to entry
Diminishing average cost over a broad range of output like a natural monopoly.
Special knowledge of a low-cost method of production.
Ownership of a key resource
Possession of unique managerial talent.
Legal barriers to entry.
Patents and copyrights.
Exclusive franchise or license.

4. Definitions Revenue = price * quantity Profit = Revenue – Costs
TR=pq
Profit = Revenue – Costs
π = TR – C
Marginal revenue= ΔTR/Δq
Change in total revenue from selling an extra unit of output

5. Revenue Analysis for a Monopoly

6. A Monopoly’s Revenue ∆TR/∆Q = MR
Marginal Revenue
∆TR/∆Q = MR
How does MR compare to P in a monopoly market?
To sell an extra unit the monopolist has to lower price.
He sells the extra unit at the new price (thus total revenue rises), but lowers price on all previous units sold (which reduces total revenue)
MR<P

7. A Monopoly’s Revenue
An increase in sales has two effects on total revenue
The output effect—revenue earned on the extra unit
The price effect—revenue lost on previous units.
MR=P + (Δp/Δq)(q) $5 $5 $5 P Q TR MR $5 3 15 $1 $4 4 16 $4 $4 $4 $4
Note that MR<P

8. Total Revenue Total Revenue increases and then decreases. Total
Price
Total Revenue increases and then decreases.
$11 10 9 8 7 6 5 4
Total
Revenue 3 2 1 –1 1 2 3 4 5 6 7 8 9
Quantity –2 –3 –4

9. Marginal Revenue is the slope of the total revenue curve
Marginal revenue is positive (negative) when total revenue is increasing (decreasing)
Marginal revenue is zero when total revenue reaches a maximum
Total
Revenue Q
Marginal
Revenue Q

10. Marginal Revenue Marginal revenue curve Below demand curve
Slope = 2* Slope of demand curve
MR=P + (Δp/Δq) (q)
MR=p-|Δp/Δq|(q)=p(1-1/|ξ|)
ξ = elasticity of demand

11. Marginal revenue and demand
Price
Inverse demand function p= f(q)=A-bq
Price – from any given quantity
Demand function: q = f(p)= (A-p)/b
quantity demanded at each price
MR =
A - 2bq D
p = A - bq a
Quantity
The marginal revenue curve is steeper than the demand curve. With a straight-line demand curve, the slope of the marginal revenue curve is twice the slope of the demand curve

12. Demand and Elasticity Price pMAX |ξ|>1 |ξ|=1 p1 μ |ξ|<1
Quantity demanded: q = A - bp
Quantity

13. Pricing and Quantity Decisions
The Elasticity Rule
The firm will never choose a point on inelastic portion of demand curve
When |ξ|<1, then marginal revenue is negative
Selling an extra unit of output will reduce profit
It increases costs and
decreases revenue

14. Optimal Price and Quantity Results
Profit-maximizing quantity, q*
Increase production if MR>MC
Until MR=MC
Profit-maximizing price, p*
On demand curve, at q*

15. Optimal price and quantityMR MC
The profit-maximizing price and quantity equate marginal cost with marginal revenue ρ p* α q*
Quantity

16. Optimal Price and Quantity Results
# 2: Profit-maximizing price
On the demand curve
At optimal quantity
MR=p(1-1/|ξ|)
p=MR(1-1/|ξ|);
MR=MC
p=MC(1-1/|ξ|)

17. Optimal Price and Quantity Results
Deadweight loss
Dollar measure - Loss to society
Profit maximization results in units not produced where marginal social benefit > marginal social cost
Some of the consumer surplus under perfect competition is transferred to the monopolist.

18. The socially optimal priceD d MR MC
Compared to perfect competition, a monopoly produces less output and charges a higher price b p q f
Quantity

19. Two-Part Tariffs Monopolist charges
A lump sum fee
A unit price
The two part tariff allows the monopoly to
Capture consumer surplus
Earn extra-normal profit
Sell the optimal output level

20. Two-Part Tariffs Assume there are identical consumers in the market
Consumers buy more of the good as its price declines
Each gets the same consumer surplus

21. Two-Part Tariffs Price c
The producer charges each consumer, in addition to the per-unit price, a fixed fee equal to her share of the consumer surplus:
Fee=CS/N MR
Fee e d
Unit Price MC b a
Quantity

22. Two-Part Tariffs and Profit
Price c
The producer earns a higher profit MR e d
Unit Price
Profit MC b a
Quantity

23. Two-Part Tariffs and A Higher Profit
Price
The producer earns a higher profit if he lowers the price to MC and charges a higher fee MR e
Profit
Unit Price MC
Quantity

24. Two-Part Tariffs and Efficiency
Price
The producer is efficient:
He sells the socially optimal amount
Sets a price equals MC MR e
Profit
Unit Price MC
Quantity

25. Two-Part Tariffs when the monopoly realizes a loss
Price MC E AC
A two-part tariff enables the monopolist to earn positive profits q c p
Quantity

26. Problems with uniform Pricing
When consumers are not identical
Some buyers with a willingness to pay above marginal cost do not buy because the price is high
Lowering price to capture this market segment may reduce monopoly profit.

27. When the monopoly charges a single price……D d
Transactions represented by the blue line are not undertaken MR MC p q b f
Quantity

28. Two part Tariff may not be optimal when consumers are not identical
Price
DElizabeths B
Half the consumers are type A and half are B
The monopoly sets a fee=A+B/2
The Elizabeths are willing to pay the fixed fee, but the Geoffreys are not
DGeoffreys A p* q1 q2
Quantity

29. Non uniform pricing / Price Discrimination
Separate consumers
Groups/ markets
Slightly different products
Tastes
No reselling
Different prices

30. Price Discrimination Price discrimination Segmented markets
Charge different prices to different consumers
Segmented markets
Physical separation/other characteristics
Arbitrage - impossible

31. Price Discrimination: the Market for Movie Tickets
(b) Demand by people below age 60
(b) Senior citizen demand P
The relative prices charged will depend on the price elasticity of demand in each market:
Demand MR P1
Q 1
Demand P2
Q 2
Marginal cost MR

32. Price Discrimination Price Discrimination in Segmented Markets
Produce q* (profit maximizing quantity)
Marginal revenue (any market) = marginal cost
Marginal revenue (one market) = Marginal revenue (other) market
MRg=MRe=MCt

33. Practice Questions: #1 Given: Find Inverse demand: P=100 - Q
MC constant at $50 and no fixed costs
Find
Socially optimal output level
Monopoly output and price
If the monopoly can charge a fee in addition to the above price, what is the fee? The profit?
What is the optimal price and fee? The profit?

34. Practice Questions: #2 Given: Find
Two groups of buyers: P1=130-2Q1 and P2=60-Q2
MC constant at $50 and no fixed costs
Find
Price and quantity to each group
Is the monopoly output socially efficient?