Introduction to Monopoly Micro: Econ: 25 61 Module Introduction to Monopoly KRUGMAN'S MICROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: How a monopolist determines the profit- maximizing price. How to determine whether a monopoly is earning a profit or a loss. How the monopoly outcome is different from the long-run outcome in perfect competition. The purpose of this module is to develop the monopoly model. Like perfect competitors, monopolists sets marginal revenue equal to marginal cost to maximize economic profit. The ability to set the price, coupled with the existence of barriers to entry, gives the monopolist the opportunity to earn profits in the long run.

Monopoly Demand and MR A Monopolist’s MR curve is below the D curve because the monopoly must lower price to sell more. In perfect competition, market demand for a product is downward sloping. However because of the special characteristics of that market structure, the demand for any one firm’s product is horizontal. Those firms are price takers.   However, a monopolist faces a different demand curve. Because the monopolist is the only producer in the market, the demand for the good is the demand for the monopolist’s good. And because demand is downward sloping, the demand for the monopolist’s product is downward sloping. This downward sloping demand curve creates a different MR curve, one that lies below the demand curve, and thus creates a gap between price and marginal revenue.

Profit-maximizing P and Q A monopoly maximizes profit by producing the output level where MC = MR (like every firm does!) For both the perfectly competitive firm and the monopoly firm, profit is maximized at the output level where MR=MC. The rule to maximize profit is the same, no matter the market structure: find the output where MR=MC. This rule will appear several times throughout the AP Micro exam.

Monopoly versus Perfect Competition Monopolies create inefficiency P > MC D Output MR Qm= 3 Pc = $10 Pm = $14 $ MC = ATC Profit = $12 To compare monopoly to perfect competition, we just need to recall where price is set under the perfectly competitive assumptions.   Perfect competition: Output is where P=MR=MC. In the graph, this occurs where the MC curve intersects Demand at Qc. The corresponding price is Pc=MC. So what can we clearly tell? Qm < Qc and Pm > Pc. In addition, the monopolist can earn positive economic profits in the long run because there are barriers to entry of new firms. We see this above because Pm>ATC and there is a profit rectangle. However in perfect competition economic profit is driven to zero because of entry. We see this on the graph because Pc=ATC. There is no profit rectangle.

The “Classic” Monopoly Graph the “classic” monopoly graph. It has the typical upward sloping MC curve and U-shaped ATC curves (constant MC is used to simplify examples in some cases). The Qm is found where MR=MC, the Pm is found vertically up to the demand curve, and the profit rectangle is formed by locating the difference between Pm and ATC.   This is one of the key graphs in microeconomics and students should be able to generate and interpret it for a monopoly earning a profit, loss, or normal profit for the AP Micro exam.

Figure 61.1 Comparing the Demand Curves of a Perfectly Competitive Producer and a Monopolist Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Table 61.1 Demand, Total Revenue, and Marginal Revenue for the De Beers Diamond Monopoly Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 61.2 A Monopolist’s Demand, Total Revenue, and Marginal Revenue Curves Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 61.3 The Monopolist’s Profit-Maximizing Output and Price Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 61.4 The Monopolist’s Profit Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers