© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eO’Sullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 10 Monopoly

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopoly Monopoly is a market in which a single firm serves the entire market.Monopoly is a market in which a single firm serves the entire market. Patent: The exclusive right to sell a particular good for some period of time.Patent: The exclusive right to sell a particular good for some period of time. Franchise or licensing scheme: A policy under which the government picks a single firm to sell a particular good.Franchise or licensing scheme: A policy under which the government picks a single firm to sell a particular good.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Total Revenue and Marginal Revenue Demand, Total Revenue, and Marginal Revenue Price Quantity Sold Total Revenue Marginal Revenue $1600 $141$14$14 $122$2410 $103$306 $ 8 4$322 $ 6 5$30-2 $ 4 6$24-6

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Total Revenue and Marginal Revenue As the firm cuts its price to sell more output, its total revenue rises for the first 4 units sold, but then decreases for the 5 th and 6 th units.As the firm cuts its price to sell more output, its total revenue rises for the first 4 units sold, but then decreases for the 5 th and 6 th units. Marginal revenue (the change in total revenue from selling one more unit) is positive for the first 4 units and then becomes negative.Marginal revenue (the change in total revenue from selling one more unit) is positive for the first 4 units and then becomes negative.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Demand Curve and Marginal Revenue Curve Marginal revenue is equal to the price for the first unit sold, but is less than price for all other units sold.Marginal revenue is equal to the price for the first unit sold, but is less than price for all other units sold. To increase the quantity sold, a firm cuts its price and receives less revenue on the units that could have been sold at the higher price.To increase the quantity sold, a firm cuts its price and receives less revenue on the units that could have been sold at the higher price.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Principle and the Output Decision Marginal PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Using the Marginal Principle to Pick a Price and Quantity Price (per Dose) Quantity sold (Doses) Marginal Revenue Marginal Cost Total Revenue Total Cost Profit $18600$12$4.00$10,800$5,710$5,090 $17700$10$4.60$11,900$6,140$5,760 $16800$8$5.30$12,800$6,635$6,165 $15900$6$6.00$13,500$7,200$6,300 $141,000$4$6.70$14,000$7,835$6,165 $131,100$2$7.80$14,300$8,560$5,740 $121,2000$9.00$14,400$9,400$5,000

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopolist Picks a Quantity and a Price To maximize profit, the monopolist picks point n, where marginal revenue equals marginal cost.To maximize profit, the monopolist picks point n, where marginal revenue equals marginal cost. The monopolist produces 900 doses per hour at a price of $15 (point m ).The monopolist produces 900 doses per hour at a price of $15 (point m ). The average cost is $8 (point c ).The average cost is $8 (point c ).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopolist Picks a Quantity and a Price The marginal cost of the 600 th dose is $4 as shown by point j on the marginal cost curve.The marginal cost of the 600 th dose is $4 as shown by point j on the marginal cost curve. The extra revenue associated with dose number 600 is shown by point i on the marginal revenue curve, the marginal revenue is $12.The extra revenue associated with dose number 600 is shown by point i on the marginal revenue curve, the marginal revenue is $12.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopoly Versus Perfect Competition (A)Monopoly The monopolist picks the quantity at which long-run marginal cost equals marginal revenue (point n ). The monopolist picks the quantity at which long-run marginal cost equals marginal revenue (point n ). As shown by point m on the demand curve, the price associated with this quantity is $18 per dose. As shown by point m on the demand curve, the price associated with this quantity is $18 per dose.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopoly Versus Perfect Competition (B)Perfect Competition The long-run supply curve of a perfectly competitive, constant- cost industry intersects the demand curve at point p. The long-run supply curve of a perfectly competitive, constant- cost industry intersects the demand curve at point p. The equilibrium price is $8, and the equilibrium quantity is 400 doses per hour. The equilibrium price is $8, and the equilibrium quantity is 400 doses per hour.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Monopoly Versus Perfect Competition Deadweight loss from monopoly: A measure of the inefficiency from monopoly;Deadweight loss from monopoly: A measure of the inefficiency from monopoly; The deadweight loss is equal to the difference between the consumer-surplus loss from monopoly pricing and the monopoly profit.The deadweight loss is equal to the difference between the consumer-surplus loss from monopoly pricing and the monopoly profit.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Deadweight Loss from Monopoly A switch from perfect competition to monopoly increases the price from $8 to $18 and decreases the quantity sold from 400 to 200 doses.A switch from perfect competition to monopoly increases the price from $8 to $18 and decreases the quantity sold from 400 to 200 doses.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Deadweight Loss from Monopoly Consumer surplus decreases by an amount shown by the areas R and D, while profit increases by the amount shown by rectangle R.Consumer surplus decreases by an amount shown by the areas R and D, while profit increases by the amount shown by rectangle R. The net loss to society is shown by triangle D (the deadweight loss of monopoly.The net loss to society is shown by triangle D (the deadweight loss of monopoly.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Rent Seeking: Using Resources to Get Monopoly Power Rent Seeking: The process under which a firm spends money to persuade the government to erect barriers to entry and pick the firm as the monopolist.Rent Seeking: The process under which a firm spends money to persuade the government to erect barriers to entry and pick the firm as the monopolist.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Natural Monopoly A natural monopoly is a market in which the entry of a second firm would make price less than average cost, so a single firm serves the entire market.A natural monopoly is a market in which the entry of a second firm would make price less than average cost, so a single firm serves the entire market.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Natural Monopolist Uses the Marginal Principle to Pick a Price and Quantity The monopolist chooses point n (where marginal revenue equals marginal cost).The monopolist chooses point n (where marginal revenue equals marginal cost). The monopoly supplies 3 billion units at a price of $8.20 per unit (point m ).The monopoly supplies 3 billion units at a price of $8.20 per unit (point m ). The average cost is $6.20 per unit (point c ). The profit per unit of electricity is $2.00.The average cost is $6.20 per unit (point c ). The profit per unit of electricity is $2.00.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Why Won’t a Second Firm Enter the Market? The entry of a second firm would shift the demand curve facing the typical firm to the left.The entry of a second firm would shift the demand curve facing the typical firm to the left. After entry, the firm’s demand curve lies entirely below the long- run average cost curve.After entry, the firm’s demand curve lies entirely below the long- run average cost curve.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Price Controls for a Natural Monopoly The average-cost pricing policy is a regulatory policy under which the government picks the point on the demand curve at which price equals average cost.The average-cost pricing policy is a regulatory policy under which the government picks the point on the demand curve at which price equals average cost.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Price Controls for a Natural Monopoly Under an average cost pricing policy, the government chooses the price at which the demand curve intersects the average cost curve.Under an average cost pricing policy, the government chooses the price at which the demand curve intersects the average cost curve. Regulation shifts the long-run average cost curve, so the government picks point r, with a price of $6.00 per unit.Regulation shifts the long-run average cost curve, so the government picks point r, with a price of $6.00 per unit.