Transcript Session12-Monopoly

Economic Analysis
for Business
Session XII: Monopoly
Instructor
Sandeep Basnyat
9841892281
[email protected]
Introduction
A monopoly is a firm that is the sole
seller of a product without close
substitutes.
 The key difference:
market power: the ability to influence
the market price of the product it sells.
 A competitive firm has no market power.

Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the
market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive right
to produce the good.
E.g., patents, copyright laws
Why Monopolies Arise
3. Natural monopoly: a single firm can produce the
entire market Q at lower ATC than could several
firms.
Cost
Electricity
Economies of
scale due to
huge FC
$80
$50
ATC
500
1000
Q
Monopoly: Demand Curves
A monopolist is the only
seller, so it faces the market
demand curve.
To sell a larger Q,
the firm must reduce P.
P
A monopolist’s
demand curve
Thus, MR ≠ P.
D
Q
A monopoly’s revenue
Moonbucks is
the only seller of
cappuccinos in
town.
The table shows
the market demand
for cappuccinos.
Fill in the missing
spaces of the table.
What is the relation
between P and AR?
Between P and
MR?
Q
P
0
$4.50
1
4.00
2
3.50
3
3.00
4
2.50
5
2.00
6
1.50
TR
AR
MR
n.a.
6
Answers
Here, P = AR,
same as for a
competitive firm.
Here, MR < P,
whereas MR = P
for a competitive firm.
Q
P
TR
AR
0
$4.50
$0
n.a.
1
4.00
4
$4.00
2
3.50
7
3.50
3
3.00
9
3.00
4
2.50
10
2.50
5
2.00
10
2.00
6
1.50
9
1.50
MR
$4
3
2
1
0
–1
7
Moonbuck’s D and MR Curves
P, MR
$5
4
3
2
1
0
-1
-2
-3
0
Demand curve (P)
MR
1
2
3
4
5
6
7
Q
Profit-Maximization
1. The profitmaximizing Q
is where
MR = MC.
Costs and
Revenue
MC
P
2. Find P from
the demand curve
at this Q.
D
MR
Q
Quantity
Profit-maximizing output
Numerical Problems and Solutions
1) Suppose the Total Cost for the Monopoly(TC) = 500 + 20Q2
Demand Equation (P) = 400 – 20Q
Total Revenue (TR) = 400Q – 20Q2
What is the profit maximizing price and quantity?
Numerical Problems and Solutions
1) Suppose the Total Cost for the Monopoly(TC) = 500 + 20Q2
Demand Equation (P) = 400 – 20Q
Total Revenue (TR) = 400Q – 20Q2
What is the profit maximizing price and quantity?
Solution:
MR = dTR / dQ = 400 -40Q
MC = dTC / dQ = 40Q
Profit Maximizing price is achieved when MR =MC
Or, 400 – 40Q = 40Q
Therefore, Q =5 (Profit maximizing output)
Putting the value of Q in demand equation
Profit Maximizing Price P = 300.
Case Study: For your Reference
Patents on new drugs give a temporary monopoly to the
seller.
When the patent expires, the market becomes competitive,
generics appear.
Follow the case study from Mankiw Book for your reference.
The Welfare Cost of Monopoly
Competitive eq’m:
Price
quantity = QE
P = MC
P
total surplus is
P = MC
maximized
MC
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
Deadweight
MC
loss
D
MR
Q M QE
Quantity
Price Discrimination

Price discrimination is the business
practice of selling the same good at
different prices to different buyers.
Some examples:
Movie tickets
Airline prices
Discounts
Need-based financial aid
Monopoly’s Pricing Decision
Single Price (without price discrimination)
 With price discrimination

Monopoly without price discrimination (single price)
Single Price
Discrimination
Here, the monopolist
charges the same price
(PM) to all buyers in all
markets.
Price
Monopoly
profit
Consumer
surplus
Deadweight
loss
PM
MC
D
MR
A deadweight loss results.
QM
Quantity
Price Discriminating Monopoly
Here, the monopolist
produces the competitive Price
quantity, but charges each
buyer his or her WTP in
different markets.
This is also called perfect
price Discrimination.
The monopolist captures
all CS
as profit.
But there’s no DWL.
Monopoly
profit
MC
D
MR
Quantity
Q
Public Policy Toward Monopolies
Increasing competition with antitrust laws
◦ US: Sherman Antitrust Act (1890), Clayton Act
(1914)
◦ Nepal: Fair Competition Bill (2004)
 Regulation
◦ Govt agencies setting price

Public ownership
Doing nothing
Market Structure Problems
2) Consider a monopolist sells in two markets and has constant
marginal cost equal to $2 per unit. The demand and marginal
revenue equations for two markets are:
PI = 14 -2QI : MRI = 14 -4QI
PII= 10 –QII : MRII = 10 -2QII
a) Using third degree discrimination, find profit maximizing
prices and quantities, combined profit from both market.
b) What is the profit maximizing price and quantity and total
profit without price discrimination.
Note:
1st degree: Charging maximum price for each unit sold.
2nd degree: Different prices depending upon quantities of goods bought by
consumers.
3rd Degree: Separating consumer market and charge separate prices.
Market Structure Problems
Solution:
a) Marginal Cost =$2 per unit. The demand and marginal revenue
equations for two markets are:
PI = 14 -2QI
: MRI = 14 -4QI
PII= 10 –QII
: MRII = 10 -2QII
Profit maximizing is possible when MRI = MRII =MC
So, for Market I:14 -4QI = 2.
Therefore, QI = 3
For Market II: 10 –2QII = 2. Therefore, QII = 4
Substituting values of QI and QII in PI and PII, we have
PI = 8 and PII = 6
Profit in Market1 = TR –TC = (PI x QI) – (MC x QI) = 24 – 6 = $18
Profit in MarketI1 = TR –TC = (PII x QII) – (MC x QII) = 24 – 8 = $16
So, combined profit = $34.
Market Structure Problems
Solution:
b) Finding demand functions in terms of quantities:
QI = 7 – P/2
QII = 10 – P
Total demand: Q = (7 – P/2) + (10 –P) = 17 – 3P/2 ……….(i)
Total demand in terms of P = 34/3 – 2Q/3 ………………..(ii)
Therefore,
TR = P x Q = (34/3 – 2Q/3)Q = 34Q/3 – 2Q2/3
MR = 34/3 – 4Q/3
Now,
MR = MC
34/3 – 4Q/3 = 2
Therefore, Q = 7
Substituting the value of Q in Eqn. (ii), P = $6.67
So, Total Profit = TR – TC = (PxQ) – (MCxQ) = 46.69 – 14 = $32.69
Thank you