Transcript Chapter 9 Monopoly © 2006 Thomson/South-Western Barriers to Entry Sole supplier of a product with no close substitutes Barriers to entry restrictions on the entry.

Chapter 9
Monopoly
© 2006 Thomson/South-Western
1
Barriers to Entry
Sole supplier of a product with no close
substitutes
Barriers to entry restrictions on the entry of
new firms into an industry
Legal restrictions
Economies of scale
Control of an essential resource
2
Legal Restrictions
Patents award an inventor the exclusive right
to produce a good or service for 20 years
Provide the stimulus to turn an invention into a
marketable product, a process called innovation
Governments often confer monopoly status by
awarding a single firm the exclusive right to
supply a particular good or service
3
Exhibit 1: Economies of Scale
$
Cost per unit
Monopoly emerges when
a firm experiences
economies of scale as
reflected by the
downward-sloping, longrun average cost curve
Long-run
average cost
Quantity per period
4
Economies of Scale
Market demand is not great enough
to permit more than one firm to achieve
sufficient economies of scale
A single firm will emerge from the
competitive process as the sole seller in
the market.
5
Control of Essential Resources
Control over some nonreproducible resource
critical to production
Professional sports teams
Alcoa was the sole U.S. maker of aluminum for
a long period of time because it controlled the
supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade
6
Demand, Average and Marginal Revenue
De Beers controls the entire diamond market
and suppose they can sell three diamonds a day
at $7,000 each  total revenue of $21,000
Total revenue divided by quantity is the
average revenue per diamond which is also
$7,000  monopolist’s price equals the average
revenue per diamond
7
Exhibit 2: Loss or Gain from Selling One More Unit
$7,000
LOSS
Price per Diamond
6,750
G
A
I
N
0
3
D = Average
revenue
4
1 - carat diamonds per day
By selling another diamond, De
Beers gains the revenue from the
sale of the 4th diamond
To sell the 4th unit, De Beers must
sell all four diamonds for $6,750
each, sacrificing $250 on each of the
first three diamonds that could have
been sold for $7,000 each
The loss in revenue from the first
three units is $750
The net change in total revenue
from selling the 4th diamond is
$6,750 - $750 = $6,000
8
Exhibit 3: Revenue Schedule
As De Beers
expands output,
total revenue
increases until
quantity reaches 15
diamonds when
total revenue tops
out
For all units of
output except the
first, marginal
revenue is less than
price and the gap
widens as the price
declines because
the loss from selling
all diamonds at the
lower price
increases
9
Exhibit 4: Monopoly Demand and Marginal and Total Revenue
Elastic
Unit elastic
$3,750
Inelastic
0
Marginal revenue
16
D = Average revenue
32
(b) Total Revenue
Dollars
Total revenue is
maximized when
marginal revenue
equals zero
When demand is
elastic, a decrease in
price increases total
revenue  marginal
revenue is positive
When demand is
inelastic, a decrease in
price reduces total
revenue  marginal
revenue is negative
$ per diamond
(a) Demand and Marginal Revenue
1-carat diamonds
per day
$60,000
Total revenue
1-carat diamonds
per day
0
16
32
10
Firm’s Costs and Profit Maximization
Monopolist can choose either the price or the
quantity, but choosing one determines the other
Because the monopolist can select the price that
maximizes profit, we say the monopolist is a price
maker
More generally, any firm that has some control
over what price to charge is a price maker
11
Exhibit 5: Short-Run Revenues and Costs for the Monopolist
Short-run Costs and Revenue for a Monopolist
Diamonds
per day
(Q)
(1)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Price
(average
Total
revenue) revenue
(p)
(TR = Q x p)
(2)
(3) =(1) x (2)
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
Marginal
Revenue
(MR =
TR / Q)
(4)
Total
Cost
(TC)
(5)
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
$15,000
19,750
23,500
26,500
29,000
31,000
32,500
33,750
35,250
37,250
40,000
43,250
48,000
54,500
64,000
77,500
96,000
121,000
Marginal
Average
Total
Cost
Total Cost Profit or
( MC =
(ACT =
Loss =
TC / Q)
TC/Q)
TR - TC
(6)
(7)
(8)
4,750
3,750
3,000
2,500
2,000
1,500
1,250
1,500
2,000
2,750
3,250
4,750
6,500
9,500
13,500
18,500
25,000
$19,750
11,750
8,830
7,750
6,200
5,420
4,820
4,410
4,140
4,000
3,930
4,000
4,190
4,570
5,170
6,000
7,120
-$15,000
-12,250
9,000
-5,500
-2,000
1,500
5,000
8,250
10,750
12,250
12,500
11,750
9,000
4,000
-4,500
-7,500
-36,000
-61,500
Profitmaximizing
monopolist
produces that
quantity where
total revenue
exceeds total cost
by the greatest
amount 
$12,500 per day
when output is 10
units per day.
Total revenue is
$52,500 and total
cost is $40,000
MR = MC at
this same level of
output
12
Exhibit 6: Monopoly Costs and Revenue
(a) Per-Unit Cost and Revenue
The intersection of the two
marginal curves at point e in
panel (a) indicates that profit is
maximized when 10 diamonds
are sold.
ATC of $4,000 is identified by
point b: the average profit per
diamond equals the price of
$5,250 minus the ATC of $4,000 =
$1,250 – the economic profit is
the equal to $1,250 * 10 units sold
= $12,500
In panel (b), the firm’s profit or
loss is measured by the vertical
distance between the TR and TC:
profit is maximized where 10
diamonds are produced per day
Marginal cost
Average total cost
a
$5,250
4,000
Profit
b
e
MR
0
10
16
D = Average revenue
32
Diamonds per day
(b) Total Cost and Revenue
Maximum
profit
Total cost
$52,500
40,000
Total revenue
15,000
0
10
16
32 Diamonds per day
13
Exhibit 7: The Monopolist Minimizes Losses in the Short Run
Marginal cost
Dollars per unit
Marginal revenue
equals marginal cost at
point e.
At quantity Q, price p
(at point b) is less than
average total cost (at
point a)
The monopolist suffers
a loss.
But the monopolist will
continue to produce
rather than shut down in
the short run because
price exceeds average
variable cost (at point c).
a
Loss
p
b
Average total cost
Average variable cost
c
e
Demand = Average revenue
Marginal revenue
0
Q
Quantity per period
14
Long-Run Profit Maximization
 If a monopoly is insulated from competition by
high barriers that block new entry, economic profit
can persist in the long run
 A monopolist that earns economic profit in the
short-run may find that profit can be increased in
the long run by adjusting the scale of the firm
 Conversely, a monopoly that suffers a loss in the
short run may be able to eliminate that loss in the
long run by adjusting to a more efficient size
15
Exhibit 8: Perfect Competition and Monopoly
Equilibrium in perfect
competition is at point c,
where market demand
and supply intersect to
yield price pc and
quantity Qc
Monopolist maximizes
profit by equating MR
with MC: point b and
price pm and output Qm
Consumer surplus is
shown by the shaded
triangle ampm
Dollars per unit
a
pm
pc
m
b
c
Sc = MC = ATC
D = AR
MRm
0
Qm
Qc
Quantity per period
16
Exhibit 8: Perfect Competition and Monopoly
Consumer surplus
under perfect competition
is the large triangle acpc
while under monopoly it
shrinks to the smaller
triangle ampm
Consumer surplus has
been reduced by more
than the profit triangle
Consumers have also
lost the triangle mcb –
the deadweight loss of
monopoly – allocative
inefficiency arising from
the higher price and
reduced output
Dollars per unit
a
m
p
m
b
p
c
c
Sc = MC = ATC
D = AR
MRm
0
Qm
Qc
Quantity per period
17
Why the Welfare Loss Might Be Lower
 If economies of scale are extensive enough, a
monopolist may be able to produce output at a
lower cost per unit than could competitive firms,
thus costs may be lower than under competition
 Monopolists may, in response to public scrutiny
and political pressure, keep prices below what the
market could bear
 A monopolist may keep the price below the profit
maximizing level to avoid attracting new
competitors
18
Why the Welfare Loss Might Be Higher
If resources must be devoted to securing and
maintaining a monopoly position, monopolies
may involve more of a welfare loss that simple
models suggest
Efforts devoted to securing and maintaining a
monopoly position are largely a social waste
because they use up scarce resources but add
nothing to output
19
Why the Welfare Loss Might Be Higher
Activities undertaken by individuals or
firms to influence public policy to directly
or indirectly redistribute income to them
are called rent seeking
Without competition, monopolists may
become inefficient
Monopolists are criticized for being slow to
adopt the latest production techniques,
develop new products, and for generally
lacking innovation
20
Price Discrimination
Charging difference prices to different customers
when the price differences are not justified by
differences in cost
Conditions:
Demand curve must slope downward – the firm has
some market power and control over price
At least two groups of consumers for the product, each
with a different price elasticity of demand
Ability, at little cost, to charge each group a different
price for essentially the same product
Ability to prevent those who pay the lower price from
reselling the product to those who pay the higher price
21
Exhibit 9: Price Discrimination
•At a given price, price elasticity of demand (panel b, elastic) is greater than in panel a
(inelastic).
22
Perfect Price Discrimination
If a monopolist could charge a different price
for each unit sold, the firm’s marginal revenue
curve from selling one more unit would equal
the price of that unit
 the demand curve would become the
marginal revenue curve
A perfectly discriminating monopolist charges
a different price for each unit of the good
23
Exhibit 10: Perfect Price Discrimination
A perfectly discriminating
monopolist would maximize profits
at point e, where MR = MC
D o lla r s p e r u n it
a
Profit
e
c
Long-run
average cost
= marginal cost
D = Marginal
revenue
0
Q
24
Quantity per period