Monopoly

Monopoly

Chapter 10

Monopoly Profit and Loss

• In a PC market, each buyer is charged the same price for every unit:

• Homogenious product• Full knowledge

• If firms charged different prices, no one would buy the product

10.3 Price Discrimination

Under certain conditions, a firm with market power is able to charge different customers different prices. This is called price discrimination.

Price Discrimination

A negatively sloped demand curve means that buyers are willing to pay different prices for different amounts of the same product

The Price-Discriminating Monopolist*

• In order to price discriminate, a monopolist must be able to:

Negatively sloping demand slope Identify groups of customers who have

different elasticities of demand;Separate them in some way; andLimit their ability to resell its product between

groups.

The Price-Discriminating Monopolist

• A price-discriminating monopolist can increase both output and profit.

It can charge customers with more inelastic demands a higher price.

It can charge customers with more elastic demands a lower price.

The Price-Discriminating Monopolist

• A price-discriminating monopolist can increase both output and profit.

• Will charge every price above and until:

MR = MC• eg. In slide 33, the firm would charge $36

for 0 , $33 for 1, $30 for 2, $27 for 3 ,$24 for 4

Perfect Price Discrimination

• By discriminating, a monopoly firm makes greater profits than it would make by charging both groups the same price.

• A firm with market power could collect the entire consumer surplus if it could charge each customer exactly the price that that customer was willing and able to pay. This is called perfect price discrimination.

MC

Q

P

DMC = MR

4

D at Qprofit max

P = $24

With perfect price discrimination the firm will produce at the perfectly competitive output where, P = MC

Revenue is $21x7 = $147

MR

Perfect Price Discrimination

PD = $21

7

PD = MC

The Early Bird Gets a Lower Price• Early Bird Specials

—Restaurants charge special, lower prices for early diners.

• Matinees—Theaters charge less for earlier shows.

• Air Fares—Airlines charge less for flyers willing to fly “off peak,” i.e. early morning and late night.

10.4 Social Evaluation of Monopoly

• In some cases a monopoly may be considered illegal if they act against the public interest

• Let’s run an experiment:• A Monopolist buys all the firms in a

perfectly competitve market

–As a result the monopolist faces a PC industry demand and supply curve...

Pe

P

21

Si = SUM of MC10 firms in industry

Di

P1 = D = MR

P

2.1

MC1

AVC1

Q Q

Industry (10 firms) Single Firm

Supply Curve for the PC Industry

Ppc=MRPC

P

21

Si = SUM of MC10 firms in industry

DiP

2.1

S = MC

Q Q

Industry (10 firms) Single Monoply

Firm

Monopolist Price and Quantity Effects

MRD

1.1

Pm

AMon

BPCMCM

Monopoly and Allocative Efficiency

• Compared to the PC firm, the monopolist produces less (1.1) and charges more (PM) See point “A” where, for the Monopolist MR=MC

• At point “B” the PC firm maxes profit where MR=MC for the PC firm. So QPC= 2.1 and price = PPC

• At point “B” the PC firm maxes profit where MR=MC

• Remember, for a PC firm MR=P so, the firm maxes profit at P=MC– If MR > MC then the PC firm will increase

production until MR(=P)=MC • The PC ALWAYS produces at the

SOCIALLY OPTIMAL point!• But, the monopolist produces at P > MC


• But, the monopolist produces at P > MC see point “A”

• Compared to the PC firm, QMON < QPC

• THE MONOPOLIST FIRM DOES NOT PRODUCE (Q) AT THE SOCIALLY OPTIMAL POINT!! – This is an example of:

Allocative INEFFICIENCY


• The PC firm has to, in the long run, produce at MIN AVC to stay in business.– This is the point at which the competiton has

driven the price down (undercut each other) until price sold = price to produce ie

If, Profit = TRev > TCost Then, in a PC market ZERO Profit = TR = TC The Monopolist doesn’t have to worry about efficiency because there is no competition! It can set price ABOVE MC where

Profit = TRev > TCost ALWAYS

Monopoly and Productive Efficiency

• Should every monoply be outlawed??Ah, no.

eg: MicrosoftMicrosoft enjoys a monopoly. However, because it is so large it enjoys productive effiicency ie. The cost of producing Windows OS is small because costs are spread amoung so many people. These lower costs are passed on to the consumer. If there were only 4 programmers who can programme the OS they can chage more for their services if 400 programmers had that skill

Monopoly and Economies of Scale

• A Natural Monopoly is a firm that first takes advantage of economies of scale (big size) which allow it to operate at low costs

• It’s MC is pretty much constant ie. horizontal to x-axis ie. perfectly elastic

• Let’s see how this looks...

10.5 Regulation of a Monopoly

Pm

P

MC

Q

Single Monoply Firm

Monopolist Price and Quantity Effects

MRD

QM

Pm

AMCM

P

ATC

Q

Regulation of a Single

Monoply Firm

MR D,P

QM=1.1

PAC

A

P,D,MRPC

QPC = 2.1

BC

QAC 1.9

(Government

Regulated)

MC

• It’s MC is pretty much constant ie. horizontal to x-axis ie. perfectly elastic but still produces at point “A” where:

MC=MR and production = QM

Not productively or allocatively efficient

• Through regulation, the government can force the monopolist to produce at the socially optimal point, “B” where:

P = MC and production = QPC

The Regulation of a Monopoly

• Through regulation, the government will force the monopolist to produce at the socially optimal point, “B” where:

P = MC and production = QPC

Productively and allocatively efficient

The Regulation of a Monopoly

• BUT, the government can’t force the monopolist to produce at point “B” because at this point in the long run the firm would have to shut down.

• They allow a FAIR RETURN to exist at point “C” through Average Cost Pricing

Not productively or allocatively efficient

Monopoly

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