Who does monopoly

Area Beneath the Demand Curve Lying Above the Price: Reflects all the net benefits buyers enjoy, the consumer surplus, from purchasing and consuming the good.

Consumer Surplus: The benefit each buyer enjoys from consuming the good less what each buyer must pay for the good.

C

50

PC= 1.25

PM = 1.50

P

Q

D

MR

MC

75

“S”A

B

D E

A profit maximizing monopoly will always

andcharge a price

that lies on the market demand curve.

produce a quantity

Marginal Revenue (MR):The marginal revenue curve lies below the market demand curve.

MR < Price

Measuring the Effect of Monopoly: Consumer and Producer Surplus

Competition Monopoly ChangeConsumer Surplus

Producer SurplusTotal Surplus

A + B + C A Lose B & Lose C

D + E + F B + D + F Gain B & Lose EA + B + C + D + E + F A + B + D + F Lose C & Lose E

F

WHAT IF the monopoly firm acts as though it

were a firm in a perfectly competitive industry?

Consumer Surplus: Net benefit buyers enjoy from purchasing and consuming the good.

Height of Market Demand Curve: Reflects the benefit a buyer enjoys from consuming a specific unit of the good.

Producer Surplus: The net benefit sellers enjoy from producing and selling the good

Height of Market Supply Curve: The seller’s opportunity cost of providing a specific unit of the good.

Area above the Supply Curve Lying beneath the Price: Reflects all the net benefit sellers enjoy, the producer surplus, from producing and selling the good.

MC = 1.00

Producer Surplus: What each seller receives from the sale of the good less the opportunity cost each seller incurs by providing it.

hurt? Consumershelp? The monopoly firm

What about society as a whole.

Dead weight loss

50

PM = 1.50

P

Q

D

MC

75

Connecting the Pareto approach to efficiency with consumer and producer surplus

MC = 1.00

Question: How did we argue that monopoly was inefficient?

We chose an individual, Joe, whoDid not by a hamburger when the price was $1.50, the monopoly price.

But would be a hamburger at a price of $1.40, a value above Mary’s marginal cost.

We then devised a special (secret) deal that made both Joe and Mary better off which did not affect anyone else.

Question: Where on the market demand curve would you “place” Joe?

Joe

Answer: Joe is in the dead weight loss (excess burden) region.

Dead weight loss

Question: What were the critical aspects in choosing Joe:

Price

Marginal Cost

The dead weight loss represent all the Joes who are around. All those who can make special deals with Mary help the two of them and do no hurt anyone else.

MCA = $60 MCB = $30

A Multi-Plant MonopolyClaim: To maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

100

80

60

40

20

qA = 50 qB = 25

Total ProductionQ = 75

Plant A produces 1 fewer unit

MC = Change in total cost resulting from a one unit change in production

Plant A’s total costs decrease

by $60

Plant A produces 1 more unit

Plant B’s total

costs increase by $30

Firm’s total costs decrease by $30

Intuition: We can reduce the firm’s total costs without reducing the total

quantity of output produced by shifting production from the high marginal cost

plant to the low marginal cost plant.

Question: Is it possible for the firm to produce 75 units more cheaply by

transferring productions from on plant to the other?

Profits will rise by $30.

Question: Can this go on indefinitely?

MCA = $60 MCB = $30

A Multi-Plant MonopolyClaim: To maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

100

80

60

40

20

qA = 50 qB = 25

Total ProductionQ = 75

MC = Change in total cost resulting from a one unit change in production

Intuition: We can reduce the firm’s total costs without reducing the total

quantity of output produced by shifting production from the high marginal cost

plant to the low marginal cost plant.

Question: Is it possible for the firm to produce 75 units more cheaply by

transferring productions from on plant to the other?

Question: Can this go on indefinitely?

As production is transferred from Plant A to Plant B

MCA decreases

MCB increases

Until they are equal

MCA = $40 MCB = $40qA = 25 qB = 50

A Multi-Plant MonopolyClaim: To maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

100

80

60

40

20

qA + qB = Q = 75MCA = $40 MCB = $40qA = 25 qB = 50

10050 150 200 200Q

D

MR

100

80

60

40

20

MR = $90

MC = Change in total cost resulting from a one unit change in production

MR = Change in total revenue resulting from a one unit change in production

Profit = TR TC

Produce 1 more unit

Up by $90

Up by $40

Up by $50

To maximize profit: MR = MC

A Multi-Plant MonopolyTo maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

10050 150 200 200Q

D

MR

100

80

60

40

20

100

80

60

40

20

qA = 50 MCA = 60 qB = 100 MCB = 60 qA + qB = = 150 MR = 60 P = 90

Question: What price will the monopoly charge?

Answer: A monopoly produces a quantity and charges a price that lies on the market demand curve.

Claim: To maximize profit:qA = 50 and qB = 100

Consumers base decisions on accurate information

Consumers base decisions on misleading information

Efficient

Inefficient

Perfectly Competitive Industry

A large number of small firms

A single firm’s production decision

does not significantly affect the price.

MR curve horizontal:MR = Price

Monopoly

One large firm

Monopoly produces a quantity and charges a price

that lies on the market demand curve.

MR curve lies beneath the market demand curve: MR < Price

MR = MC

Profit Maximization

Price = MR = MC Price > MR = MC

Price = MC

Price > MC

Review: Efficiency and the Two Polar Cases of Market Structure

orPrice = MR

orPrice > MR

Perfectly Competitive Industry

A large number of small firms

Efficient

Monopoly

One large firm

Inefficient

Oligopoly

A few moderately sized firms

Question: Efficient or Inefficient?

Project: Explaining OPEC’s Vacillating Behavior in 1993In late September, the members of OPEC negotiated quotas to restrict the quantity of oil produced. The agreement was applauded by OPEC oil ministers.

Shortly thereafter, oil prices promptly rose. The increase in oil prices proved to be short lived, however. OPEC members violated their agreement within two weeks of consummating it.Within a few weeks, the price of oil fell.

Conflicting Interests of an Oligopolies and Cartels: Collective versus IndividualIt is in the collective interests of the firms in an industry to establish a cartel to maximize their joint profits.

It is in their collective interests to collude by reducing production below the competitive level; by do so they can act like a monopoly to maximize the joint profits of the entire industry by restricting production below the competitive level.

On the other hand, if a cartel is established it may be in the individual interests of each firm to cheat on the cartel agreement to maximize its individual profit.

If the cartel agreement is in place, it may be in the individual interests of a firm to produce more than the agreement allows thereby pushing production toward the competitive level.

Strategy: Begin with a multi-plant monopoly and then “convert” it to an oligopoly.

OligopolyChallenge of Oligopoly: While it is straightforward to predict the price and quantity in a perfectly competitive market or a monopoly it is more difficult to do so in an oligopoly.

Marginal Revenue for the Monopoly

A Multi-Plant MonopolyTo maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

10050 150 200 200Q

D

MR

100

80

60

40

20

100

80

60

40

20

qA = 50 MCA = $60 qB = 100 MCB = $60 qA + qB = = 150 MR = $60 P = $90

Slope of Demand Curve = RiseRun

20

100= = .20

Quantity Price Total Revenue = Price Quantity

Tomorrow:

Today: 150

151 89.80 89.8015189.80(1 + 150)

= 89.80 + 89.80150 90.00150Marginal Revenue

= 89.80 30.00

90.00150

= 89.80 + (.20)150

TR tends to rise by 89.80, the price, as a

consequence of the additional unit sold.

TR tends to fall by 30.00, as a consequence of the

lower price.

Output Effect

Price Effect

MR

90.00

= 89.80 + 89.80150

Quantity PriceTomorrow 151Today 150 $90.00

Slope of Demand Curve = .20 To clear the market the quantity demanded must increase by 1 unit.

The price must fall by .20, from $90.00 to $89.80.

$89.80

= $59.80

= 89.80 + (89.80 90.00)150

$60

Marginal Revenue for the Monopoly

Convert the Multi-Plant Monopoly into an OligopolyTo maximize profits, two conditions must be satisfied when a firm has two plants:

Marginal costs of each plant must be equal: MCA = MCB

Marginal revenue must equal each plant’s marginal cost: MR = MCA = MCB

100

80

60

40

20

10050 10050 150 200

MCA MCB

qA qB

MCA MCB

10050 150 200 200Q

D

MR

100

80

60

40

20

100

80

60

40

20

qA = 50 MCA = $60 qB = 100 MCB = $60 qA + qB = = 150 MR = $60 P = $90

Owner retires and gives Plant A to his son Adam and Plant B to his daughter BethAdam’s Firm Beth’s Firm Total Production

qA = 50

MCA = $60

qB = 100

MCB = $60

Q = 150

P = $90

Adam’s Adam’sQuantity Price Total Revenue = Price Quantity

Tomorrow:

Today: 50

51 89.80 89.805189.80(1 + 50)

= 89.80 + 89.8050 90.0050Adam’s Marginal Revenue

= 89.80 10.00

90.0050

= 89.80 + (.20)50

TR tends to rise by 89.80, the price, as a

consequence of the additional unit sold.

TR tends to fall by 10.00, as a consequence of the

lower price.

Output Effect

Price Effect

MRA = Adam’s Marginal Revenue

90.00

= 89.80 + 89.8050

Adam Beth Joint PriceTomorrow 51 100 151Today 50 100 150 90.00

Quantity Slope of Demand Curve = .20 To clear the market the quantity demanded must increase by 1 unit.

The price must fall by .20, from $90.00 to $89.80.

89.80

Scenario 1: No Retaliation – Does Adam have an incentive to cheat if Beth does not retaliate?

= $79.80

MCA = $60.00

Does Adam have an incentive to cheat if

Beth does not retaliate?

Yes

= 89.80 + (89.80 90.00)50Question: What does

Adam’s marginal revenue (MRA) equal?

MC = Change in total cost resulting from a one unit change in production

MR = Change in total revenue resulting from a one unit change in production

Adam’s Profit = TR TCProduce 1 more unit

Up by $79.80

Up by $60.00

Up by $19.80

Adam produces one more unit of output and Beth does not retaliate: qA: 50 51 qB = 100

MRA = $79.80 MCA = $60.00

P: $90.00 $89.80

Adam’s Profit

Beth’s Profit

P: $90.00 $89.80 Down by $.20

Beth’s Profit = TR TC

Down by $20.00

Unchanged

Down by $20.00

$.20 100

qA: 50 51 Increased by 1

qB = 100: Unchanged

Production unchanged: 100 units

Question: What happens to their joint profit? Question: Down by $.20

MC = Change in total cost resulting from a one unit change in production

MR = Change in total revenue resulting from a one unit change in production

Beth’s Profit = TR TCProduce 1 more unit

Up by $69.80

Up by $60.00

Up by $9.80

Beth produces one more unit of output and Adam does not retaliate: qB: 100 101 qB = 50

MRA = $69.80 MCA = $60.00

P: $90.00 $89.80

Beth’s Profit

Adam’s Profit

P: $90.00 $89.80 Down by $.20

Adam’s Profit = TR TC

Down by $10.00

Unchanged

Down by $10.00

$.20 50

qB: 50 51 Increased by 1

qA = 50: Unchanged

Production unchanged:

50 units

Question: What happens to their joint profit? Question: Down by $.20

= 89.80 + 89.8050 90.0050Adam’s Marginal Revenue

= 89.80 10.00

= 89.80 + (.20)50

TR tends to rise by 89.80, the price, as a

consequence of the additional unit sold.

TR tends to fall by 10.00, as a consequence of the

lower price.

Output Effect

Price Effect

MRA

= 79.80

Beth: MRB = $69.80 MCB = $60

Adam: MRA = $79.80 MCA = $60

Question: Who has the greater incentive to cheat?

= 89.80 + 89.80100 90.00100Beth’s Marginal Revenue

= 89.80 20.00

= 89.80 + (.20)100

TR tends to rise by 89.80, the price, as a

consequence of the additional unit sold.

TR tends to fall by 20.00, as a consequence of the

lower price.

Output Effect

Price Effect

MRB

= 69.80

Summary= 89.80 + (89.80 90.00)50

= 89.80 + (89.80 90.00)100

When Adam producers 1 more unit his profit risesby approximately $19.80

When Beth producers 1 more unit her profit rises

by approximately $9.80.

Adam has a greater incentive to cheat. Why?

Adam’s MR is greater. Why?

Adam’s price effect is smaller. Why?

Adam is the smaller producer.Conclusion: The smaller

producer has a greater incentive to cheat.