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Topic 9 - Monopoly.pdf

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James Pesando

Topic 9 – Monopoly (Week night Nov 10 - Nov 15 ) th Outline: 1. Definition; 2. MR < P (DD) 3. Profit-Maximizing output & price 4. “Contrived Scarcity”: when Competitive Industry is monopolized; 5. Price Discrimination; 6. Why is Monopoly Bad? 7. Natural Monopoly & Regulation of a natural monopoly.  Monopoly -- Single seller of product with no close substitutes; -- Barrier to entry: 1) legal barriers (legal monopoly); -- e.g. post office (legal monopoly on first class mail); patents 2) natural barriers (natural monopoly);  MR < P -- In monopoly, Marginal Revenue is always smaller than Price. Why? Because monopolists face a downward-sloping demand unlike perfectly competitive firms face horizontal demand. The Output Effect: More output is sold, so Q is higher; The Price Effect: The Price falls, so P is lower. Monopoly Perfect Competition Price Price PPrice PPrice ee Price effect ee P 0 P0= P1 Output effect P 1 Q0 Q 1 Quantity Q0 Q1 Quantity Assume Q -1 =10(an additional unit) MR = change in TR/change in Q = (P1xQ 1 P 0Q )0 MR = change in TR/change in Q = output effect – price effect = P1/( Q1-Q0) = P1(Q 1Q 0 – Q 0P 0P 1 = P1 = P – a real number 1 which is always smaller than simply P 1 Monopolists face a downward-sloping Firms in perfect competition face a demand, so higher quantity must have a horizontal demand curve, and the firm is trade-off of a lower price. Thus MR of able to sell any quantity it likes in a constant monopolists is affected by both output price. Thus there is no price effect on effect and price effect; individual firms in perfect competition. Therefore, the downward-sloping demand curve that monopolists face lead to the fact that at certain level of output, its MR is always smaller than the price it charges at that quantity. Numerical Example Price P Q TR MR (PXQ) (△TR/△Q) PPrice ee0 10 0 0 - 9 9 1 9 9 8 8 2 16 7 7 7 3 21 5 6 5 6 4 24 3 4 5 5 25 1 3 4 6 24 -1 2 DD 3 7 21 -3 1 2 3 4 5 6 7 8 Quantity 2 8 16 -5 MR For monopolists, MR lies everywhere to the left of market DD.  Profit Maximizing Output and Price Price PPrice Observation: ee 1. Downward-Sloping demand; MC 2. The revenue you received for additional P M output is everywhere less than the price you sell for that output; DD MR Q1 Q M Q2 Quantity 1. Monopolist chooses M where MR=MC; At Q1, MR > MC: the revenue of producing an additional unit of output exceeds the cost of it; the firm should expand output; At Q2, MR < MC: the cost of producing an additional unit of output exceeds the revenue of it; the firm should contract output; At Q0, MR = MC: the revenue of producing an additional unit of output equals the cost of it; this is the profit – maximizing level of output for the firm. 2. To sell the maximized outpuM Q , monopolists must chaMge P (according to the demand curve); Insight: 1. Monopolists cannot charge “unlimited price”; 2. In a monopoly there is no supply curve. Why? -- Monopolists are not price takers; They do not set price equal to marginal revenue, the price does not equal marginal cost. -- Similarly, a monopoly firm does not respond to price changes by moving along its marginal cost curve. A monopoly does not necessarily supply larger quantities at higher prices or smaller quantities at lower prices. -- Therefore monopolists don’t have a market supply curve. Economic Profit for Monopolists Price PPrice ee MC P > ATC Economic Profit; P = ATC Breaks Even; PM P < ATC Economic Loss P=ATC DD MR Q M Quantity  When Competitive Markets are monopolized Q: what will happen to price and output if a perfectly competitive industry becomes a monopoly? Price Perfect Competition Price Monopoly PPrice SS = MC PPrice ee ee MC PM PC DD MR DD Quantity Q M C Quantity Observation: 1. Market SS = sum of all individual firms’ ss schedules = MC for the industry as a whole; = MC of the monopolist. 2. Output is reduced (“contrived scarcity”) and price increases. Application 1 – Government Policy Towards New Drugs Objective: 1) encourage research and development; 2) Protect consumers from monopoly prices Policy: Government grants patent protection for monopoly (as a reward for the innovation), but only for a limited period of time; Within the patent protection, consumer pay the monopoly price P , and M after the patent expires (legal barrier of entry was eliminated), other firms are free to enter the market, and price drops, with quantity increases. Application 2 – Superbugs Existing antibiotics are becoming less useful. -- Objective: How to encourage development of new antibiotics? -- Solution: Extend patent protection for new antibiotics -- How does it work? Patent creates a temporary monopoly; the economic profit provides incentives for innovation.  Price Discrimination Q: Why do firms issue coupons? Why do firms offer student or senior discount? A: To further maximize their profit using price discrimination. Price Discrimination: Firm sell the same product to different consumers at different prices.
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