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Lecture 17

Lecture 17-Economic Profit of Monopolist

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University of Toronto St. George
Jack Carr

Tuesday, November 17th, 2009. Economic Profit of Monopolist P > ATC Æ Profit P = ATC Æ Zero Profit P < ATC Æ Loss At Qm, P > ATC => Economic Profits Digression 0DUNHW66 VXPRIILUPV¶VVVFKHGXOHV VXPRIILUPV¶PFVFKHGXOHV = MC for industry as a whole = MC of monopolist Pm DD Qm MC MR ATC Economic profit earned by monopolist SS Q P DD CONTRIVED SCARCITY: A competitive Industry is Monopolized Results: RXWSXWLVUHGXFHGµFRQWULYHGVFDUFLW\´ (2) price increases A Perfectly Competitive Industry is Monopolized Government Policy Towards New Drugs Objective: 1) Encourage research and development 2) Protect consumers from monopoly prices Policy: Grant patent protection (monopoly), but for limited period of time. Period of Patent Protection: Consumers Pay Monopoly Price (PM) PM DD QM QC MR PC SS = MC PM DD QM QC PC MC [=SS in Perfect Competition] MR After Patent Expires: Legal Barrier to Entry is Eliminated and Consumers Pay Competitive Price (PC) Price Discrimination: Publishing Hardback: $35.00 Six Month Later Paperback: $10.00 Price Discrimination: Firm sells same product to different customers at different prices Example Let MC = ATC = $1 to produce a Widget 1,000 A customers: will pay $20 5,000 B customers: will pay $5 Alternative Strategies for Firm: (1) P = 20 Profits: 1,000 * (20 ± 1) = 19,000 (2) P = 5 Profits: 1,000 * (5 ± 1) = 4,000 + 5,000 * (5 ± 1) = 20,000 24,000 (3) P = 20 for A customers Ù Price Discrimination P = 5 for B customers Profits: 1,000 * (20 ± 1) = 19,000 + 5,000 * (5 ± 1) = 20,000 39,000 Examples: (1) airline tickets (2) hard cover / paperback books Price Discrimination If monopolist can, will charge high price to customers with low price elasticity of demand, and conversely Low price elasticity: charge high price (airline: business travelers) High price elasticity: charge low price (airline: weekend travelers) :K\LV0RQRSRO\³%DG´" 1. There is no supply curve for a monopolist (downward-sloping DD means that once monopolist has chosen Q, P is also determined 2. If perfectly competitive industry ZHUHWREHFRPHDPRQRSRO\«GLGQ¶WILQLVK 0RQRSROLVW¶V3URILW" 1. If consumer pays $1 more to producer as a result of monopoly price: Consumer worse off by $1 Producer better off by $1 2. Transfer from consumer to producer - Is consumer more deserving? - Is producer more deserving? - Who decides? 3. Welfare cost of monopoly is loss in total surplus as output is reduced Perfect Competition: P = MC Æ Allocatively Efficient Monopoly: P > MC Æ Not Allocatively Efficient Allocative Efficiency: The Gains from Trade are Exhausted (Fully Realized) At Q1, the value to buyers exceeds the cost to sellers, so raising output will increase the gains from trade At Q2, the value to buyers is less than the cost to sellers, so reducing output will increase the gains from trade. At Q*, the gains from trade are exhausted (i.e., fully realized), and thus Q* is the allocatively efficient level of output. Note: This highly intuitive result is formalized through the concepts of consumer and producer surplus. Q* Q MC P Q2 Q1 DD PM DD QM QC PC SS = MC MR A Perfectly Competitive Industry is Monopolized Monopoly is Allocatively Inefficient: At Qm, value to buyer > cost to seller SS = MC Qm P DD Deadweight loss [loss in total surplus] www.notesolution.comTuesday, November 17 , 2009. Economic Profit of Monopolist P > ATC Profit P = ATC Zero Profit P < ATC Loss MC Pm ATC Economic profit earned by monopolist DD Qm MR At Q m P > ATC => Economic Profits Digression SS P DD Q ,7N09$$8:2411L728888.K0:O08 8:2411L7282.8.K0:O08 = MC for industry as a whole = MC of monopolist
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