Topic 10: Monopoly
1. Introduction
2. Possible SR Equilibrium
3. Possible LR Equilibrium
4. Dead-weight loss and question of efficiency
5. Conclusion
1. Introduction
We really like perfect competition, but nothing’s perfect so we’re looking at the exact opposite.
1. One seller
2. Homogenous product - you have no choice.
3. Very difficult entry. like an expensive hooker.
What can create a monopoly?
*Control of scarce resources (gold only in a few countries, etc.)
*Government - stamps
*Patents
Monopolists to do have a perfectly elastic demand curve (horizontal).
They are both the firm and the industry so the market is a profit maximizing entity.
Any firm has to follow the criteria in topic 6, so monopoly will follow that too.
2. Possible SR Equilibrium
There are three possible short run equilibria for the monopolist. One in which the monopolist earns
positive economic profits, one in which it earns zero economic profits and one in which is negative. In
the latter case, the firm may or may not operate.
MC MC AC AC AC
AC AVC AVC
MR D=AR=P MC MC
Positive Zero Negative – Open Negative – Closed
Find where MR and MC meet. This is Q*. Go up from there to AC – that’s the cost to run at Q*. Continue
up to the demand curve – that’s the price. If P is above AC, you’re fine and operating in a dandy fashion.
Space between P and AVC is profit or loss.
P ≥ AVC… multiply both sides by Q and get TR ≥ TVC 3. Possible LR Equilibrium
Perfect competition – positive economic profit = more people entering & weed out lower profits
Here, entry is very difficult. In the case of positive economic profits, the same signal that things are good
is sent out, but entry is hard so people are screwed :3 Technological experience, people choose tradition
over newness, superior. (i.e. Lower the price of gas 20 cents)
Possible outcomes: positive and zero profit
All factors of production are variable
4. Dead-weight loss and question of efficiency
Digression: Consumer surplus – is an amount that the consumer is willing to pay for a product, but did
not have to
S curve for perfect comp. is MC for the monopolist
Dead-weight loss triangle
Space between where D meets MC
(perfect competition E), E line up from the mon,
where those two lines (red and green) meet.
Blocks = revenue
If you could go “you’re fat, so I’m charging you more for cake”, firms would earn all the revenue – the
full funny shape up to E*
But you can’t. So you charge P* for Q*
We don’t have allocative efficiency since we a level of output where P ≠ MC. In other words (*assuming
no externalities) we have underproduction (too small an output).
Underproduction brings dead-weight loss (which brings underproduction. Look at it both ways)
5. Conclusion
1) How to affect a monopolist’s output decision
Q TC old MC old TC new MC new
3 50 - 40 -
4 60 10 50 10
5 80 20 70 20
6 110 30 100 30
Subside the monopolist – TC drops. (Subsidy of 10) MR AR ↖MC
To actually influence their output, subsidise per unit, not a flat rate. Vertical distance is subsidy – vertical
line up from where mc cuts mr up to ar – increasing the quantity decreases the price. Is good. MR AR MC
Negative externality – pollution
Fine of $10 million – does nothing
Per unit tax = better – vert. dist.
Fine = lump sum tax.
2) Deadweight loss of taxation (this is a digression, doesn’t really relate to monopoly)
A
B C
E I F
H G
Consumer surplus pre-tax: A, F, H
Consumer surplus after tax: A, B, C
Difference between consumer surplus: B, C, F, H
Per unit tax: C – G
Gov’t collects: B, C, G, H
Consumer share of tax: B – E
Firm share of tax: E – H
Consumer pocket straight to gov’t: B, C, E, I
Amount of consumer surplus not going to gov’t: C, I, F dead weight loss triangle. Bad for economy.
Cost of taxing: reduce the volume of goods transacted = l
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