4 - Monopoly

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Gustavo Indart

MONOPOLY A monopoly is the sole producer in an industry This means industry demand is demand for the monopoly and that the marginal cost and average cost functions of the monopoly are the marginal cost and average cost functions for the industry Since price is not constant marginal revenue is not equal to price for a monopolist Also since P is not constant and price is dependent upon the output of the monopoly a monopoly can determine commodity price by restricting output The marginal cost function of the monopoly is not the supply function for the industry because quantity supplied is not simply determined by the marginal cost in response to a price but depends upon the monopolists determination of price to maximize profit Profit Maximization for a Monopolist MRMCSlope 2Slope for Linear Demand MR DMR for linear demand has the same intercept term as the Demand function and twice the slopeElasticity is unit elastic at the midpoint of a Demand function which means that MR is 0 at the midpoint because Total Revenue doesnt change A monopoly will not produce in the inelastic portion of a Demand function since a decrease in quantity will a increase Total Revenue and b reduce Variable Costs The monopolist reduces quantity in the elastic portion of the Demand function so long as the decreased Variable Cost of one less unit is greater than the decreased revenue from one less unit ie until MRMCMonopoly Equilibrium and Economic Profit Monopoly Equilibriummonopoly output Q where MRMC MMonopoly Price P from Demand at Q MMAverage Cost AC from Average Cost at Q MMEconomic ProfitPACQ or PQ Total Cost MMMMM M Types of Monopoly 1 Government Monopolies governments perform functions that otherwise might be monopolized establish public corporations with monopoly power in an industry or grant monopoly power to private firms The rationale for government monopolies is to prevent private exploitation of a natural monopoly for revenue purposes 2 Control of an Essential Input Normal monopoly control over an essential resource technology or product establishes the barrier to entry for most monopolies Since control over an input or output eliminates the entry of other firms the Normal need only be large enough to produce the output that maximizes profit This means the minimum average cost of the monopoly is to the left of the demand function for the industry3 Natural Monopolies occur where MES of production is sufficient to supply the quantity demanded in an industry at falling AC thereby making it impossible for other firms to enter Minimum AC is to the right of Demand for such a monopoly The barrier to entry of new firms is therefore the economies of scale of the optimally sized firm in the industry A feature of Natural Monopolies is that MC tends to be constant for all output below minimum AC because economies of scale allow low MC for most output Cartels Otherwise competitive firms could get together and act as a monopolist in order to Restrict the total industry output Set higher market price for the goodIncrease the total and individual profitsCartels can face problems as well Enforcement of output restrictions cartels maximize collective not individual profitsRestrict entry into the industryWhen a cartel forms each firm in the industry will decrease its output to increase price in the industry After the cartel successfully increases price a single firm can increase its profits by increasing its quantity produced With the higher quantity at the same cartel price the cheating firm will have a greater profit than other firms in the cartelSummary of Questions to be Asked 1 What will happen to price and quantity of a good if an industry is monopolized2 What will happen to a monopolists economic profits if TFC or TVC falls3 Draw a monopoly in shortrun equilibrium determine equilibrium price and quantity4 Calculate a monopolys profit5 If a monopolist could perfectly pricediscriminate what is price and quantity 6 Determine the expression for a cartels MC and MR curve given the expressions for the demand and supply curve of the formerly competitive industry7 At what level will the cartels profits be maximized Determine equilibrium price and quantity8 Show in a diagram the profits that a member of a cartel will make if all cartel members complied with the agreement of output produced 9 Determine what would happen if a member of the cartel cheated quantity supplied and profits made by that firm Sample Questions from July 2012 Midterm
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