AP Micro Unit 6 - Other lectures

To find the price the monopolist will charge, we extend a vertical line from Qm up to the demand curve D. The unique price Pm at which Qm units can be sold is $122. In this case, $122 is the profit-maximizing price. So the monopolist sets the quantity at Qm to charge its profit-maximizing price of $122. Columns 2 and 5 in Table 11.1 show that at 5 units of output, the product price ($122) exceeds the average total cost ($94). The monopolist thus obtains an economic profit of $28 per unit, and the total economic profit is $140 (= 5 units × $28). In Figure 11.4, per-unit profit is Pm − A, where A is the average total cost of producing Qm units. Total economic profit—the green rectangle—is found by multiplying this per-unit profit by the profit-maximizing output Qm. Another way to determine the profit-maximizing output is by comparing total revenue and total cost at each possible level of production and choosing the output with the greatest positive difference. Use columns 3 and 6 in Table 11.1 to verify that 5 units is the profit-maximizing output. An accurate graphing of total revenue and total cost against output would also show the greatest difference (the maximum profit) at 5 units of output. Table 11.2 summarizes the process for determining the profit-maximizing output, profit-maximizing price, and economic profit in pure monopoly.

1. Determine the profit-maximizing output by finding where MR = MC. Step 2. Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolist's demand curve Step 3. Determine the pure monopolist's economic profit using one of two methods:Method 1.Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any).Method 2.Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine economic profit (if any).

studied in Chapters 9 and 10. By using the same cost data that we developed in Chapter 8 and applied to the competitive firm in Chapters 9 and 10, we will be able to directly compare the price and output decisions of a pure monopoly with those of a pure competitor. This will help us demonstrate that the price and output differences between a pure monopolist and a pure competitor are not the result of two different sets of costs. Columns 5 through 7 in Table 11.1 restate the pertinent cost data from Table 8.2.

A monopolist seeking to maximize total profit will employ the same rationale as a profit-seeking firm in a competitive industry. If producing is preferable to shutting down, it will produce up to the output at which marginal revenue equals marginal cost (MR = MC). A comparison of columns 4 and 7 in Table 11.1 indicates that the profit-maximizing output is 5 units because the fifth unit is the last unit of output whose marginal revenue exceeds its marginal cost. What price will the monopolist charge? The demand schedule shown as columns 1 and 2 in Table 11.1 indicates there is only one price at which 5 units can be sold: $122.

Column 4 in Table 11.1 shows that marginal revenue is always less than the corresponding product price in column 2, except for the first unit of output. Because marginal revenue is the change in total revenue associated with each additional unit of output, the declining amounts of marginal revenue in column 4 mean that total revenue increases at a diminishing rate (as shown in column 3).

Demand, marginal revenue, and total revenue for a pure monopolist. (a) Because it must lower price on all units sold in order to increase its sales, an imperfectly competitive firm's marginal-revenue curve (MR) lies below its downsloping demand curve (D). The elastic and inelastic regions of demand are highlighted. (b) Total revenue (TR) increases at a decreasing rate, reaches a maximum, and then declines. Note that in the elastic region, TR is increasing and hence MR is positive. When TR reaches its maximum, MR is zero. In the inelastic region of demand, TR is declining, so MR is negative. Note that the monopolist's MR curve lies below the demand curve, indicating that marginal revenue is less than price at every output quantity but the very first unit. Observe also the special relationship between total revenue (shown in the lower graph) and marginal revenue (shown in the top graph). Because marginal revenue is the change in total revenue, marginal revenue is positive while total revenue is increasing. When total revenue reaches its maximum, marginal revenue is zero. When total revenue is diminishing, marginal revenue is negative.

Pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes. Here are the main characteristics of pure monopoly: Single seller A pure, or absolute, monopoly is an industry in which a single firm is the sole producer of a specific good or the sole supplier of a service; the firm and the industry are synonymous. Page 215No close substitutes A pure monopoly's product is unique in that there are no close substitutes. The consumer who chooses not to buy the monopolized product must do without it. Price maker The pure monopolist controls the total quantity supplied and thus has considerable control over price; it is a price maker (unlike a pure competitor, which has no such control and therefore is a price taker). The pure monopolist confronts the usual downsloping product demand curve. It can change its product price by changing the quantity of the product it produces. The monopolist will use this power whenever it is advantageous to do so. Blocked entry A pure monopolist has no immediate competitors because certain barriers keep potential competitors from entering the industry. Those barriers may be economic, technological, legal, or of some other type. But entry is totally blocked in pure monopoly. Nonprice competition The product produced by a pure monopolist may be either standardized (as with natural gas and electricity) or differentiated (as with Windows or Frisbees). Monopolists that have standardized products engage mainly in public relations advertising, whereas those with differentiated products sometimes advertise their products' attributes.

Examples of pure monopoly are relatively rare, but there are many examples of less pure forms. In most cities, government-owned or government-regulated public utilities—natural gas and electric companies, the water company, the cable TV company, and the local telephone company—are all monopolies or virtually so. There are also many "near-monopolies" in which a single firm has the bulk of sales in a specific market. Intel, for example, produces 80 percent of the central microprocessors used in personal computers. First Data Corporation, via its Western Union subsidiary, accounts for 80 percent of the market for money order transfers. Brannock Device Company has an 80 percent market share of the shoe sizing devices found in shoe stores. Wham-O, through its Frisbee brand, sells 90 percent of plastic throwing disks. Google executes nearly 70 percent of all U.S. Internet searches and consequently controls nearly 75 percent of all the revenue generated by search ads in the United States. Professional sports teams are, in a sense, monopolies because they are the sole suppliers of specific services in large geographic areas. With a few exceptions, a single major-league team in each sport serves each large American city. If you want to see a live Major League Baseball game in St. Louis or Seattle, you must patronize the Cardinals or the Mariners, respectively. Other geographic monopolies exist. For example, a small town may be served by only one airline or railroad. In a small, isolated community, the local barber shop, dry cleaner, or grocery store may approximate a monopoly. And in the skies above, airlines control the only Internet access that is available to the passengers flying on their planes.

If this type of price discrimination increases revenue and profit, why don't teams also price discriminate at the concession stands? Why don't they offer half-price hot dogs, soft drinks, peanuts, and Cracker Jack to children? The answer involves the three requirements for successful price discrimination. All three requirements are met for game tickets: (1) The team has monopoly power; (2) it can segregate ticket buyers by age group, each group having a different elasticity of demand; and (3) children cannot resell their discounted tickets to adults. It's a different situation at the concession stands. Specifically, the third condition is not met. If the team had dual prices, it could not prevent the exchange or "resale" of the concession goods from children to adults. Many adults would send children to buy food and soft drinks for them: "Here's some money, Billy. Go buy six hot dogs." In this case, price discrimination would reduce, not increase, team profit. Thus, children and adults are charged the same high prices at the concession stands. (These prices are high relative to those for the same goods at the local convenience store because the stadium sellers have a captive audience and thus considerable monopoly power.)

Finally, price discrimination often occurs in international trade. A Russian aluminum producer, for example, might sell aluminum for less in the United States than in Russia. In the United States, this seller faces an elastic demand because several substitute suppliers are available. But in Russia, where the manufacturer dominates the market and trade barriers impede imports, consumers have fewer choices and thus demand is less elastic.

Price discrimination to different groups of buyers. The price-discriminating monopolist represented here maximizes its total profit by dividing the market into two segments based on differences in elasticity of demand. It then produces and sells the MR = MC output in each market segment. (For visual clarity, average total cost, ATC, is assumed to be constant. Therefore, MC equals ATC at all output levels.) (a) The price-discriminating monopolist charges a high price (here Pb) to small-business customers because they have a relatively inelastic demand curve for the product. (b) The firm charges a low price (here Ps) to students because their demand curve is relatively elastic. The firm's total profit from using price discrimination (here, the sum of the two green rectangles) exceeds the profit (not shown) that would have occurred if the monopolist had charged the same price to all customers.

Firms engage in price discrimination because it enhances their profit. The numbers (not shown) behind the curves in Figure 11.8 would clearly reveal that the sum of the two profit rectangles shown in green exceeds the single profit rectangle the firm would obtain from a single monopoly price. How do consumers fare? In this case, students clearly benefit by paying a lower price than they would if the firm charged a single monopoly price; in contrast, the price discrimination results in a higher price for business customers. Therefore, compared to the single-price situation, students buy more of the software and small businesses buy less. Such price discrimination is widespread in the economy and is illegal only when it is part of a firm's strategy to lessen or eliminate competition. We will discuss illegal price discrimination in Chapter 18, which covers antitrust policy.

market demand, only a few large firms or, in the extreme, only a single large firm can achieve low average total costs. Figure 11.1 indicates economies of scale over a wide range of outputs. If total consumer demand is within that output range, then only a single producer can satisfy demand at least cost. Note, for example, that a monopolist can produce Page 216200 units at a per-unit cost of $10 and a total cost of $2,000. If the industry has two firms and each produces 100 units, the unit cost is $15 and total cost rises to $3,000 (= 200 units × $15). A still more competitive situation with four firms each producing 50 units would boost unit and total cost to $20 and $4,000, respectively. Conclusion: When long-run ATC is declining, only a single producer, a monopolist, can produce any particular amount of output at minimum total cost.

If a pure monopoly exists in such an industry, economies of scale will serve as an entry barrier and will protect the monopolist from competition. New firms that try to enter the industry as small-scale producers cannot realize the cost economies of the monopolist. They therefore will be undercut and forced out of business by the monopolist, which can sell at a much lower price and still make a profit because of its lower per-unit cost associated with its economies of scale. A new firm might try to start out big, that is, to enter the industry as a large-scale producer so as to achieve the necessary economies of scale. But the massive expense of the plant facilities along with customer loyalty to the existing product would make the entry highly risky. Therefore, the new and untried enterprise would find it difficult to secure financing for its venture. In most cases the risks and financial obstacles to "starting big" are prohibitive. This explains why efforts to enter such industries as computer operating software, commercial aircraft, and household laundry equipment are so rare. A monopoly firm is referred to as a natural monopoly if the market demand curve intersects the long-run ATC curve at any point where average total costs are declining. If a natural monopoly were to set its price where market demand intersects long-run ATC, its price would be lower than if the industry were more competitive. But it will probably set a higher price. As with any monopolist, a natural monopolist may, instead, set its price far above ATC and obtain substantial economic profit. In that event, the lowest-unit-cost advantage of a natural monopolist would accrue to the monopolist as profit and not as lower prices to consumers. That is why the government regulates some natural monopolies, specifying the price they may charge. We will say more about that later.

Rent-Seeking Expenditures Rent-seeking behavior is any activity designed to transfer income or wealth to a particular firm or resource supplier at someone else's, or even society's, expense. We have seen that a monopolist can obtain an economic profit even in the long run. Therefore, it is no surprise that a firm may go to great expense to acquire or maintain a monopoly granted by government through legislation or an exclusive license. Such rent-seeking expenditures add nothing to the firm's output, but they clearly increase its costs. Taken alone, rent seeking implies that monopoly involves even higher costs and even less efficiency than suggested in Figure 11.6b.

Monopoly is a legitimate concern. Monopolists can charge higher-than-competitive prices that result in an underallocation of resources to the monopolized product. They can stifle innovation, engage in rent-seeking behavior, and foster X-inefficiency. Even when their costs are low because of economies of scale, there is no guarantee that the price they charge will reflect those low costs. The cost savings may simply accrue to the monopoly as greater economic profit. Fortunately, however, monopoly is not widespread in the United States. Barriers to entry are seldom completely successful. Although research and technological advance may strengthen the market position of a monopoly, technology may also undermine monopoly power. Over time, the creation of new technologies may work to destroy monopoly positions. For example, the development of courier delivery, fax machines, and e-mail has eroded the monopoly power of the U.S. Postal Service. Similarly, cable television monopolies are now challenged by satellite TV and by technologies that permit the transmission of audio and video over the Internet.

Now we must recognize that costs may not be the same for purely competitive and monopolistic producers. The unit cost incurred by a monopolist may be either larger or smaller than that incurred by a purely competitive firm. There are four reasons costs may differ: (1) economies of scale, (2) a factor called "X-inefficiency," (3) the need for monopoly-preserving expenditures, and (4) the "very long run" perspective, which allows for technological advance. Economies of Scale Once Again Where economies of scale are extensive, market demand may not be sufficient to support a large number of competing firms, each producing at minimum efficient scale. In such cases, an industry of one or two firms would have a lower average total cost than would the same industry made up of numerous competitive firms. At the extreme, only a single firm—a natural monopoly—might be able to achieve the lowest long-run average total cost. Some firms relating to new information technologies—for example, computer software, Internet service, and wireless communications—have displayed extensive economies of scale. As these firms have grown, their long-run average total costs have declined because of greater use of specialized inputs, the spreading of product development costs, and learning by doing. Also, simultaneous consumption and network effects have reduced costs. A product's ability to satisfy a large number of consumers at the same time is called simultaneous consumption (or nonrivalrous consumption). Dell Computers needs to produce a personal computer for each customer, but Microsoft needs to produce its Windows program only once. Then, at very low marginal cost, Microsoft delivers its program by disk or Internet to millions of consumers. A similarly low cost of delivering product to additional customers is true for Internet service providers, music producers, and wireless communication firms. Because marginal costs are so low, the average total cost of output declines as more customers are added.

Network effects are present if the value of a product to each user, including existing users, increases as the total number of users rises. Good examples are computer software, cell phones, and website like Facebook where the content is Page 225provided by users. When other people have Internet service and devices to access it, a person can conveniently send e-mail messages to them. And when they have similar software, various documents, spreadsheets, and photos can be attached to the e-mail messages. The greater the number of persons connected to the system, the more the benefits of the product to each person are magnified. Such network effects may drive a market toward monopoly because consumers tend to choose standard products that everyone else is using. The focused demand for these products permits their producers to grow rapidly and thus achieve economies of scale. Smaller firms, which either have higher-cost "right" products or "wrong" products, get acquired or go out of business.

At first glance we would suspect that the pure monopolist's marginal-cost curve would also be its supply curve. But that is not the case. The pure monopolist has no supply curve. There is no unique relationship between price and quantity supplied for a monopolist. Like the competitive firm, the monopolist equates marginal revenue and marginal cost to determine output, but for the monopolist marginal revenue is less than price. Because the monopolist does not equate marginal cost to price, it is possible for different demand conditions to bring about different prices for the same output. To understand this point, refer to Figure 11.4 and pencil in a new, steeper marginal-revenue curve that intersects the marginal-cost curve at the same point as does the present marginal-revenue curve. Then draw in a new demand curve that is roughly consistent with your new marginal-revenue curve. With the new curves, the same MR = MC output of 5 units now means a higher profit-maximizing price. Conclusion: There is no single, unique price associated with each output level Qm, and so there is no supply curve for the pure monopolist.

Not Highest Price Because a monopolist can manipulate output and price, people often believe it "will charge the highest price possible." That is incorrect. There are many prices above Pm in Figure 11.4, but the monopolist shuns them because they yield a smaller-than-maximum total profit. The monopolist seeks maximum total profit, not maximum price. Some high prices that could be charged would reduce sales and total revenue too severely to offset any decrease in total cost. Total, Not Unit, Profit The monopolist seeks maximum total profit, not maximum unit profit. In Figure 11.4 a careful comparison of the vertical distance between average total cost and price at various possible outputs indicates that per-unit profit is greater at a point slightly to the left of the profit-maximizing output Qm. This is seen in Table 11.1, where the per-unit profit at 4 units of output is $32 (= $132 − $100) compared with $28 (= $122 − $94) at the profit-maximizing output of 5 units. Here the monopolist accepts a lower-than-maximum per-unit profit because additional sales more than compensate for the lower unit profit. A monopolist would rather sell 5 units at a profit of $28 per unit (for a total profit of $140) than 4 units at a profit of $32 per unit (for a total profit of only $128). Possibility of Losses by Monopolist The likelihood of economic profit is greater for a pure monopolist than for a pure competitor. In the long run the pure competitor is destined to have only a normal profit, whereas barriers to entry mean that any economic profit realized by the monopolist can persist. In pure monopoly there are no new entrants to increase supply, drive down price, and eliminate economic profit. But pure monopoly does not guarantee profit. The monopolist is not immune from changes in tastes that reduce the demand for its product. Nor is it immune from upward-shifting cost curves caused by escalating resource prices. If the demand and cost situation faced by the monopolist is far less favorable than that in Figure 11.4, the monopolist will incur losses in the short run. Consider the monopoly enterprise shown in Figure 11.5. Despite its dominance in the market (as, say, a seller of home sewing machines), it suffers a loss, as shown, because of weak demand and relatively high costs. Yet it continues to operate for the time being because its total loss is less than its fixed cost. More precisely, at output Qm the monopolist's price Pm exceeds its average variable cost V. Its loss per unit is A − Pm, and the total loss is shown by the red rectangle.

Government also creates legal barriers to entry by awarding patents and licenses. Patents A patent is the exclusive right of an inventor to use, or to allow another to use, her or his invention. Patents and patent laws aim to protect the inventor from rivals who would use the invention without having shared in the effort and expense of developing it. At the same time, patents provide the inventor with a monopoly position for the life of the patent. The world's nations have agreed on a uniform patent length of 20 years from the time of application. Patents have figured prominently in the growth of modernday giants such as IBM, Pfizer, Intel, Xerox, General Electric, and DuPont. Research and development (R&D) is what leads to most patentable inventions and products. Firms that gain monopoly power through their own research or by purchasing the patents of others can use patents to strengthen their market position. The profit from one patent can finance the research required to develop new patentable products. In the pharmaceutical industry, patents on prescription drugs have produced large monopoly profits that have helped finance the discovery of new patentable medicines. So monopoly power achieved through patents may well be self-sustaining, even though patents eventually expire and generic drugs then Page 217compete with the original brand. (Chapter 10's Last Word has more on the costs and benefits of patents.) Licenses Government may also limit entry into an industry or occupation through licensing. At the national level, the Federal Communications Commission licenses only so many radio and television stations in each geographic area. In many large cities one of a limited number of municipal licenses is required to drive a taxicab. The consequent restriction of the supply of cabs creates economic profit for cab owners and drivers. New cabs cannot enter the industry to drive down prices and profits. In a few instances the government might "license" itself to provide some product and thereby create a public monopoly. For example, in some states only state-owned retail outlets can sell liquor. Similarly, many states have "licensed" themselves to run lotteries.

Ownership or Control of Essential Resources A monopolist can use private property as an obstacle to potential rivals. For example, a firm that owns or controls a resource essential to the production process can prohibit the entry of rival firms. At one time the International Nickel Company of Canada (now called Vale Canada Limited) controlled 90 percent of the world's known nickel reserves. A local firm may own all the nearby deposits of sand and gravel. And it is very difficult for new sports leagues to be created because existing professional sports leagues have contracts with the best players and have long-term leases on the major stadiums and arenas.

Even if a firm is not protected from entry by, say, extensive economies of scale or ownership of essential resources, entry may effectively be blocked by the way the monopolist responds to attempts by rivals to enter the industry. Confronted with a new entrant, the monopolist may "create an entry barrier" by slashing its price, stepping up its advertising, or taking other strategic actions to make it difficult for the entrant to succeed. Some examples of entry deterrence: In 2005 Dentsply, the dominant American maker of false teeth (80 percent market share) was found to have unlawfully precluded independent distributors of false teeth from carrying competing brands. The lack of access to the distributors deterred potential foreign competitors from entering the U.S. market. As another example, in 2015 American Express was found guilty of an unlawful restraint of trade because it prohibited any merchant who had signed up to accept American Express credit cards from promoting rival credit cards—such as Visa or MasterCard—to their customers.

Patents, economies of scale, or resource ownership secures the firm's monopoly. No unit of government regulates the firm. The firm is a single-price monopolist; it charges the same price for all units of output. The crucial difference between a pure monopolist and a purely competitive seller lies on the demand side of the market. The purely competitive seller faces a perfectly elastic demand at the price determined by market supply and demand. It is a price taker that can sell as much or as little as it wants at the going market price. Each additional unit sold will add the amount of the constant product price to the firm's total revenue. That means that marginal revenue for the competitive seller is constant and equal to product price. (Refer to the table and graph in Figure 9.1 for price, marginal-revenue, and total-revenue relationships for the purely competitive firm.) The demand curve for the monopolist (and for any imperfectly competitive seller) is quite different from that of the pure competitor. Because the pure monopolist is the industry, its demand curve is the market demand curve. And because market demand is not perfectly elastic, the monopolist's demand curve is downsloping. Columns 1 and 2 in Table 11.1 illustrate this concept. Note that quantity demanded increases as price decreases.

The opportunity to engage in price discrimination is not readily available to all sellers. Price discrimination is possible when the following conditions are met: Monopoly power The seller must be a monopolist or, at least, must possess some degree of monopoly power, that is, some ability to control output and price. Market segregation At relatively low cost to itself, the seller must be able to segregate buyers into distinct classes, each of which has a different willingness or ability to pay for the product. This separation of buyers is usually based on different price elasticities of demand, as the examples below will make clear. No resale The original purchaser cannot resell the product or service. If buyers in the low-price segment of the market could easily resell in the high-price segment, the monopolist's price-discrimination strategy would create competition in the high-price segment. This competition would reduce the price in the high-price segment and undermine the monopolist's price-discrimination policy. This condition suggests that service industries such as the transportation industry or legal and medical services, where resale is impossible, are good candidates for price discrimination.

Price discrimination is widely practiced in the U.S. economy. For example, we noted in Chapter 6's Last Word that airlines charge high fares to business travelers, whose demand for travel is inelastic, and offer lower, highly restricted, nonrefundable fares to attract vacationers and others whose demands are more elastic.

Like the pure competitor, the monopolist will not persist in operating at a loss. Faced with continuing losses, in the long run the firm's owners will move their resources to alternative industries that offer better profit opportunities. A Page 223monopolist such as the one depicted in Figure 11.5 must obtain a minimum of a normal profit in the long run or it will go out of business.

Recall that this price-output combination results in both productive efficiency and allocative efficiency. Productive efficiency is achieved because free entry and exit force firms to operate where average total cost is at a minimum. The sum of the minimum-ATC outputs of the 1,000 pure competitors is the industry output, here, Qc. Product price is at the lowest level consistent with minimum average total cost. The allocative efficiency of pure competition results because production occurs up to that output at which price (the measure of a product's value or marginal benefit to society) equals marginal cost (the worth of the alternative products forgone by society in producing any given commodity). In short: P = MC = minimum ATC. Now let's suppose that this industry becomes a pure monopoly (Figure 11.6b) as a result of one firm acquiring all its competitors. We also assume that no changes in costs or market demand result from this dramatic change in the industry structure. What formerly were 1,000 competing firms is now a single pure monopolist consisting of 1,000 noncompeting branches. The competitive market supply curve S has become the marginal-cost curve (MC) of the monopolist, the summation of the individual marginal-cost curves of its many branch plants. (Since the monopolist does not have a supply curve, as such, we have removed the S label.) The important change, however, is on the demand side. From the viewpoint of each of the 1,000 individual competitive firms, demand was perfectly elastic, and marginal revenue was therefore equal to the market equilibrium price Pc. So each firm equated its marginal revenue of Pc dollars per unit with its individual marginal cost curve to maximize profits. But market demand and individual demand are the same to the pure monopolist. The firm is the industry, and thus the monopolist sees the downsloping demand curve D shown in Figure 11.6b.

Monopoly is worth studying both for its own sake and because it provides insights about the more common market structures of monopolistic competition and oligopoly (Chapters 12 and 13). These two market structures combine, in differing degrees, characteristics of pure competition and pure monopoly.

The factors that prohibit firms from entering an industry are called barriers to entry. In pure monopoly, strong barriers to entry effectively block all potential competition. Somewhat weaker barriers may permit oligopoly, a market structure dominated by a few firms. Still weaker barriers may permit the entry of a fairly large number of competing firms giving rise to monopolistic competition. And the absence of any effective entry barriers permits the entry of a very large number of firms, which provide the basis of pure competition. So barriers to entry are pertinent not only to the extreme case of pure monopoly but also to other market structures in which there are monopoly-like characteristics or monopoly-like behaviors.

If the monopoly is achieved and sustained through anticompetitive actions, creates substantial economic inefficiency, and appears to be long-lasting, the government can file charges against the monopoly under the antitrust laws. If found guilty of monopoly abuse, the firm can either be expressly prohibited from engaging in certain business activities or be broken into two or more competing firms. An example of the breakup approach was the dissolution of Standard Oil into several competing firms in 1911. In contrast, in 2001 an appeals court overruled a lower-court decision to divide Microsoft into two firms. Instead, Microsoft was prohibited from engaging in a number of specific Page 227anticompetitive business activities. (We discuss the antitrust laws and the Microsoft case in Chapter 18.) If the monopoly is a natural monopoly, society can allow it to continue to expand. If no competition emerges from new products, government may then decide to regulate its prices and operations. (We discuss this option later in this chapter and also in Chapter 18.) If the monopoly appears to be unsustainable because of emerging new technology, society can simply choose to ignore it. In such cases, society simply lets the process of creative destruction (discussed in Chapter 10) do its work.

We have assumed in this chapter that the monopolist charges a single price to all buyers. But under certain conditions the monopolist can increase its profit by charging different prices to different buyers. In so doing, the monopolist is engaging in price discrimination, the practice of selling a specific product at more than one price when the price differences are not justified by cost differences. Price discrimination can take three forms: Charging each customer in a single market the maximum price she or he is willing to pay. Charging each customer one price for the first set of units purchased and a lower price for subsequent units purchased. Charging some customers one price and other customers another price.

X-Inefficiency In constructing all the average-total-cost curves used in this book, we have assumed that the firm uses the most efficient existing technology. This assumption is only natural because firms cannot maximize profits unless they are minimizing costs. X-inefficiency occurs when a firm produces output at a higher cost than is necessary to produce it. In Figure 11.7 X-inefficiency is represented by operation at points X and X′ above the lowest-cost ATC curve. At these points, per-unit costs are ATCX (as opposed to ATC1) for output Q1 and ATCX′ (as opposed to ATC2) for output Q2. Producing at any point above the average-total-cost curve in Figure 11.7 reflects inefficiency or "bad management" by the firm.

Why is X-inefficiency allowed to occur if it reduces profits? The answer is that managers may have goals, such as expanding power, an easier work life, avoiding business risk, or giving jobs to incompetent relatives, that conflict with cost minimization. Or X-inefficiency may arise because a firm's workers are poorly motivated or ineffectively supervised. Or a firm may simply become lethargic and inert, relying on rules of thumb in decision making as opposed to careful calculations of costs and revenues.

In Figure 9.7 we drew separate demand curves for the purely competitive industry and for a single firm in such an industry. But only a single demand curve is needed in pure monopoly because the firm and the industry are one and the same. We have graphed part of the demand data in Table 11.1 as demand curve D in Figure 11.2. This is the monopolist's demand curve and the market demand curve. The downsloping demand curve has three implications that are essential to understanding the monopoly model.

With a fixed downsloping demand curve, the pure monopolist can increase sales only by charging a lower price. Consequently, marginal revenue—the change in total revenue associated with a one-unit change in output—is less than price (average revenue) for every unit of output except the first. Why so? The reason is that the lower price of the extra unit of output also applies to all prior units of output. The Page 218monopolist could have sold these prior units at a higher price if it had not produced and sold the extra output. Each additional unit of output sold increases total revenue by an amount equal to its own price less the sum of the price cuts that apply to all prior units of output.

All imperfect competitors, whether pure monopolists, oligopolists, or monopolistic competitors, face downsloping demand curves. As a result, any change in quantity produced causes a movement along their respective demand curves and a change in the price they can charge for their respective products. Economists summarize this fact by saying that firms with downsloping demand curves are price makers. This is most evident in pure monopoly, where an industry consists of a single monopoly firm so that total industry output is exactly equal to whatever the single monopoly firm chooses to produce. As we just mentioned, the monopolist faces a downsloping demand curve in which each amount of output is associated with some unique price. Thus, in deciding on the quantity of output to produce, the monopolist is also determining the price it will charge. Through control of output, it can "make the price." From columns 1 and 2 in Table 11.1 we find that the monopolist can charge a price of $72 if it produces and offers for sale 10 units, a price of $82 if it produces and offers for sale 9 units, and so forth.

demand is inelastic, a decline in price will reduce total revenue. Beginning at the top of demand curve D in Figure 11.3a, observe that as the price declines from $172 to approximately $82, total revenue increases (and marginal revenue therefore is positive). This means that demand is elastic in this price range. Conversely, for price declines below $82, total revenue decreases (marginal revenue is negative), indicating that demand is inelastic there. Page 220 The implication is that a monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease (marginal revenue to be negative). The profit-maximizing monopolist will always want to avoid the inelastic segment of its demand curve in favor of some price-quantity combination in the elastic region. Here's why: To get into the inelastic region, the monopolist must lower price and increase output. In the inelastic region a lower price means less total revenue. And increased output always means increased total cost. Less total revenue and higher total cost yield lower profit.

Differences in worker productivity, varying trade patterns, patterns of past discrimination and tax policies are some of the reasons for what economists call -- --

income inequality

Wealth is accumulated assets minus --

liabilities

This means that marginal revenue is less than price, that graphically the MR curve lies below demand curve D. In using the MR = MC rule, the monopolist selects output Qm and price Pm. A comparison of both graphs in Figure 11.6 reveals that the monopolist finds it profitable to sell a smaller output at a higher price than do the competitive producers. Monopoly yields neither productive nor allocative efficiency. The lack of productive efficiency can be understood most directly by noting that the monopolist's output Qm is less than Qc, the output at which average total cost is lowest. In addition, the monopoly price Pm is higher than the competitive price Pc that we know in long-run equilibrium in pure competition equals minimum average total cost. Thus, the monopoly price exceeds minimum average total cost, thereby demonstrating in another way that the monopoly will not be productively efficient. The monopolist's underproduction also implies allocative inefficiency. One way to see this is to note that at the monopoly output level Qm, the monopoly price Pm that consumers are willing to pay exceeds the marginal cost of production. This means that consumers value additional units of this product more highly than they do the alternative products that could be produced from the resources that would be necessary to make more units of the monopolist's product. The monopolist's allocative inefficiency can also be understood by noting that for every unit between Qm and Qc, marginal benefit exceeds marginal cost because the demand curve lies above the supply curve. By choosing not to produce these units, the monopolist reduces allocative efficiency because the resources that should have been used to make these units will be redirected instead toward producing items that bring lower net benefits to society. The total dollar value of this efficiency loss (or deadweight loss) is equal to the area of the gray triangle labeled abc in Figure 11.6b.

n general, a monopoly transfers income from consumers to the owners of the monopoly. The income is received by the owners as revenue. Because a monopoly has market power, it can charge a higher price than would a purely competitive firm with the same costs. So the monopoly in effect levies a "private tax" on consumers. This private tax can often generate substantial economic profits that can persist because entry to the industry is blocked.

Taxes that take a larger share of income from high income groups

progressive taxes

Taxes that take the same percent of income from all income groups

proportional taxes

Taxes that take a larger percentage from low income groups

regressive taxes

The x axis that accommodates the Lorenz curve is..

the percentage of households