Microeconomics Chapter 24: Monopoly

Real World Informational Limits:

The monopolist can only estimate the actual demand curve and therefore can make only an educated guess when it sets its profit-maximizing price This is not a problem for the perfect competitor because the price is given by the intersection of market demand and market supply The monopolist reaches the profit-maximizing output-price combination by trial and error

24.1 Monopolist:

The single supplier of a good or service for which there is no close substitute. The monopolist therefore constitutes its entire industry

Price Searcher:

A firm that must determine the price-output combination that maximizes profit because it faces a downward sloping demand curve

24.1 Patent:

A patent is issued to an inventor to provide protection from having the invention copied or stolen for a period of 20 years; The patent holder has a monopoly

24.1 Barriers to Entry:

For any amount of monopoly power to continue to exist in the long run, the market must be closed to entry in some way. Either legal means or certain aspects of the industries technical or cost structure may prevent entry

Why Produce Where Marginal Cost Equals Marginal Revenue?:

If the monopolist produces where marginal costs exceeds marginal revenue, the incremental cost of producing any more units will exceed incremental revenue and will not be worthwhile and will not be maximizing profits

Monopoly vs. Perfect Competition:

Monopolists raise the price and restrict production, compared to a perfectly competitive situation. For a monopolist's product consumers pay a price that exceeds marginal cost of production. Resources are misallocated in such a situation - too few resources are being used in the monopolist's industry , and too many are used elsewhere

The Marginal Revenue - Marginal Cost Approach:

Profit maximization will also occur where marginal revenue equals marginal cost. This is as true for the monopolist as it is for the perfect competitor, although the monopolist will charge a price in excess of marginal revenue

The Total Revenues - Total Costs Approach:

For any given demand curve, in order to sell more, the monopolist must lower the price. This reflects the fact that the basic difference b/w a monopolist and a perfect competitor has to do with the demand curve for the two types of firms. Profit maximization occurs where MC=MR. The MC curve must cut the MR curve from below. Profit maximization involves maximizing the positive difference between total revenues and total costs

Price Searching to Maximize Monopoly Profits:

For the pure monopolist we must seek a profit-maximizing price-output combination because the monopolist is a price searcher

What Price to Charge for Output?:

How does the monopolist set prices? Quantity is set at the point where marginal costs equal marginal revenue. The monopolist then finds out how much it can charge for that particular quantity. The monopolist does so by identifying the price corresponding to the quantity on its demand curve

Price Differentiation:

Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers - Price discrimination should not be confused with price differentiation, the latter of which occurs when differences in price reflect differences in marginal cost.

24.1 Natural Monopoly:

A monopoly that arises from the peculiar production characteristics in an industry. It usually arises when there are large economies of scale relative to the industries demand such that one firm can produce at a lower average cost than can be achieved by multiple firms Is the first firm to take advantage of persistent declining long-run average costs as scale increases. The natural monopolist is able to underprice its competitors and eventually force them all out of the market

24.2 The Demand Curve a Monopolist Faces:

A pure monopolist is the sole supplier of one product. A pure monopolist faces the industry demand curve because because the monopolist is the entire industry Because the monopolist faces the industry demand curve, which is by definition downward sloping, its choice regarding how much to produce is not the same as for a perfect competitor When a monopolist changes output it does not receive the same price per unit that it did before the change

24.1 The Phenomenon of Economies of Scale:

A situation in which demand is insufficient to allow more than one producer in a market may arise because of economies of scale. Economies of scale exist whenever proportional increases of output yield proportionately smaller increases in total cost, and per-unit prices drop Larger firms with greater output have the advantage in that they experience lower per-unit costs. Their lower expenses enable them to charge lower prices and drive smaller firms out of the business

24.2 Marginal Revenue for the Monopolist:

Because a monopoly is the entire industry, its demand curve is the market curve. The market demand curve slopes downward. To induce consumers to buy more, given the industry demand curve, the firm must lower the price, thus moving down the demand curve Study Plan Question- Explanation: if the price​ decreases, quantity increases and total revenue​ increases, the quantity response is large relative to the price decrease so demand is elastic. If the price​ decreases, quantity increases and total revenue​ decreases, the quantity response is small relative to the price decrease so demand is inelastic. - If the revenue of a monopolist varies directly with changes in price; it IS NOT maximizing its economic profits because a​ profit-maximizing monopolist will never operate in a price range in which demand is inelastic since this is range in which revenues are falling and the firm could raise revenues by raising the price into the elastic range of demand.

24.2 Demand Curve for Perfect Competition and Pure Monopoly:

Demand Curve for Perfect Competition: the demand curve is straight and horizontal, perfectly elastic Question: Demand Curve for Pure Monopoly: the demand curve is steep and downward sloping; is the same as the industry demand curve. Question: The demand curve faced by the monopolist has greater price elasticity of demand as close substitutes for the monopoly product are developed. As close substitutes for the monopoly product are​ developed, consumers have greater ability to respond to price​ changes, so the demand has greater elasticity.

Study Plan Questions: 24.3

- Marginal cost equals the change in cost divided by the change in output. - Marginal revenue equals the change in revenue divided by the change in output. Q: A manager of a monopoly firm notices that the firm is producing output at a rate at which average total cost is falling but is not at its minimum feasible point. The manager argues that surely the firm must not be maximizing its economic profits. The​ manager's argument is A: ​incorrect, since profit maximization requires that marginal revenue equals marginal cost but does not require the average total cost to be at any particular level. Q: The marginal revenue curve of a monopoly crosses its marginal cost curve at ​$31 per​ unit, and an output of 5 million units. A: Economic profits are equal to the​ price, or average ​revenue($47​) minus the average total cost ​($38​), times the units of output ​(5 ​million) = ​$45 million. Q: A​ monopolist's maximized rate of economic profits is ​$1,200 per week. Its weekly output is 400 ​units, and at this output​ rate, the​ firm's marginal cost is ​$27 per unit. The price at which it sells each unit is ​$37 per unit. A: 1,200/400 = 3 At these profit and output​ rates, the​ firm's average total cost is ​$34 (37-3) At these profit and output​ rates, the​ firm's marginal revenue is ​$27 Q: Currently, a​ monopolist's profit-maximizing output is 300 units per week. It sells its output at a price of ​$60 per unit and collects ​$35 per unit in revenues from the sale of the last unit produced each week. The​ firm's total costs each week are $8,500. A: Firm's profit​ = TR-TC. But TR equals PxQ equals $60 x 300 = $ 18, 000. Since TC​ = ​$8,500​, profit​ = ​$18,000 - $8,500​= $9500 At the profit maximizing​ output,MR =MC. Since MR is given to be ​$35​, MC must also be ​$35 Q: A new competitor enters the industry and competes with a second​ firm, which had been a monopolist. The second firm finds that although demand is not perfectly​ elastic, it is now relatively more elastic. The second​ firm's marginal revenue will be​ _____________ and its​ profit-maximizing price will be​ ___________ A: more elastic, lower Q/A: If a​ monopolist's marginal cost curve shifts​ upward, the​ monopolist's price will increase, the output rate will decrease. Q/A: When the demand for a monopolist​ falls, the marginal revenue also shifts left and will intersect the marginal cost at a lower output level. the output rate will decrease, and economic profits will likely decrease. Q: Suppose that in the figure to the​ right, a monopolist knows that if it produces 10 units of​ output, its total revenues equal ​$60.00. If it were to reduce the price of its product to ​$5.80 per​ unit, the quantity​ demanded, and hence its​ output, would rise to 11 units per week. What would be the marginal revenue that the monopolist would derive from producing and selling a 11th ​unit? A: Total revenues from the production and sale of 11 units would equal ​$5.80 per unit times 11 units equals​ $63.8 Since total revenues for 10 units equal ​$60.00​, marginal revenue from the production and sale of the 11th unit would be ​$63.80 - ​$60.00 =$3.8 per unit. Q/A: Suppose that in the figure to the​ right, a monopolist knows that if it produces 11 units of​ output, its total revenues equal ​$63.80. If it were to reduce the price of its product to ​$5.60 per​ unit, the quantity​ demanded, and hence its​ output, would rise to 12 units per week. What would be the marginal revenue that the monopolist would derive from producing and selling a 12th ​unit? Since total revenues for 11 units equal ​$63.80​, marginal revenue from the production and sale of the 12th unit would be ​$3.4 per unit. ​ Q: Suppose that in the figure to the​ right, a monopolist knows that if it produces 11 units of​ output, its total revenues equal ​$63.80 and its total costs equal ​$48.70. If it were to reduce the price of its product to ​$5.60 per​ unit, the quantity​ demanded, and hence its​ output, would rise to 12 units per week. If the total costs of producing 12 units were equal to ​$57.70 per​ week, would the marginal revenue of producing the 12th unit be greater or less than the marginal cost of producing that​ unit? How would the​ firm's weekly economic profits be affected if the firm were to produce the 12th ​unit? A: The marginal revenue of producing the 12th unit would be less than the marginal cost by ​$5.60 If the firm were to produce the 12th ​unit, its weekly economic profits would fall by ​$5.60

Necessary Conditions for Price Discrimination:

1. The firm must face a downward sloping demand curve 2. The firm must be able to readily and cheaply identify buyers or groups of buyers with different elasticities of demand 3. The firm must be able to prevent resale of the product or service - The monopolist will sell some of its output at higher prices to consumers with less elastic demand. - A monopoly will engage in price discrimination whenever feasible to increase profits. - Charging different prices to different customers does not mean the monopoly is necessarily using price discrimination Air transport for businesspeople and tourists. - business people will pay more Serving food on weekdays to businesspeople and retired people.​ (Hint: Which group has less flexibility during a weekday to adjust to a price change​ and, hence, a lower price elasticity of​ demand?) - business people will pay more A theater that shows the same movie to large families and to individuals and couples.​ (Hint: For which set of people will the overall expense of a movie be a smaller part of their​ budget, so that demand is less​ elastic?) - individuals and couples will pay more

24.4 On Making Higher Profits: Price Discrimination

A monopolist may be able to charge different people, different prices or different unit prices for successive units sought by a given buyer. When there is no cost difference, such strategies are called price discrimination A firm will partake in price discrimination whenever feasible to increase profits. A price discriminating firm is able to some customers more than other customers - Successful price discrimination will provide the firm with more profit than if it did not discriminate.

Costs and Monopoly Profit Maximization:

Assume that profit maximization is the goal of the pure monopolist, just as it is for the perfect competitor. The perfect competitor only has to decide the rate of output because price is given. Perfect competitors are price takers.

Underproduction at a Higher Price:

Because price represents what consumer are willing to pay for that commodity, that price represents society's valuation of that unit The monopoly outcome of P exceeding MC means that the value to society of the last unit produced is greater than its cost, MC. Hence, not enough of the good is being used.

Implications of Higher Monopoly Prices:

By setting MC=MR the monopolist produces at a rate of output where P is greater than MC. The marginal cost of a commodity (MC), represents what society had to give up in order to obtain the last unit produced. Price represents what buyers are willing to pay

24.1 Legal or Government Restrictions:

Governments and legislators can erect barriers to entry. These include: licenses, franchises, patents, tariffs, and specific regulations that tend to limit entry

The Monopolist's Price and Quantity:

If the monopolist is profit maximizing, it is going to look at the marginal revenue curve (MR) and produce at the output where marginal revenue equals marginal cost What is the marginal cost curve in the graph? S B/C we said that S is equal to the horizontal summation of the portions of the individual marginal cost curves above each firm's respective minimum average variable cost

24.5 The Social Cost of Monopolies:

If we were to compare the amount produced by firms in a competitive industry to the output produced by a​ monopoly, the monopolist will produce on the elastic portion of the demand curve and charge a higher price.

24.1 The Monopolist as the Industry:

In a monopoly market structure, the firm (the monopolist), and the industry are one in the same. Should we think of aluminum and steel as separate industries? Or should we define the industry as basic metals? The answer depends on the extent to which aluminum and steel can be substituted in a range of products A seller prefers to have a monopoly rather than face to face competitors We think of monopoly prices as being higher than prices under perfect competition, and of monopoly profits as being higher than profits under perfect competition.

24.1 Licenses, Franchises, and Certificates of Convenience:

It is illegal to enter many industries without a gov. license or "certificate of convenience and public necessity" E.G in some states you cannot form an electrical utility to compete with the electrical utility already operating in your area

24.2 Perfect Competition vs. Monopoly:

It is sometimes useful to compare monopoly markets to perfectly competitive markets. The monopolist is constrained by its demand curve for the product, just as a perfectly competitive firm is constrained by its demand. The difference is the nature of the demand curve each type of firm faces

24.2 Profits to be Made from Increasing Production: Marginal Revenue for the Perfect Competitor

Marginal revenue equals the change in total revenue due to a one-unit change in the quantity produced and sold: Recall; a firm in a perfectly competitive industry faces perfectly elastic demand curve. The perfectly competitive firm is so small that it cannot influence the price of its product. It is a price taker If the forces of supply and demand established a price per constant-quality pair of shoes at $50, the firm can produce and sell each pair of shoes at $50, the per unit price is $50 and the marginal revenue would also be $50 In a perfectly competitive industry, each time a firm changes production by one unit, total revenue changes by the going price, and price is unchanged

24.2 The Monopolist's Marginal Revenue: Less Than Price; Figure 24-3

Marginal revenue is always less than price. Question: Marginal revenue for a monopolist is downward sloping and always less than price. Question: The marginal revenue curve for a perfectly competitive firm is​ horizontal while the marginal revenue curve of the monopolist is​ downward sloping

24.2 Elasticity and Monopoly:

Monopolist faces a downward sloping market demand curve. This means that the monopolist cannot charge just ANY price with no changes in quantity because, depending on the price charged, a different quantity will be demanded. A monopolist is a seller of a well-defined good with no CLOSE substitutes; this does not mean that the demand curve for the monopoly is vertical or exhibits zero price elasticity of demand. Consumer have limited income and unlimited wants. The market demand curve slopes downward because individuals compare the marginal satisfaction they will receive to the cost of the commodity purchased. Even if there were no substitutes, the market demand curve would still slope downwards. There are several imperfect substitutes: the more substitutes there are, and the better those substitutes are, the more elastic the demand curve will be Question: For a​ monopoly, price equals average revenue only. Question: As the number of imperfect substitutes for a monopoly​ firm's product​ increases, the price elasticity of demand.. increases Question: The better the substitutes for a monopoly​ firm's product, the...greater the price elasticity of demand. Explanation: As substitutes for the monopoly product are​ developed, consumers have greater ability to respond to price​ changes, so the demand has greater elasticity. Question: Evaluate the following statement. A profit maximizing monopolist will never operate in a price range in which price elasticity of demand is inelastic.... TRUE Explanation: If a profit maximizing monopolist operated on the inelastic portion of its demand​ curve, it could decrease output and raise its price. This would increase total revenue and decrease total​ cost; thus, increasing profits. Question: A monopolist can sell 30 toys per day for $ 12.00 each. To sell 31 toys per​ day, the price must be cut to $ 11.00. The marginal revenue of the 31st toy​ is: -$19.00 Explanation: Total revenue from selling 30 toys per day for $ 12.00 each is $ 360.00. Total revenue from selling 31 toys per day for $ 11.00 each is $ 341.00. The marginal revenue is negative $ 19.00. Question: The monopolist estimates its marginal revenue​ curve, where marginal revenue is defined as the change in total revenues due to a​ one-unit change in quantity sold. Explanation: The monopolist estimates its marginal revenue​ curve, where marginal revenue is defined as the change in total revenues due to a​ one-unit change in quantity sold. Question: For the perfect​ competitor, price equals marginal revenue equals average revenue. For the​ monopolist, marginal revenue is always less than price because price must be reduced on all units to sell more.

No Guarantee of Profits:

Numerous monopolies have gone bankrupt. If the average total cost curve (ATC) lies everywhere above the demand curve, there is no price-output combination that will allow the monopolist to even to cover costs, much less earn profits. The monopolist will then, in the short-run, suffer economic losses

24.1 Ownership of Resources without Close Substitutes:

Some economists contend that no monopoly acting without government support has been able to prevent entry into an industry unless THAT monopoly has had the control of some essential natural resource. - the possibility of one firm owning the entire supply of raw material input that is essential to the production of a particular commodity

24.1 Economies of Scale:

Sometimes it is not profitable for more than one firm to exist in an industry This is true if one firm would have to produce such a large quantity in order to realize lower unit costs that there would not be sufficient demand to warrant a second produce of the same product

24.1 Tariffs:

Special taxes that are imposed on certain imported goods. Tariffs make imports more expensive, relative to their domestic counterparts, encouraging consumer to switch to the cheaper domestically made products. If the tariffs are high enough the domestic producers may be able to act like a single firm and gain monopoly advantage as the sole suppliers

The Monopoly Price:

The demand curve shows the maximum price for which a given quantity can be sold; so to sell Q, it can charge only P, because that is the price at which that specific quantity, Q, is demanded The price is found by drawing a vertical line from the quantity, Q, to the market demand curve. Where that line hits the market demand curve, the price is determined We find that price by drawing a horizontal line from the demand curve to the price axis- this gives us the profit maximizing price

24.1 How Does a Firm Obtain a Monopoly in an Industry?:

There must be barriers to entry that enable firms to receive monopoly profits in the long run. Barriers to entry are restrictions on who can start a business or who can stay in business

24.1 Regulations:

U.S firms incur billions of dollars in expenses each year to comply with federal, state, and local regulations of business conduct These large fixed costs can be spread over a greater number of outputs by larger firms than smaller firms, putting the smaller firms at a competitive disadvantage Entry will be deterred to the extent that the scale of operation of a potential entrant must be large enough to cover the average fixed costs of compliance

Calculating Monopoly Profit:

We find monopoly profit by subtracting total costs from total revenues of the product, labeled Q, which is the profit-maximizing rate of output for the product monopolist

24.1 The Cost Curves that Might Lead to a Natural Monopoly:

When average costs are falling, marginal costs are less than average costs When the long run average cost curve (LAC) slopes downward, the long run marginal cost (LMC) curve will be below the LAC

The Graphical Depiction of Monopoly Profits:

When we add the average total cost curve, we find that the profit a monopolist makes is equal to the green shaded area, or total revenues (PxQ), minus total costs, (ATCxQ) A monopolist cannot make more profit than those shown in the green shaded area. The monopolist is maximizing profit where marginal cost equals marginal revenue If the monopolist produces less OR more than that, it will forfeit some profit