Unit 3 Lesson 4
The Monopoly Firm
Pure Monopoly:
1) Single Seller
2) No Close substitute
3) Price Maker (Downward sloping demand curve)
4) Blocked entry: Barriers are economic, technological, legal...
5) Advertising: will advertise if a luxury but not if it is a necessity.
Barriers to Entry:
1) Economies of Scale: efficient low cost production can only be achieved if producers are
extremely large both absolutely and in relation to the market. (ATC must be large and Q large.) When
it is required for a firm to be so big that without economies of scale they would not be able to stay in
business this is a Natural Monopoly.
: utilities, cable companies, MARTA...
2) Legal Barriers: patents, licenses...
3) Ownership of resources: diamond mines, Aluminum deposits... (Notice this is not a natural
monopoly)
HAVE THE STUDENTS FILL IN THE MONOPOLY 1 OVERHEAD (calculate TR, MR, AR,
TC, ATC, MC and profit from the supply and demand curve)
Q
0
1
2
3
4
5
P
14
12
10
8
6
4
TR
0
12
20
24
24
20
AR
0
12
10
8
6
4
MR
12
8
4
0
-4
TC
2
6
8
12
20
35
ATC
0
6
4
4
5
6
MC
Profit
4
2
4
8
15
6
12
12
4
-15
In order to increase sales the monopoly must lower its price.
When it lowers its price the MR will be lower than the price!!!
When the price is lowered, the gain in total revenue (change in MR) is the price of that unit less the
difference in between the old and new price.
EX: If it could have sold 2 units at $10 it would have a total revenue of $20. If it wants to sell
more it has to lower its price. Suppose it lower the price to $8. It can now sell 3 units. The total
revenue is now $24 dollars. This represents the 8 dollars times the 3 units. However, you will notice
the gain is not 3 units * $10 = 30 but rather the $30 - (3 units * $2) = $24.
This means that as each successive unit is sold the
marginal revenue from each unit will decline. It will
decline by the change in price times the quantity sold.
IN ORDER TO SELL ANOTHER UNIT THE
MONOPOLY MUST LOWER THE PRICE ON NOT
ONLY THAT UNIT BUT ALL OTHER UNITS!!!
In a monopoly the firms demand curve is the industry
demand curve. It will be downwardly sloping. (A
perfectly competitive industry demand curve is
downwardly sloping but not the individual firms.)
SEE OVERHEAD 24-1
Earlier we learned that:
On the elastic portion of the D curve a decline in
price will increase total revenue. (Marginal Revenue
is positive)
What happens when Marginal Revenue is zero?
The demand curve is unitary elastic.
On an inelastic portion of the D curve a decline in
price will decrease total revenue. (Marginal Revenue
is negative)
With this in mind the Monopolist will product as far down the elastic D curve as it can.
Will a monopoly every produce in the inelastic portion of the demand curve? NO. Its total
revenue would be down here.
Monopoly Day 2
Now that you see the shape of the MR and the D
curves lets add in the ATC and the MC curves. Both
of these are the same for a monopoly as they are for
the individual firm.
What then in the point at which the firm will produce?
The monopolist will still produce where MR=MC. It
is at this point on the D curve that the greatest profit
will be made. It is also at this point that the ATC is at
its lowest.
Q
0
1
2
3
4
5
6
7
8
9
10
P
172
162
152
142
132
122
112
102
92
82
72
TR
0
162
304
426
528
610
672
714
736
738
720
MR
ATC
162
142
122
102
82
62
42
22
2
-18
190
135
113.33
100
94
91.67
91.43
93.73
97.78
103
TC
100
190
270
340
400
470
550
640
750
880
1030
MC
90
80
70
60
70
80
90
110
130
150
Given the above information you should be able to find the profit maximizing point using both
MR=MC and TR - TC.
Profit
-100
-28
34
86
128
140
122
74
-14
-142
-310
What is the profit per unit? 122 - 94 = 28
What is the total profit? 5 units * 28 = $140 (see
shaded region)
(OVERHEAD 24-3)
A pure monopolist has no supply curve. It produces at a single point. There is no relation between price and
quantity supplied. This is why we say a monopolist is a price maker.
The monopolist depends on the slope of the demand curve (and the MR curve that results to determine its
output.)
A monopoly will not necessarily produce in order to get the highest price. This is not the optimum point on
the D curve. They look at TR - TC = profits.
The monopolist is interested in total profits not per unit profits. This is because they have a downwardly
sloping demand curve.
If demand is weak the monopoly may suffer a loss. As
long as it is covering its AVC it will continue to do
business
See OVERHEAD 24-4
When working with a NATURAL MONOPOLY you
will find that the curves are different.
A natural monopoly is one in which the quantity
produced must be very high in order to accommodate
the costs. In other words, the ATC continues down
over a large quantity. This means that the Demand
curve will intersect the ATC before the minimum of
the ATC. If someone tries to enter the market the
Natural Monopolist can lower the price way down and
still keep earning a profit.
Overhead 24-3
From this we can see that a monopoly does not
produce at the most efficient point. Instead, it limits
its output. This drives up the price. This means
people want the product more that it costs to make.
This is not allocative efficiency.
In order to achieve efficiency you must achieve
equality between price, marginal cost and average cost.
Price and Marginal cost for allocative and price and
average cost for productive efficiency.
Regulation of a Monopoly
Socially Optimal Price (P = MC)
This would be achieved by placing a ceiling on the
price. When this is done the regulation will achieve
allocative efficiency.
This would take away the firms desire to restrict
output.
The problem is that it does not allow the firm to
maximize profits. In some cases it will cause them to
obtain a loss.
Allocative Efficiency: P = MC
Right goods for consumers. (use resources for what people want them to be used for.
$ value of a good is societies measure of the worth of the good.
MC is the measure of value of other products the resources could have been used for.
Fair Return; (P = AC)
By allowing the monopoly to charge where P = AC
they will then earn a normal profit. This however,
does not achieve efficiency.
Consumer Surplus for a Monopoly
Producer Surplus
Keep in mind that the total surplus to society
is the Producer Surplus and the Consumer
Surplus minus the cost of production.
Because of this, when you are working with a
monopoly the producer surplus is the area
between the MC curve and the price.
Deadweight Loss
Because the monopoly charges a price above
marginal cost, not all consumers who value
the good at more than its cost buy it. The
result is a Deadweight Loss.
This is represented by the shaded triangle.
If you compare the consumer surplus and
producer surplus of a monopolist to the
consumer surplus and producer surplus of a
perfect competitor you will see that the
monopolist transfers some consumer surplus to
themselves.
Price Discrimination
When a company can charge one customer a
different price than another customer this is
known as price discrimination.
The result is that the MR achieved from selling
another unit is the same as price. The
monopolist does NOT have to lower the price
on previous units.
The effect of this is that the company takes the
consumer profit.
When a company can perfectly price
discriminate it can set the price where MC= D.
This allows them to produce more units than
they would otherwise have produced. The net
effect is that they now have taken the consumer
surplus and the dead weight loss. They have
turned this into economic profit.
Practice Free Response Questions for Perfectly Competitive and Monopoly
In answering the following questions you should emphasize the line of reasoning that generated the
results. It is not enough to just list the results of your analysis. Include diagrams in explaining your
answers. All diagrams should be clearly labeled.
1) Assume that initially a perfectly competitive industy is in long-run equilibrium.
a) For the typical profit-maximizing firm in this industry explain the following.
i. How the firm determines its level of output
ii. What the level of profit is and why it is at that level
b) A change occurs that reduces the variable costs of production for all firms in this industry.
Explain how and why this decrease in variable costs affect each of the following in the short run.
i. The typical firm’s level of output
ii. The industry price and level of output.
2) A perfectly competitive manufacturing industry is in long-run equilibrium. Energy is an
important variable input in the production process and therefore the price of energy is a variable cost.
The price of energy decreases for all firms in the industry.
a) Explain how and why the decrease in this input price will affect this manufacturing industry's
output and price in the short run.
b) What will be the short-run effect on price, output, and profit of a typical firm in this
manufacturing industry? Explain.
c) Will firms enter or exit this manufacturing industry in the long run? Why or why not?
3) A single airline provides service from City A to City B.
a) explain how the airline will determine the number of passengers it will carry and the price it
will charge.
b) Suppose fixed costs for this airline increase. How will this increase in fixed costs affect the
airlines price and output in the short run?