Firm Behavior Under
Monopoly
AP Econ - Micro II B
Mr. Griffin
MHS
Monopoly Defined
• Only one firm in the industry
• No close substitutes for the product
• Little chance of successful entry by a
competitor
Sources of Monopoly
Barriers to Entry
• Economies of Scale (cost advantages)
• Legal Barriers: Patents and Licenses
• Control of Essential Resources
• Strategic Barriers to Entry
Natural Monopoly
• Declining long-run average costs
(economies of scale) exist over an
extended output range
• Least-cost production can only be
achieved by a single producer.
Average Total Cost
THE NATURAL MONOPOLY CASE
$20
15
ATC
10
If ATC declines over extended
output, least-cost production is
realized only if there is one
producer - a natural monopoly.
0
50
100
Quantity
200
FOUR MARKET MODELS
Pure Monopoly:
• Single Seller
• No Close Substitutes
• Price Maker
• Blocked Entry
• Nonprice Competition
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
MONOPOLY DEMAND
3 Basic Assumptions:
• Monopoly Status is Secure
• No Governmental
Regulation
• Firm Charges the Same
Price for all Units Sold
Market Demand Curve is the
Firm’s Demand Curve
MONOPOLY DEMAND
P
As price decreases from
$142 to $132...
revenue will
$142 Loss = $30
increase with the
132
additional
unit sold.
D
Gain = $132
1
2
3
4
5
6
Q
MONOPOLY DEMAND
P
As price decreases from
$142 to $132...
revenue will
$142 Loss = $30
increase with the
132
additional
unit sold.
Marginal Revenue
Gain = $132
$132 - $30 = $102
must be
less than price $132.
1
2
3
4
5
6
Q
D
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
0 x $172 = $ 0
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
- $100
= - $100
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
0 $172 $ 0
$100 90 - $100
] $162
]
x
1
162 = 162
- 28
$190.00 190
MR = $162 – 0 = $162
MC = $190 – 100 = $90
MR > MC
Loss Improvement
from -$100 to -$28
Check next unit of
output!
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
0
1
2
3
4
5
6
7
8
9
10
$172 $ 0
]
162 162
]
152 304
]
142 426
]
132 528
]
122 610
]
112 672
]
102 714 ]
92 736 ]
82 738 ]
72 720
Cost Data
Average
Total
Cost
$162
$190.00
142
135.00
122
113.33
102
100.00
82
94.00
62
91.67
42
91.43
22
93.73
2
97.78
- 18
103.00
Profit +
Total Marginal or
loss Cost
Cost
$100
]
190
]
270
]
340
]
400
]
470
]
550
]
640 ]
750 ]
880 ]
1030
90
80
70
60
70
80
90
110
130
150
- $100
- 28
+ 34
+ 86
+ 128
+ 140
+ 122
+ 74
- 14
- 142
- 310
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
Can0 you
$172see
$ profit
0
] $162
1
162 162
maximization?
] 142
2
3
4
5
6
7
8
9
10
152
142
132
122
112
102
92
82
72
304
] 122
426
] 102
528
] 82
610
] 62
672
] 42
714 ]
22
736 ]
2
738 ]
- 18
720
Cost Data
Average
Total
Cost
Profit +
Total Marginal or
loss Cost
Cost
$100 90 - $100
]= MC
MR
>
- 28
$190.00 190 80
]
135.00 270 70 + 34
]
113.33 340 60 + 86
]
100.00 400 70 + 128
]
94.00 470 80 + 140
]
91.67 550 90 + 122
]
91.43 640 ] 110 + 74
- 14
93.73 750 ] 130
97.78 880 ] 150 - 142
- 310
103.00 1030
MONOPOLY REVENUES & COSTS
Revenue Data
Quantity Price
of (Average Total
Marginal
Output Revenue) Revenue Revenue
0
1
2
3
4
5
6
7
8
9
10
$172 $ 0
]
162 162
]
152 304
]
142 426
]
132 528
]
122 610
]
112 672
]
102 714 ]
92 736 ]
82 738 ]
72 720
Cost Data
Average
Total
Cost
$162
$190.00
142
135.00
122
113.33
102
100.00
82
94.00
62
91.67
42
91.43
22
93.73
2
97.78
- 18
103.00
Profit +
Total Marginal or
loss Cost
Cost
$100
]
190
]
270
]
340
]
400
]
470
]
550
]
640 ]
750 ]
880 ]
1030
90
80
70
60
70
80
90
110
130
150
- $100
- 28
+ 34
+ 86
+ 128
+ 140
+ 122
+ 74
- 14
- 142
- 310
MONOPOLY REVENUES & COSTS
Dollars
$200
150
200
50
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MONOPOLY REVENUES & COSTS
Elastic
Dollars
$200
150
200
50
MR
D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
MONOPOLY REVENUES & COSTS
Elastic
Inelastic
Dollars
$200
150
200
50
MR
D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
OUTPUT AND PRICE DETERMINATION
Cost Data
MR = MC Rule
No Monopoly Supply Curve
Monopoly Pricing
Misconceptions
• Not Highest Price
• Total, Not Unit, Profit
• Possibility of Losses
Graphically…
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
Remember
the
MR=MC
Rule?
200
Profit
Per Unit
Price, costs, and revenue
175
150
$122
125
$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
200
Profit
Per Unit
Price, costs, and revenue
175
150
$122
125
$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
OUTPUT AND PRICE DETERMINATION
Loss Minimization Under Monopoly
200
Since Pm exceedsLoss
AVC,
Per Unit
the firm will produce
Price, costs, and revenue
175
MC
ATC
AVC
150
A
125 Loss
Pm
100
V
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
Qm
6
7
8
9
10
Q
OUTPUT AND PRICE DETERMINATION
Loss Minimization Under Monopoly
200
Loss
Per Unit
What are the MC
ATC
A
Economic
EffectsAVC
P
V of Monopoly?
Price, costs, and revenue
175
150
Loss
125
m
100
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
Qm
6
7
8
9
10
Q
INEFFICIENCY OF PURE MONOPOLY
P An industry in pure competition S = MC
sells where supply and
demand are equal.
At MR=MC
A monopolist
will sell less
units at a
higher price
than in
competition.
Pm
Pc
D
MR
Qm
Qc
Q
INEFFICIENCY OF PURE MONOPOLY
P
S = MC
At MR=MC
A monopolist
will sell less
Pm Monopoly pricing effectively
units at a
higher
price
Pccreates an income transfer
from
than in
buyers to the seller!
competition
D
MR
Qm
Qc
Q
COST COMPLICATIONS
Average total costs
Economies of Scale
Simultaneous Consumption
Network Effects
X-Inefficiency Inefficient internal
ATCx
X
operation leads to
higher-thannecessary costs.
X’
ATC1
ATCx’
ATC2
Q1 Quantity
Q2
Average
Total Costs
COST COMPLICATIONS
Economies of Scale
Simultaneous Consumption
Network Effects
X-Inefficiency
Rent-Seeking Expenditures
Rent-Seeking Behavior
Technological Advance
Assessment and Policy Options
Antitrust Action
Regulate Natural Monopoly
Ignore it, if it is Short-Lived
PRICE DISCRIMINATION
Conditions
Monopoly Power
Market Segregation
No Resale
Consequences
More Profit
More Production
Graphically…
PRICE DISCRIMINATION
Price and Costs
P
Economic profits with
a single MR=MC
price
MC
ATC
MR
Q1
D
Q
PRICE DISCRIMINATION
Price and Costs
P
A perfectly discriminating
monopolist has MR=D,
producing more product
and more profit!
MC
ATC
MR=D
D
Q1
Q2
Q
PRICE DISCRIMINATION
Economic profits with
price discrimination
Price and Costs
P
MC
ATC
MR=D
D
Q1
Q2
Q
REGULATED MONOPOLY
Natural Monopolies
Rate Regulation
Socially Optimum Price
P = MC
Fair-Return Price
P = ATC
Dilemma of Regulation
Graphically…
REGULATED MONOPOLY
Monopoly Price
MR = MC
Price and Costs
P
Pm
ATC
MC
D
MR
Qm
Q
REGULATED MONOPOLY
Price and Costs
P
Fair-Return Price
Normal Profit Only
ATC
MC
Pf
D
MR
Qf
Q
REGULATED MONOPOLY
Price and Costs
P
Socially-Optimum
Price
P = MC
ATC
MC
Pr
D
MR
Qr
Q
REGULATED MONOPOLY
Dilemma of Regulation
MR = MC Which Price?
Fair-Return Price
Price and Costs
P
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q
What do I need to know about
monopoly for the AP Exam?
RELATIONSHIP
ECONOMIC INTERPRETATION
MR = MC
The firm has chosen the output that
maximizes profits.
P > ATC
Firm is earning Economic Profits
P = ATC
Firm is earning NORMAL PROFIT
(Break-Even Point) (EP = 0)
P < ATC;
P > AVC
Loss Minimization
P = AVC
SHUTDOWN POINT (firm cannot
cover its AVC
P < AVC
Firm does not produce
MONOPOLY
P > MR
The firm’s DEMAND CURVE is relatively INELASTIC (but
monopolists always operate in the ELASTIC region)
MR = MC
The firm maximizes profit.
P > ATC
Long Run ECONOMIC PROFITS.
PRODUCTIVE INEFFICIENCY
P > min ATC
Firm is not forced to operate with maximum productive efficiency.
(Least-Cost Method Production not necessary)
ALLOCATIVE INEFFICIENCY
P > MC
There is an UNDERALLOCATION of resources.
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
Remember
the
MR=MC
Rule?
200
Profit
Per Unit
Price, costs, and revenue
175
150
$122
125
$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
PRICE DISCRIMINATION
Price and Costs
P
A perfectly discriminating
monopolist has MR=D,
producing more product
and more profit!
MC
ATC
MR=D
Q1
Q2
D
Q