Unit 3: Chapter 22 Notes - Lake Central High School

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22

Pure Monopoly

Chapter Objectives


Characteristics of Pure Monopoly


How Pure Monopoly Sets Profit
Maximizing Output and Price


The Economic Effects of Monopoly


Why A Monopolist May Wish to
Charge Different Prices in Different
Markets

Characteristics


Single Seller


No Close Substitutes


“Price Maker



controls total
QS and thus controls price


Blocked Entry


Nonprice

Competition


Examples


Regulated Monopolies


Near
-
Monopolies


Western Union
-
Frisbee
-
De Beers


Dual Objectives of
Study


studying monopoly also helps
understand monopolistic
competition and oligopoly

O 22.1

Barriers to Entry


Economies of
Scale


if economies of scale exists
over a long range of output, only a single producer
can satisfy consumer demand at least cost


Ex. Entrance into industries such as steel, auto
manufacturing…


Legal Barriers to Entry


Patents


exclusive right of inventor to use his/her
invention


Ex. Pharmaceuticals, IBM, GE


Licenses


Ex. Taxicab drivers, radio and
tv

stations


Ownership or Control of Essential
Resources


Ex. Inco owning 90% world’s nickel reserves


Pricing and Other Strategic Barriers to Entry

Monopoly Demand

Three assumptions made:


Monopoly
Status is Secure


No Governmental Regulation


Firm is a Single
-
Price
Monopolist


it charges the
same price for all units of
output
(No Price
Discrimination)

Monopoly Demand


Difference b/w monopoly and pure
competition lies on demand side of market


Demand curve for monopolist is the market
demand curve since the single seller is the
industry


Since market demand is not perfectly elastic,
monopolists demand curve is
downsloping


No need for side
-
by
-
side curves; firm and
industry are one and the same

3 Implications of Downward
-
sloping
Demand Curve


1. MR is less than P


2. Monopolist is price maker


3. Monopolist sets prices in the elastic region
of demand

Implication #1:MR is less than price



MR is less than price (AR) for every level of
output except the first unit


Why?


The lower price applies not only to the extra
units of output but also to all prior units of
output


See p.428 Figure 22.3

Implication #2: The Monopolist is a
Price Maker


All imperfect competitors face downward
-
sloping demand curves and are price makers


When a monopolist chooses the volume of
output to produce, they are indirectly
determining the price they will charge



Through control of output, monopolists can
“make the price”

Implication #3: The Monopolist Sets
Price in the Elastic Region
of Demand


Total revenue test reveals that when demand
is elastic, a
dec
. in P will increase TR and vice
versa


A monopolist will never choose a price
quantity combo that will decrease TR (MR is
negative)


To get into inelastic region, monopolist must
lower P and increase output


Less TR and higher TC yield lower profit

0

1

2

3

4

5

6

$142

132

122

112

102

92

82

Price and Marginal Revenue

Marginal Revenue is Less Than Price

D


A Monopolist is


Selling 3 Units at


$142


To Sell More (4),


Price Must Be


Lowered to $132


All Customers


Must Pay the Same


Price


TR Increases $132


Minus $30 (3x$10)

Gain = $132

Loss = $30

0

1

2

3

4

5

6

$142

132

122

112

102

92

82

Price and Marginal Revenue

Marginal Revenue is Less Than Price

D


A Monopolist is


Selling 3 Units at


$142


To Sell More (4),


Price Must Be


Lowered to $132


All Customers


Must Pay the Same


Price


TR Increases $132


Minus $30 (3x$10)


$102 Becomes a


Point on the MR


Curve


Try Other Prices to


Determine Other


MR Points

Gain = $132

Loss = $30

The Constructed Marginal Revenue Curve

Must Always Be Less Than the Price

MR

Monopoly Revenue and Costs

Revenue and Cost Data of a Pure
Monopolist

(1)

Quantity

Of Output

(2)

Price

(Average

Revenue)

(3)

Total

Revenue

(1) X (2)

(4)

Marginal

Revenue

(5)

Average

Total Cost

(6)

Total Cost

(1) X (5)

(7)

Marginal

Cost

(8)

Profit (+)

or Loss (
-
)

0

1

2

3

4

5

6

7

8

9

10

$172

162

152

142

132

122

112

102

92

82

72

$0

162

304

426

528

610

672

714

736

738

720

$162

142

122

102

82

62

42

22

2

-
18

$190.00

135.00

113.33

100.00

94.00

91.67

91.43

93.75

97.78

103.00

$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

Revenue Data

Cost Data

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

]

Can you See Profit Maximization?

$200

150

100

50

0

$750

500

250

0

2

4

6

8

10

12

14

16

18

2

4

6

8

10

12

14

16

18

Price

Total Revenue

Monopoly Revenue and Costs

Demand, Marginal Revenue, and Total Revenue for a Pure
Monopolist

Elastic

Inelastic

Demand and Marginal Revenue Curves

Total
-
Revenue Curve

D

MR

TR

Monopoly Revenue and Costs


Monopolist is a Price Maker


Sets Price in the Elastic Region


Output and Price
Determination


Cost Data


MR = MC Rule


No Supply Curve

G 22.1

W 22.1

Output and Price Determination


At what price
-
quantity combo will a profit
-
maximizing monopolist choose to operate?


Cost data: same cost data as used in Ch.20
-
21


produce output where MR=MC


How to find price?


Draw a vertical line from MR=MC up to
Demand curve to find profit
-
maximizing price

3 Steps for Maximizing Profit in Pure
Monopoly


1. Determine profit
-
maximizing output where
MR=MC


2. Determine profit
-
maximizing price by
drawing a vertical line upward from the
output in Step 1 to the demand curve


3. Determine profit: TR
-
TC or profit per unit by
P
-
ATC x quantity

Profit Maximization

0

$200

175

150

125

25

100

75

50

Price, Costs, and Revenue

1

2

3

4

5

6

7

8

9

10

Quantity

By A Pure Monopolist

D

MR

ATC

MC

MR=MC

P
m
=$122

A
=$94

Economic

Profit

No Monopoly Supply Curve


The pure monopolist has no S. curve


There is no unique relationship b/w price and
QS


Since monopolist does not equate P to MC, it
is possible to have different prices for the
same output

Misconceptions


Not the Highest Price


Total, Not Unit, Profit


Possibility of Losses

Concerning Monopoly Pricing

Not Highest Price


Since monopolist can manipulate P and Q,
there is a misconception that it will charge the
highest P possible


Monopolist seeks maximum total profit, NOT
maximum price

Total, Not Unit, Profit


Monopolist seeks to maximize total profit, not
unit profit



Ex. See Table 22.1


Possibility of Losses by Monopolist


Likelihood of economic profit is greater for pure
monopolist than pure competitor


In LR, pure competitor will only have normal
profit, economic profit can persist by monopolist
since there will be no entrance of new firms


Pure monopoly does not guarantee profit. Profit
can be affected by changes in demand and
changing cost curves


If D curve (price) is lower than ATC, firm
experiences losses

Loss Minimization

0

Price, Costs, and Revenue

Quantity

By A Pure Monopolist

D

MR

ATC

MC

MR=MC

Loss

AVC

P
m

Q
m

V

A

Economic Effects of Monopoly


Price, Output and Efficiency


Since the firm IS the industry, market and
individual demand are same for monopolist


Monopoly yields neither productive nor
allocative

efficiency


Price exceeds min ATC, price is higher than MC


An efficiency loss occurs (total economic
surplus is not maximized)

Economic Effects of Monopoly

Price, Output, and Efficiency

Purely

Competitive

Market

Pure

Monopoly

D

D

S=
MC

MC

P=MC=

Minimum

ATC

MR

P
c

Q
c

P
c

P
m

Q
c

Q
m

Pure Competition is Efficient

Monopoly Price is Greater Than MC

And Is Therefore Inefficient

a

b

c

Economic Effects of Monopoly

Price, Output, and Efficiency


Income Transfer


Cost Complications


Economies of Scale


Simultaneous Consumption


Network Effects

Income Transfer


Monopoly transfers income from consumers
to stockholders who own the monopoly



Monopolies benefit at the expense of
consumers who overpay for the products

Cost Complications


Pure monopoly will charge higher P, produce less
output, and allocate resources less efficiently
than a purely competitive firm


In reality, costs may differ for monopolistic
producers


Why?


1. economies of scale


2. X
-
inefficiency


3. need for monopoly
-
preserving expenditures


4. the “very long run” perspective

Economies of Scale


Due to extensive economies of scale, an industry
of one or two firms may produce at lower ATC
than industry of several firms


Ex. natural monopoly


Simultaneous consumption


ability of a product
to satisfy large # consumers at same time


Network effects


increases in the value of
products to each user as the total number of
users rises (Ex. Internet, cell phones)

X
-
Inefficiency


Occurs when a firm produces output at higher
than lowest possible cost of producing it


Result of “bad management” of firm


Lack of pressure from competition


X
-
Inefficiency






Rent
-
Seeking Expenditures


Rent
-
Seeking Behavior


Technological Advance


Assessment and Policy Options

X

X


Average Total Costs

ATC
X

ATC
1

ATC
X’

ATC
2

Quantity

Q
1

Q
2

Average

Total Cost

Economic Effects of Monopoly

O 22.3

Rent
-
Seeking Expenditures and
Technological Advance


Rent
-
Seeking behavior


any activity designed
to transfer income or wealth to a firm at
someone else’s expense


Firm may go to great expense to acquire or
maintain right to monopoly


Technological advance


general view of
economists that monopolist will not be
technologically progressive

Representative Highly Competitive Foreign
Multinational Corporations

GLOBAL PERSPECTIVE

Economic Effects of Monopoly

Company (Country)

Main Products

Bayer (Germany)

BP Amoco (United Kingdom

Michelin (France)

NEC (Japan)

Nestl
é

(Switzerland)

Nokia (Finland)

Royal Dutch/Shell (Netherlands)

Royal Philips (Netherlands)

Sony (Japan)

Toyota (Japan)

Unilever (Netherlands)

Chemicals

Gasoline

Tires

Computers

Food Products

Wireless Phones

Gasoline

Electronics

Electronics

Automobiles

Food Products

Source: Fortune.com

Price Discrimination


The practice of selling a specific
product at more than one price when
the price differences are not justified
by cost differences


Three
Forms


Charging Each Customer the Maximum
They Are Willing to Pay


Charging Each Customer One Price For
The First Set of Units Purchased and a
Lower Price for Subsequent Units


Charging Some Customers One Price and
a Different Price for Other Customers

O 22.4

Price Discrimination


Conditions


Monopoly
Power


some ability to
control output and price


Market
Segregation


firm must be
able to classify buyers based on
willingness to pay for product


No Resale


Examples of Price Discrimination


Airfares


fares for business travelers
vs. vacationers


Electric Utilities


Theaters & Golf
Courses


vary prices
by price and age of consumers


See p.438 for graphical analysis

W 22.1

Regulated Monopoly


Natural
Monopolies


subject to rate regulation


Rate Regulation


Socially Optimum
Price


price that achieves
allocative

efficiency



P = MC


Fair Return
Price


if socially optimal price leads
to loss for firm, regulatory agencies may
establish fair
-
return price



P = ATC

0

Price and Costs (Dollars)

Quantity

Regulated Monopoly

Dilemma of Regulation

Monopoly

Price

Fair
-
Return

Price

Socially

Optimal

Price

P
r

D

r

f

b

a

P
f

P
m

Q
m

Q
f

Q
r

MR

MC

ATC

De Beers Diamonds


66 Year Policy of Monopolizing the
Diamond Trade


Mid
-
2000 Abandoned Monopoly
Efforts


Decline in Number of Select
Dealers and Cutters


Classic Monopoly Behavior


Pricing


Single
-
Channel Marketing

Are Monopolies Forever?

De Beers Diamonds


End of an Era


New Diamond Discoveries
-
Angola,
Canada


Australian Producer Withdrew


Bad Press and Public Perception
Over Civil Strife Financing Role


Becoming Cartel of Specialized
High
-
End Diamonds


Monopoly Didn’t Last Forever!

Are Monopolies Forever?