Monopoly

1
Monopoly

• Perloff Chapter 11

2
Marginal revenue and price competitive firm
Price,
p
,
per unit
Demand curve
p
1
A
B
q
q

1
Quantity,
q
, Units per year
Source Perloff
3
Marginal revenue and price monopoly
Price,
p
,
per unit
p
1
C
p
2
Demand curve
A
B
Q
Q

1
Quantity,
Q
, Units per year
Source Perloff
4
Deriving the MR curve
MRchange in revenue when output changes by one
unit
price of additional unit change in price when
output changes by one unit times existing
sales vol.
Assume a linear demand curve
5
MR and Price Elasticity
Multiply by p/p1
6
MR and Demand Curves
p
, per unit
Perfectly elastic
24
Elastic,
lt

1
e
MR


2
D
p


1
D
Q

1
Q

1
D
D


1
e
12
Inelastic,

1 lt
e
lt 0
Demand (
p
24


Q
)
Perfectly
inelastic
0
12
24
Q
, Units per day
MR
24

2
Q
Source Perloff
7
Maximising profit
MC
p
, per unit
24
AC
AVC
e
18
Shutdown Firm illustrated makes a positive
profit. If AVCgt18 the firm would shut down.
p
60
12
8
6
Demand
MR
6
0
12
24
Q
, Units per day
(b) Profit, Revenue
R
,
p
,
144
Revenue,
R
108
60
Profit, p
0
12
6
24
, Units per day
Q
Source Perloff
8
Mathematical approach
9
Market Power
In competition PMC. Monopolists have the ability
to set PgtMC, the extent of the this ability is a
measure of market power.
Market power depends only on the elasticity of
demand at the profit maximising
quantity. Elasticity of demand is in turn
influenced by the number of substitutes.
10
Lerner Index
Price markup is an alternative measure of market
power
11
Elasticity and Market Power
Source Perloff
12
The Effects of a Shift in Demand
p
, per unit
E
MC
2
p
2
E
1
p
1
1
MR
1
D
2
D
2
MR

Q
Q
Q
, Units per year
2
1
Source Perloff
13
Welfare effects of a monopoly
p
, per unit
24
MC
e
A
18
m
C

2
18
p
m
B
12
e
c
p
16
c
E
4
D
60
MR

MC

12
Demand
MR
Q

6
Q

8
24
12
0
m
c
Q
, Units per day
Source Perloff
14
A specific tax
p
, per unit
2
MC
(after tax)
24
1
MC
(before tax)
e
A
t

8
2
p
20
2
e
C
B
1
p

18
1
E
F
D
8
G
Demand
MR
0
Q

4
Q
6
24
12
2
1
Q
, Units per day
Source Perloff
15
Ad-valorem vs specific tax
p
, per unit
e
2
p
2
A
e
1
p
1
p

p



t
s
2
MC
Before-tax
demand,
D
MR
a
s
D
D
Q
, Units per year
Q
Q
a
s
MR
MR
2
1
Source Perloff
16
Natural Monopoly

• Where one firm can produce the market output more
  cheaply than several.
• eg. Utilities
• High fixed costs
• Constant marginal cost (sometimes zero)
• ACMCAFC
• AC declines with output

17
Natural Monopoly in Water
AC
,
MC
,
per unit
40
20
AC

10

60/
Q


15
10
MC



10
6
0
12
15
Q, Units per day
18
Government actions that create monopolies

• Barriers to entry
• Licensing
• Granting rights (post office)
• Auctioning rights (mobile phone)
• Government ownership
• Privatisation gives access to future monopoly
  profit.
• Patents
• Stimulate research
• Alternatives include grants and prizes.

19
Optimal price regulation
p
, per unit
MC
24
Market demand
Regulated demand
e
A
m
18
C
B
e
16
o
E
D
MR
r
MR
24
12
8
6
0
Q
, Units per day
Source Perloff
20
Non-optimal price regulation
, per unit
p
MC
Market demand
B
A
Regulated demand
e
p
1
D
1
C
p
2
e
2
E
MR
r
MR
Q
, Units per day
Q
Q
Q
2
1
d
Excess demand
Source Perloff
21
Problems in regulation shutdown
, Yen (
p
) per

hundred KWH
53
MC
AC
e
1
30.3
A
26.9
e
2
22.3
21.9
B
e
19.5
3
Demand
MR
31
23
0
34
54
Q
, Billion kWh per year
Source Perloff
22
Dominant firm and competitive fringe
p
, per unit
f
S
D
p
2
d
d
MC
e
f
p

r
D
p
1
r
MR



Q
, Units of output per year
Q
q
Q
d
d
f
Source Perloff
23
Happy Christmas