Monopoly

1
Monopoly

• Here we see what a monopoly is and its revenue
  potential.

2
Overview
Monopoly means one seller. In perfect
competition many sellers were price takers. Any
one seller could not influence the price of the
product in the market. The competitive firm
could only choose what amount to sell. A
monopoly firm will have to determine both how
much to sell and at what price. Lets look at
these ideas a little more on the following few
slides.
3
p
Review
D
Market Q
In a market, consumers as a group are thought to
want to buy a greater quantity the lower the
price. We see this as a downward sloping demand
curve.
4
Review
p
S
p
PMRD
D
Market Q Firm
Q
In a competitive market, the market demand from
consumers interacts with market supply from many
sellers and we get an equilibrium price, like p
in the graph. At this point, since any one firm
is a small part of the market, when we look at a
firm it is a price taker. Thus, when the firm
thinks about selling another unit it can sell
that unit at the same price as the previous unit
and thus MR P for a competitive firm.
5
Analogy To think about the marginal revenue for
a competitive firm I like to think about a pop
machine. Say the price of a pop is 1.25. Say
the machine has been refilled and the pops are
not chilled to perfection and you are the first
one to make a purchase. What is the total
revenue in the machine after you make your
purchase? 1.25! Since the total revenue was
zero before you bought, the change in total
revenue from the sale of another unit (in this
case the first one), was 1.25. This is exactly
what we mean by marginal revenue. Marginal
revenue is the change in total revenue from
changing output by 1 unit. Now say I buy a pop
right after you. The total revenue in the
machine is 1.25(2) 2.50 and the marginal
revenue is 1.25. SO, MR P for a competitive
firm.
6
Monopoly
For a monopoly firm the demand is the same as
the market demand we see in competition. The
demand is downward sloping to the right, what is
called less than perfectly elastic.
Since the monopolist is the only seller, it is
natural they face the market demand curve.
The situation of monopoly is often called
imperfect competition.
7
Sources of monopoly
1) Exclusive control of an input deBeers is an
example 2) Economies of scale the case of a
natural monopoly. The idea here is that AC can
be pushed really low by one firm and it then
makes sense for only one firm to serve the
market. 3) Patents protecting inventions for a
time may give monopoly power. 4) Network
economies Microsoft Windows is an example of
the idea once enough people use a product
sometimes using another type of product becomes
less functional. 5) Granted by government
8
Maximize profit
Since the monopolist is the only seller in the
market, the monopolist must decide 1) what price
to charge and 2) how much to sell. When the
monopolist sells, she is worried about profit.
The goal is to maximize profit. But, in order to
maximize profit, the pattern of revenues and
costs at various output levels must be
understood. The pattern of cost was the topic of
an earlier section. Now we look at the pattern
of revenue.
9
p
Monopoly
6 5
D
2 3
Market Q
Here the monopoly is the only firm in the market.
When the price is 6, in this example the
consumers want 2 units. Total revenue would be
12. But, this firm, if it wants to sell 3 units
has to lower the price on all units to 5. The
competitive firm didnt have to worry about
another price like the monopoly firm.
10
Monopoly marginal revenue

So, because the way consumers are in this example
on the previous screen, when P 6, 2 units will
be sold and when the P 5, 3 units will be sold.
Total revenue would move from 12 to 15 when the
quantity moves from 2 to 3. So, the additional
revenue from the 3rd unit is 3. This is the
marginal revenue of the 3rd unit. Note, the price
to get the third unit sold is 5, but the
marginal revenue is only 3. SO, PgtMR at a
quantity.


11
Interpretation
When the price is lowered from 6 to 5 the amount
sold rises. In fact, the 3rd unit sold brings in
5 in revenue. But this isnt all we need to look
at to have MR. Since the monopolist must sell to
all consumers at the same price, the first 2
units now get sold at 5 as well. That means
revenue on those 2 units will not include 6 per
unit when the price is lowered. Continuing with
the example, MR(of the 3rd unit) 5 - (6-5)
2 3
12
interpretation
P
6
area c is the gain in revenue from
selling more area a is the loss in revenue from
selling at a lower price.
a
5
b
c
Q
2
3
Area a b 6 times 2 12 TR when P 6 Area b
c 5 times 3 15 TR when P 5 MR c - a
5 - 2 3
13
Lets do another example
P Q 5 0 4 1 3 2 2 3 1 4 0 5
Say this is the demand from consumers in the
market. If the price is 5 consumers want
nothing, for instance. Lets put TR on the next
slide.
14
Lets do another example
P Q TR 5 0 0 4 1 4 3 2 6 2 3 6 1 4 4 0 5 0
Total revenue is just P times Q, so you should
check what I have here. Next lets add MR to the
table.
15
Lets do another example
P Q TR MR 5 0 0 ---- 4 1 4 4 3 2 6 2 2 3 6
0 1 4 4 -2 0 5 0 -4
MR, marginal revenue, is the change in TR when we
add a unit of output. Note at Q 0 I have the
line --- because we have not had a change yet.
The MR 4 for a Q 1 because TR went from 0 to
4 when Q went from 0 to 4. The MR 2 for Q 2
because TR went from 4 to 6 when Q went from 1 to
2. Note MR can become negative, in theory.
Also note that P gt MR at each Q (except Q 1,
but we usually ignore this.)
16
MR from areas to height
P
In the above diagram we think of MR as area c - a
and we get a number.
a
In the bottom graph we can think of the
number as a height. Note still the MR is lower
than the price on the demand curve. On the next
screen we will see the whole MR curve.
D
b
c
Q
P
height MR
D
Q
17
Monopoly MR in a graph

I do not have a proof for you, but you can see
in this diagram that MR is also a straight line
that starts at the same place as demand in the
upper left, but is always below demand
because PgtMR. Like at Q 3, MR 3 and P 5.
5
3
D
Q
3
Note that a good way to draw in MR is to first
draw demand and then put MR through the Q axis
halfway out to the demand curve. I put an X at
that point.
18
Monopoly Pricing and Output

• We study the pricing and output decision of the
  monopoly firm.

19
Price and output decision for the monopolist in
the short run
The amount of output the monopolist should sell
in the short run is the amount where MR MC(as
long as PgtAVC), just as in the case of the
competitive firm. The price charged would then
be the price on the demand curve above the
quantity where MR MC. (recall P MR for
firms in comp, but PgtMR for the monopolpy firm.)
20
Logic of MR MC rule

The Q b is the Q where MR MC. But look at Q
a. At that point, Q could be increased and
more would be added to revenue than to cost and
thus profit would rise. We know this because
the MR gt MC for these Q (Compare the heights of
the curves).
MC
D
Q
a b c
MR
Now lets look at a Q greater than where MR MC,
like at point c. More has been added to cost
than to revenue and thus profit would fall. We
know this because MC gt MR at this Q.
21
What price?

MC
At Q, where MR MC, P is the price on the
demand curve consumers are willing to pay for Q
and thus this is the price charged by the
monopolist.
P
D
Q
Q
MR
22
Qualification
ATC .12

ATC
Note that the ATC is above the demand curve, so
the firm will lose money. In the short run,
the question is whether the firm should
shutdown or continue to operate. Lets go to
the next screen and say more about this.
MC
AVC1 .11
AVC1
AVC2
P .10
D
AVC2 .08
20
MR
23
continue
Note that the Q where MR MC 20. So, if the
firm operates at all it should make 20. Note at
Q 20, the price on the demand curve is .10 but
the ATC .12 Now, remember ATC TC/Q so ATC
times Q TC. TR P Q .1(20) 2 TC ATC Q
.12(20) 2.4 Profit TR TC 2 2.4 -
.4 Or Profit (P ATC)Q (1 - .12)20 -.4
The firm is losing money.
24
continue 2
If the AVC curve is AVC2 for the firm then at Q
20 the AVC .08. This means the TVC AVC Q
.08(20) 1.6. Thus the TR 2 can cover the
1.6 of TVC and what is left of TR, .4 can go to
paying some of the total fixed costs. If the
firm shuts down it would have nothing going to
fixed cost. So the firm should operate. Thus,
operate if at the Q where MR MC the P gt
AVC. Note if the AVC is AVC 1 .11 the P lt AVC.
The firm should shut down. TR of 2 falls short
of TVC of 2.2 and covers none of fixed while if
the firm shuts down it only has to cover the
fixed cost.
25
Quiz 1 not a real quiz

MC
Is this monopoly firm earning a profit? If
so, draw in the graph the rectangle that
represents the profit.
ATC
P
D
Q
MR
26
Quiz 2 not a real quiz

MC
ATC
Is it possible for a monopoly to lose
money? Indicate in the graph how much
this monopoly is losing by indicating the
loss rectangle.
AVC
P
D
Q
MR
27
Is a monopoly guaranteed a profit. I have a
monopoly I make a pizza fork (not really, but
listen up). Look at the palm of your right hand,
thumb up. When you wrap your hand around the
fork your thumb is next to a button on the fork
(sorry, only right handed version.). When you
press the button
Thumb
Palm of hand
A razor blade edge comes out here and you move
your hand so your thumb is now pointing left and
you cut your pizza real easily. The demand for my
item is much lower than where my costs are.
28
Can Monopolies charge whatever price they want?
The answer is yes, but with a qualification. Remem
ber consumers have a demand for the product and
have prices they are willing to pay. As long as
the monopoly is charging a price the consumers
are willing to pay then they can charge whatever
they like. But if the monopoly charges too high
a price consumers will not buy at all. OUR
ECONOMIC RULE sell Q where MR MC, charge the
price on the demand curve above this Q (So charge
whatever you want but to profit max charge this
one) and both of these ideas are dependent on
the PgtAVC at this Q.
29
The monopoly solution and elasticity
Without proof I tell you that with a given demand
curve and MR curve for the monopoly, we have MR
P (1 F), where F 1/absolute value of
elasticity of demand. Recall that elasticity of
demand changes as we move down the demand curve
(in absolute value the number gets
smaller). Monopoly mark-up We see the monopoly
has P gt MC at its profit maximizing level of
output. So the mark-up of P over MC as a
percentage of the price is (P MC)/P.
30
Mark-up and elasticity
The mark-up again is (P MC)/P. The profit
maximization condition was MR MC. The MR,
elasticity connection was MR P(1 F) P -
PF. SO, the mark-up can be changed to (P MC)/P
(P MR)/P (P (P PF))/P (P P PF)/P
PF/P 1/absolute value of elasticity of
demand. The monopoly mark-up is a function of the
elasticity of demand. Note that since we have
absolute value of elasticity, the mark-up is a
positive number, and since PgtMC, 1/abs lt1, or
absgt1. This means the elasticity of demand will
be in the elastic range for a monopoly.