10/4/2017

ECO 9730 | Fall 2017 | Henry

MCKENZIE & LEE:

CHAPTER 11

OBJECTIVE
At the end of our discussion, you should have an
understanding of

o the characteristics of a monopoly market

o the monopoly profit-maximizing decision (quantity price

choice)

o the monopolys inefficiency compared to the competitive

firms efficiency

o the monopolys increase in profit when it is able to price

discriminate

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MONOPOLY

market power ~ the ability of the firm to raise market

price by reducing production and hence market supply

o monopoly faces the downward sloping market demand

curve

o price-searcher

o extent of monopoly power varies grocery store

o barriers to entry main condition that separates price-

searchers and price-takers

MONOPOLY
What may be a barrier to entry?

o monopolist owns the key resource has a patent or copyright

has an exclusive franchise

o monopolist owns the right to a brand with a highly loyal group of

customers

o monopolist keeps an essential feature of the product as a trade

secret

o monopolist has customers locked-in on their product

o monopolist enjoys large economies of scale

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MONOPOLY

Are there any limitations to monopoly power?

o without government assistance, the monopolys market

control is not complete | consumer chooses a substitute
good

o market condition upward sloping marginal cost and

downward sloping market demand

MONOPOLY
Price > MR at all quantities

500

450
Demand (price), Average Revenue, Marginal Revenue ($)

400

350

300

250

200

150
D = AR
100

50
MR
0
0 10 20 30 40 50 60 70
Quantity

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MONOPOLY
How is it that price > marginal revenue at all quantities?
o as the firm increases quantity, the price falls such that the revenue
gained from the higher quantity < price at which this quantity is
sold

Consider the market price = $305 and Q = 20

o If the firm increases Q to 30, the price falls to $257.50

o overall TRprice at $305 = $6100 overall TRprice at $257.50 = $7725

o TR lost: Q = 20 @ P = $257.50 ($950) | TR gained: Q = 10 @ P = $257.50 ($2570)

TR 7725 6100
o marginal revenue = = = $162.50 < new price, P = $257.50
Q 30 20

MONOPOLY
Profit = (price ATC) x Q = ($257.50 - $191.67) x 30 = $1,974.90
500

450
Demand (price), AR, MR, ATC, AVC, MC ($)

400 MC

350

300
257.50
250
ATC
200
191.67
AVC
150

D = AR
100

50
MR
0
0 10 20 30 40 50 60 70
Quantity

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MONOPOLY

Profit maximizing decision (single price)

o MR = MC at Q = 30

o produce Q = 30 and charge the price P = $257.50

o profit = ($257.50 $191.67) x 30 = $1,974.90

INEFFICIENCY WITH THE MONOPOLY

(quantity, price): M (30, $257.50) | P(42, $200)
500

450
Demand (price), AR, MR, ATC, AVC, MC ($)

400 MC

350

300
257.50
250
ATC
200
200
AVC
150

D = AR
100

50
MR
0
0 10 20 30 40 42 50 60 70
Quantity

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MONOPOLY

Key points ~
o the monopoly firms profit maximizing quantity <
competitive firms profit maximizing quantity

o monopoly firms quantity is inefficient

o the monopolys behavior produces a DWL > 0 and

erodes the consumers surplus

Price discrimination can improve efficiency but it will

erode the consumers surplus

MONOPOLY

Types of price discrimination ~

o 1st degree (perfect) ~ the firm sells each unit at the
maximum amount the consumer for that unit is willing to pay

o 2nd degree (non-linear) ~ the firm varies the price with the
quantity purchased

o 3rd degree (group) ~ the firm charges different group of

customers different prices most common

We will focus on the third-degree and the first-degree

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MONOPOLY

Consider that the firm can charge a high price and low
price (3rd degree price discrimination)

o high price = $352.50 and low price = $233.75

From the demand curve

o at P = $352.50, Q = 10 | at P = $233.75, Q = 35

o decision: produce Q = 35 sell Q = 10 at $352.50 and

the remaining Q = 25 at $233.75

PRICE DISCRIMINATING MONOPOLY

High price = $352.50 low price = $233.75
500

450
Demand (price), AR, MR, ATC, AVC, MC ($)

400 MC

352.50
350

300

250
233.75
ATC
200
AVC
150

D = AR
100

50
MR
0
0 10
10 20 30 35 40 50 60 70
Quantity

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MONOPOLY

Profit maximizing decision (single price)

o MR = MC at Q = 30
o produce Q = 30 and charge the price P = $257.50
o profit = ($257.50 $191.67) x 30 = $1,974.90

Profit maximizing decision (2nd degree)

o produce Q = 35
o sell Q = 10 at the price, P = $352.50 for Q = 10 sell Q = 25
at the price P = $233.75
o TR = ($352.50 x 10) + (233.75 x 25) = $9,368.75
o TC = (ATC x Q) = ($182.68 x 35) = $6,393.80
o Profit = TR TC = $2,974.95

MONOPOLY

Consider that the firm can perfectly price discriminate (1st

degree price discrimination)

o decision: produce Q = 42 (the efficient quantity)

o MC = MB at this level of output

o sell each quantity at the price consumers are willing to

pay.

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PRICE DISCRIMINATING MONOPOLY

Prices vary from just below $400 to $200
500

450
Demand (price), AR, MR, ATC, AVC, MC ($)

400 MC

350

300

250
ATC
200
200
AVC
150

D = AR
100

50
MR
0
0 10
10 20 30 40 42 50 60 70
Quantity

MONOPOLY
Profit maximizing decision (single price)
o produce Q = 30 P = $257.50
o profit = $1,974.90

Profit maximizing decision (2nd degree)

o produce Q = 35 P = $352.50 for Q = 10 & P = $233.75 for Q = 25
o profit = $2,974.95

Profit maximizing decision (1st degree)

o produce Q = 35 P ranges from $200 to $400
o profit = CS at Q = 35 & P = $200 + firms profit at Q = 35 & P = $200
o profit = [0.5 x ($400 - $200) x 35] + [($200 - $182.68) x 35]
o profit = $3,500 + $606.20 = $4,106.20