CPA1L8 9 Monopoly

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8uS3008
In this chapter,
look for the answers to these questions:
Pow can a rm monopollze a markeL?
Why do monopolles arlse?
Why ls !" < # for a monopollsL?
Pow do monopolles choose Lhelr # and $?
Pow do monopolles aecL socleLy's well-
belng?
WhaL can Lhe governmenL do abouL
monopolles?
WhaL ls prlce dlscrlmlnauon?
lnLroducuon
A !"#"$"%& ls a rm LhaL ls Lhe sole seller of a
producL wlLhouL close subsuLuLes. 1here are many
demanders, so many LhaL no buyer has any conLrol
over Lhe prlce
ln Lhls chapLer, we sLudy monopoly and conLrasL lL
wlLh perfecL compeuuon.
1he key dlerence:
A monopoly rm has !'()*+ $"-*(, Lhe ablllLy Lo
lnuence Lhe markeL prlce of Lhe producL lL sells. A
compeuuve rm has no markeL power.
Why Monopolles Arlse
1he maln cause of monopolles ls .'((/*(0
+" *#+(&-oLher rms cannoL enLer Lhe markeL.
8arrler Lo enLry
Any lmpedlmenL LhaL prevenLs new rms from enLerlng an
lndusLry. And compeung on an equal basls wlLh exlsung
rms
1hree sources of barrlers Lo enLry:
12 A slngle rm owns a key resource.
L.g., ue8eers owns mosL of Lhe world's
dlamond mlnes
32 1he govL glves a slngle rm Lhe excluslve rlghL Lo produce
Lhe good.
L.g., paLenLs, copyrlghL laws
Why Monopolles Arlse
42 5'+6('% !"#"$"%&: a slngle rm can produce Lhe
enure markeL ! aL lower cosL Lhan could several
rms.
!
CosL
&'(
1000
$30
Lxample: 1000 homes
need elecLrlclLy
LlecLrlclLy
&'( slopes
downward due
Lo huge )( and
small !(
&'( ls lower lf
one rm servlces
all 1000 homes
Lhan lf Lwo rms
each servlce
300 homes.
300
$80
Monopoly vs. Compeuuon: uemand Curves
ln a compeuuve markeL, Lhe
markeL demand curve slopes
downward.
8uL Lhe demand curve
for '#& /#7/8/76'% 9(!:0
producL /0 ;"(/<"#+'%
aL Lhe markeL prlce.
1he rm can lncrease !
wlLhouL lowerlng #,
so !" = # for Lhe
compeuuve rm.
$
#

!
A compeuuve rm's
demand curve
Monopoly vs. Compeuuon: uemand Curves
A monopollsL ls Lhe only
seller, so lL faces Lhe markeL
demand curve.
1o sell a larger !,
Lhe rm musL reduce #.
1hus, !" = #.
$
#

!
A monopollsL's
demand curve
A C T I V E L E A RNI NG
1

A monopoly's revenue
Q P TR AR MR
0 $4.50
1 4.00
2 3.50
3 3.00
4 2.50
5 2.00
6 1.50
n.a.
Common Crounds
ls Lhe only seller of
cappucclnos ln Lown.
1he Lable shows Lhe
markeL demand for
cappucclnos.
llll ln Lhe mlsslng
spaces of Lhe Lable.
WhaL ls Lhe relauon
beLween # and %&?
8eLween # and '&?
A C T I V E L E A RNI NG
1

Answers
Pere, # = %&,
same as for a
compeuuve rm.
Pere, '& < #,
whereas '& = #
for a compeuuve rm.
1.30 6
2.00 3
2.30 4
3.00 3
3.30 2
1.30
2.00
2.30
3.00
3.30
$4.00 4.00 1
n.a.
9
10
10
9
7
4
$ 0 $4.30 0
'& %& (& # !
-1
0
1
2
3
$4
Common Crounds' * and !" Curves
-3
-2
-1
0
1
2
3
4
3
0 1 2 3 4 3 6 7
!
#, '&
'&
$
uemand curve (#)
1.30 6
2.00 3
2.30 4
3.00 3
3.30 2
4.00 1
$4.30 0
'& # !
-1
0
1
2
3
$4
undersLandlng Lhe MonopollsL's M8
lncreaslng ! has Lwo eecLs on revenue:
)*+,*+ -.-/+: hlgher ouLpuL ralses revenue
#01/- -.-/+: lower prlce reduces revenue
1o sell a larger !, Lhe monopollsL musL reduce
Lhe prlce on all Lhe unlLs lL sells.
Pence, !" < #
!" could even be negauve lf Lhe prlce eecL
exceeds Lhe ouLpuL eecL (e.g., when Common
Crounds lncreases ! from 3 Lo 6).
A MonopollsL's Caln and Loss ln 1oLal 8evenue
from Selllng a lourLh unlL
12
D = Average revenue
D
o
l
l
a
r
s

p
e
r


d
i
a
m
o
n
d

$7,000
6,750
1-carat diamonds
per day
3 4 0
Loss
Gain
If De Beers increases
quantity supplied from 3 to 4
diamonds per day, the gain in
revenue from the fourth
diamond is $6,750. But the
monopolist loses $750 from
selling the first 3 diamonds
for $6,750 each instead of
$7,000 each. Marginal
revenue from the fourth
diamond equals the gain
minus the loss, or $6,750
$750 $6,000. Thus, the
marginal revenue of $6,000 is
less than the price of $6,750.
roL-Maxlmlzauon
Llke a compeuuve rm, a monopollsL
maxlmlzes proL by produclng Lhe quanuLy
where '& = '2.
Cnce Lhe monopollsL ldenues Lhls quanuLy,
lL seLs Lhe hlghesL prlce consumers are wllllng
Lo pay for LhaL quanuLy.
lL nds Lhls prlce from Lhe $ curve.
roL-Maxlmlzauon
12 1he proL-
maxlmlzlng !
ls where
!" = !(.
32 llnd # from
Lhe demand curve
aL Lhls !.
CuanuLy
CosLs and
8evenue
!"
*
!(
roL-maxlmlzlng ouLpuL
#
!
1he MonopollsL's roL
As wlLh a
compeuuve rm,
Lhe monopollsL's
proL equals
(# - %(2) x !
CuanuLy
CosLs and
8evenue
&'(
*
!"
!(
!
#
%(2
A Monopoly uoes noL Pave an S Curve
=6$$%& >6(8* +*%%0 60 +;* ?6'#@+& +;'+ ' 9(!
>;""0*0 +" 06$$%& '+ '#& A/8*# $(/>*
B >"!$*@@8* 9(!
Lakes # as glven
has a supply curve LhaL shows how lLs ! depends on #.
B !"#"$"%& 9(!
ls a prlce-maker," noL a prlce-Laker"
! does noL depend on #,
! and # are [olnLly deLermlned by
!(, !", and Lhe demand curve.
Pence, no supply curve for monopoly.
1he Welfare CosL of Monopoly
8ecall: ln a compeuuve markeL equlllbrlum,
# C '2 345 '26 '& and LoLal surplus ls
maxlmlzed.
ln Lhe monopoly eq'm, # D '& C '2
1he value Lo buyers of an addluonal unlL (#)
exceeds Lhe cosL of Lhe resources needed Lo
produce LhaL unlL (!().
1he monopoly ! ls Loo low -
could lncrease LoLal surplus wlLh a larger !.
1hus, monopoly resulLs ln a deadwelghL loss.
# + !(
ueadwelghL
loss
#
!(
1he Welfare CosL of Monopoly
Compeuuve eq'm:
quanuLy = !
E

# = !(
LoLal surplus ls
maxlmlzed
Monopoly eq'm:
quanuLy = !
F

# > !(
deadwelghL loss
CuanuLy
rlce
*
!"
!(
!
F
!
E
G*'7-*/A;+ H"00 "I F"#"$"%&

ueadwelghL loss
of monopoly

-neL loss Lo
socleLy

-When a rm
wlLh markeL
power
resLrlcLs
ouLpuL and
lncreases Lhe
prlce
J*(I*>+ E"!$*@@"# '#7 F"#"$"%& E"!$'(*7
20
S
c
=MC=ATC
Quantity
per period
Q
m
Q
c
0
D
o
l
l
a
r
s

p
e
r

u
n
i
t

p
m

p
c

D
c
a
MR
m

b
m
A perfectly competitive industry
would produce output Q
C
,
determined by the intersection of
the market demand curve D and
the market supply curve S
C
. The
price would be p
C
. A monopoly that
could produce output at the same
minimum average cost as a
perfectly competitive industry
would produce output Q
m
,
determined at point b, where
marginal cost intersects the
monopolist's marginal revenue.
The monopolist would charge price
p
m
. Thus, given the same costs,
output is lower and price is
higher under monopoly than
under perfect competition.
rlce ulscrlmlnauon
ulscrlmlnauon: Lreaung people dlerenLly based
on some characLerlsuc, e.g, race or gender.
J(/>* 7/0>(/!/#'@"#: selllng Lhe same good
aL dlerenL prlces Lo dlerenL buyers.
1he characLerlsuc used ln prlce dlscrlmlnauon
ls wllllngness Lo pay (W1):
A rm can lncrease proL by charglng a hlgher prlce Lo
buyers wlLh hlgher W1.
J(/>* G/0>(/!/#'@"# /# +;* K*'% L"(%7
ln Lhe real world, perfecL prlce dlscrlmlnauon
ls noL posslble:
no rm knows every buyer's W1
8uyers do noL reveal lL Lo sellers
So, rms dlvlde cusLomers lnLo groups
based on some observable LralL
LhaL ls llkely relaLed Lo W1, such as lncome.
rlce ulscrlmlnauon
Condluons for prlce dlscrlmlnauon
uownward sloplng demand curve
Some markeL power
AL lasL Lwo groups of consumers
WlLh dlerenL prlce elasuclLy of demand
AblllLy Lo charge dlerenL prlces
AL low cosL
CusLomers can be separaLed ln ume
revenL reselllng of Lhe producL
23
A Model of rlce ulscrlmlnauon
1wo groups of consumers
Cne group (a): less elasuc demand
1he oLher (b): more elasuc demand
Maxlmlze proL
M8 = MC ln each markeL
Lower prlce for group (b)
24
rlce ulscrlmlnauon wlLh 1wo Croups of Consumers
23
D
(a) Consumer group
with less elastic demand
LRAC, MC
(b) Consumer group
with more elastic demand
400 Quantity per period 0 500 Quantity per period 0
A monopolist facing two groups of consumers with different demand elasticities may be
able to practice price discrimination to increase profit or reduce loss. With marginal
cost the same in both markets, the firm charges a higher price to the group in panel
(a), which has a less elastic demand than group in panel (b).
D
o
l
l
a
r
s

p
e
r

u
n
i
t

$3.00
1.00
LRAC, MC
MR
D
o
l
l
a
r
s

p
e
r

u
n
i
t

$1.50
1.00
D!
MR!
Lxamples of rlce ulscrlmlnauon
Movle uckeLs
ulscounLs for senlors, sLudenLs, and people
who can auend durlng weekday aernoons.
1hey are all more llkely Lo have lower W1
Lhan people who pay full prlce on lrlday nlghL.
Alrllne prlces
ulscounLs for SaLurday-nlghL sLayovers help
dlsungulsh buslness Lravelers, who usually have
hlgher W1, from more prlce-sensluve lelsure
Lravelers.
Lxamples of rlce ulscrlmlnauon
ulscounL coupons
eople who have ume Lo cllp and organlze
coupons are more llkely Lo have lower lncome
and lower W1 Lhan oLhers.
need-based nanclal ald
Low lncome famllles have lower W1 for
Lhelr chlldren's college educauon.
Schools prlce-dlscrlmlnaLe by oerlng
need-based ald Lo low lncome famllles.
Lxamples of rlce ulscrlmlnauon
CuanuLy dlscounLs
A buyer's W1 oen decllnes wlLh addluonal
unlLs, so rms charge less per unlL for large
quanuues Lhan small ones.
Lxample: A movle LheaLer charges $4 for
a small popcorn and $3 for a large one LhaL's
Lwlce as blg.
CCnCLuSlCn: 1he revalence of Monopoly
ln Lhe real world, -./0 monopoly ls rare.
?eL, many rms have markeL power, due Lo:
selllng a unlque varleLy of a producL
havlng a large markeL share and few slgnlcanL
compeuLors
ln many such cases, mosL of Lhe resulLs from
Lhls chapLer apply, lncludlng:
markup of prlce over marglnal cosL
deadwelghL loss
SUMMARY
A monopoly rm ls Lhe sole seller ln lLs
markeL. Monopolles arlse due Lo barrlers Lo
enLry, lncludlng: governmenL-granLed
monopolles, Lhe conLrol of a key resource, or
economles of scale over Lhe enure range of
ouLpuL.
A monopoly rm faces a downward-sloplng
demand curve for lLs producL. As a resulL, lL
musL reduce prlce Lo sell a larger quanuLy,
whlch causes marglnal revenue Lo fall below
prlce.
SUMMARY
Monopoly rms maxlmlze proLs by produclng
Lhe quanuLy where marglnal revenue equals
marglnal cosL. 8uL slnce marglnal revenue ls less
Lhan prlce, Lhe monopoly prlce wlll be greaLer
Lhan marglnal cosL, leadlng Lo a deadwelghL loss.
Monopoly rms (and oLhers wlLh markeL power)
Lry Lo ralse Lhelr proLs by charglng hlgher prlces
Lo consumers wlLh hlgher wllllngness Lo pay.
1hls pracuce ls called prlce dlscrlmlnauon.
SUMMARY
ollcymakers may respond by regulaung
monopolles, uslng anuLrusL laws Lo promoLe
compeuuon, or by Laklng over Lhe monopoly
and runnlng lL. uue Lo problems wlLh each of
Lhese opuons, Lhe besL opuon may be Lo Lake
no acuon.