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Eco101 Monopoly Chapter 15 (Mankiw)

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0% found this document useful (0 votes)
44 views28 pages

Eco101 Monopoly Chapter 15 (Mankiw)

Uploaded by

Tamara Haque
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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N.

GREGORY MANKIW NINTH EDITION

PRINCIPLES OF
ECONOMICS
CHAPTER

15 Monopoly
1
Why Monopolies Arise
• Monopoly
– A firm that is the only single seller of a
product, without any close substitutes
– Has market power
• The monopolist can decide the market price
of the product it sells: “price maker”
– Arise due to barriers to entry
• Other firms cannot enter the market to
compete with it

2
Why Monopolies Arise
• In order for the firm to be considered a
monopoly, the product it sells must have no
close substitutes available from other firms
• So, can a monopoly charge whatever price
they want for a good? No! because the
monopoly has to satisfy the market demand,
so his price can only go as high as
consumers’ “willingness to pay” for each
level of output.

3
Three Barriers to Entry
1. Monopoly resources
– A single firm owns a key resource.
• Single water supplier in town (owns the
pipelines)
• DeBeers - owns most of the world’s
diamond mines
2. Government regulation
– The government gives a single firm the
exclusive right to produce the good.
• Patent and copyright laws
4
Three Barriers to Entry
3. The production process: natural
monopoly
– A single firm can produce the entire
market Q at lower cost compared to if
several firms produced the same level of
output jointly.
– Arises when there are economies of
scale over the relevant range of output
– For example, WASA and DESCO are
examples of Natural Monopolies.
5
EXAMPLE 1: Natural monopoly
In a small town, suppose 1,000 houses need electricity.
• ATC is lower if one firm supplies all 1,000 houses
than if two firms each supply to 500 houses.
Electricity

Cost
ATC slopes downward due to
huge FC and small MC
$80
$50 ATC
Q
500 1000
6
Monopoly versus Perfect Competition
• A Perfectly Competitive firm is:
– A “Price taker”; it does not have any market power
– Small, one of many
– Faces an individual demand curve at P = MR:
perfectly elastic demand curve.
• The Monopoly firm is:
– A “Price maker”; it has market power
– It faces the entire market demand; it has a
downward sloping demand curve. This means the
Price of the good needs to be reduced in order to
increase the Quantity Demanded.
7
Demand curves: Perfectly Competitive firm vs. Monopoly

P A perfectly P A monopolist’s
competitive firm’s demand curve
demand curve
P = MR
D
The market
demand curve D
Q Q

The firm can increase Q To sell a larger Q, the


without lowering P, so firm must reduce P.
MR = P for the perfectly Thus, MR ≠ P.
competitive firm. 8
Active Learning 1: JJ’s salon revenue
Jack and Jill own the Q P TR AR MR
only hair salon in town, 0 $60
“JJ’s salon.” 1 55
The table shows the 2 50
market demand for 3 45
haircuts. 4 40
• Fill in the missing 5 35
spaces of the table. 6 30
• What is the relation 7 25
between P and AR? 8 20
9 15
• Between P and MR?
10 10

9
Active Learning 1: Answers
• P = AR Q P TR AR MR
(same as for a 0 $60 $0 -
perfectly competitive 1 55 55 55 55
firm) 2 50 100 50 45
3 45 135 45 35
4 40 160 40 25
• MR < P for a 5 35 175 35 15
monopoly, whereas 6 30 5
180 30
MR = P for a perfectly 7 25 -5
175 25
competitive firm. 8 20 -15
160 20
9 15 -25
135 15
10 10 -35
100 10
10
EXAMPLE 2: JJ’s MR and demand curves
P, MR
Q P MR $60
0 $60 ---
50
1 55 55 Demand curve (P)
40
2 50 45 30
3 45 35 20
4 40 25 10
5 35 MR
15 0
6 30
5 -10
Q
7 25
-5 -20
8 20
-15
9 15 -30
-25 0 1 2 3 4 5 6 7 8 9 10
10 10
-35
11
Monopoly Profit Maximization
• Produce Q where MR = MC
• Sets the highest price consumers are
willing to pay for that quantity (according
to the Market Demand curve)
• P > MR = MC (always)
• If (and only if) the P > ATC, the monopoly
earns a profit

12
Profit-maximization for a monopoly
Costs and
Revenue MC

P
The profit-maximizing
Q is where MR = MC.

D
At this Q, find P
according to the MR
demand curve. Q Quantity

Profit-maximizing output

13
The monopolist’s profit
Costs and
Revenue MC
The monopolist’s
profit is calculated using P
EXACTLY the same ATC
formula as Perfect ATC
Competition.
D
Profit = TR – TC MR
= P*Q – ATC*Q
Q Quantity
= (P – ATC) x Q
(taking Q
common)

14
CASE STUDY: Monopoly vs. Generic Drugs

The market for


Price a typical drug
Patents on new
drugs give a temporary
monopoly to the seller: PM
PM, QM.
PC = MC
D
When the patent
MR
expires, the market
becomes competitive, QM QC
generic drugs appear: Quantity
PC, QC.
15
The Welfare Cost of Monopolies
• Monopoly equilibrium: at P > MR = MC
– P > MR = MC can be broken down into:
P > MR, MR = MC (substituting MR)  P > MC
– P > MC means: The value to buyers of an additional
unit (P) exceeds the cost of the resources needed
to produce that unit (MC)
– The monopoly Q is too low – it is not the best
outcome for the society as a whole. A larger
Quantity of Output could increase the Total Surplus
(Consumer Surplus + Producer Surplus).
– Monopoly results in a Deadweight Loss

16
The deadweight loss of monopoly

Price Deadweight
Perfectly Competitive MC
equilibrium: loss
• quantity = QC PM
PC = MC
• PC = MC
MC
• total surplus is
D
maximized
MR
Monopoly equilibrium:
• quantity = QM QM QC Quantity
• PM > MC
• deadweight loss
17
The Monopoly’s Profit: A Social Cost?
• Monopoly profit is not in itself necessarily
a problem for society
– Greater producer surplus for monopoly
– Smaller consumer surplus
– Transfer of surplus from consumers to
monopoly
• The inefficiency:
– Monopoly produces Q < efficient quantity
– Deadweight loss
18
Price Discrimination
• Price discrimination:
– Sell the same good at different prices to different
buyers
– A firm can increase profit by charging a higher
price to buyers who have a higher “willingness
to pay”
– Requires the ability to separate customers
according to “high willingness to pay” and “low
willingness to pay”
– Strangely, Price Discrimination can increase
social welfare
19
Active Learning 2: At the Movies
You are the manager of the only movie theater in
town. The price you charge is $18 per ticket, and in a
given week you sell Q = 1,000 movie tickets. Assume
that you incur only a fixed cost of $10,000 in a week.
A. How much profit is the movie theater making?
B. If you are reducing the price to $5, you will be able
to sell Q = 2,500 movie tickets. Calculate the
profit.
C. Suggest a way you can price discriminate when
selling movie tickets. Calculate the profit if you
price discriminate, with P1 = $18 and P2 = $5.

20
Active Learning 2: Answers

A. Single price P = $18, Q = 1,000, TC = $10,000


Total revenue TR = P × Q = $18,000
Profit = TR – TC = $8,000
B. Single price P = $5, Q = 2,500, TC = $10,000
 Total revenue TR = P × Q = $12,500
Profit = TR – TC = $2,500
C. Price discrimination: P1 = $18 and P2 = $5.
Sell Q = 1,000 at P1, so TR1 = $18,000
Sell Q = (2,500 – 1,000) at P2, so TR2 = $7,500
Profit = TR1 + TR2 – TC = $15,500
21
Perfect Price Discrimination
• Perfect price discrimination
– Charge each customer a different price
• Exactly his or her willingness to pay
– Monopoly firm gets the entire surplus
(Profit)
– No deadweight loss (resources are no
wasted). So it is good for the society.

22
Welfare with and without price discrimination
Single price monopoly Perfect price discrimination
Price Price
Consumer
surplus Monopoly
profit
PM
Monopoly
profit DWL
MC MC
D D

MR MR

QM Q
Quantity Quantity
23
Price Discrimination in the Real World
• Perfect price discrimination
– Not possible in the real world
• No firm knows every buyer’s Willingness To
Pay
• Buyers do not reveal it to sellers
• Price discrimination
– Firms divide customers into groups
based on some observable trait
that is likely related to their Willingness To Pay
(WTP), such as age, location etc.

24
EXAMPLE 3: Price discrimination

A. Movie tickets
– Discounts for senior citizens, students, and
people who can attend during weekday
afternoons (the last category are very likely
to be unemployed).
– This group has lower WTP than people who
pay full price on Friday night
B. Airline prices
– Discounts for Saturday-night stayovers
– Business travelers (higher WTP) vs. more
price-sensitive leisure travelers
25
EXAMPLE 3: Price discrimination

C. Discount coupons
– People who have time to clip and organize
coupons are more likely to have lower
income and lower WTP than others
D. Need-based financial aid
– Low income families have lower WTP for
their children’s college education
– Schools price-discriminate by offering
need-based financial aid to low income
families
26
EXAMPLE 3: Price discrimination

E. Quantity discounts
– A buyer’s WTP often declines with additional
units, so firms charge less per unit for large
quantities than small ones.
– Example: A movie theater charges $7 for
a small popcorn and $9 for a large one that’s
twice as big (In this example, the firm is not charging
different prices to different customers, but charging
different prices to the same customer based on that
customer’s declining willingness to pay for additional
units)

27
Perfect Competition versus Monopoly
Perfect Monopoly
Competition
Similarities
Goal of firms Maximize profits Maximize profits
Rule for maximizing MR = MC MR = MC
Can earn economic profits in SR? Yes Yes
Differences
Number of firms Many One
Marginal revenue MR = P MR < P
Price P = MC P > MC
Produces welfare-maximizing Yes No
level of output?
Entry in the LR? Yes No
Can earn economic profits in LR? No (don’t worry) Yes
Price discrimination possible? No Yes
28

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