Pure Monopoly A monopolized market has a single seller The monopolists demand curve is the downward sloping market demand curve So the monopolist can alter the market price by adjusting its output level ID: 1028069
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1. Chapter Twenty-FourMonopoly
2. Pure MonopolyA monopolized market has a single seller.The monopolist’s demand curve is the (downward sloping) market demand curve.So the monopolist can alter the market price by adjusting its output level.
3. Pure MonopolyOutput Level, y$/output unitp(y)Higher output y causes alower market price, p(y).
4. Why Monopolies?What causes monopolies?a legal fiat; e.g. US Postal Service
5. Why Monopolies?What causes monopolies?a legal fiat; e.g. US Postal Servicea patent; e.g. a new drug
6. Why Monopolies?What causes monopolies?a legal fiat; e.g. US Postal Servicea patent; e.g. a new drugsole ownership of a resource; e.g. a toll highway
7. Why Monopolies?What causes monopolies?a legal fiat; e.g. US Postal Servicea patent; e.g. a new drugsole ownership of a resource; e.g. a toll highwayformation of a cartel; e.g. OPEC
8. Why Monopolies?What causes monopolies?a legal fiat; e.g. US Postal Servicea patent; e.g. a new drugsole ownership of a resource; e.g. a toll highwayformation of a cartel; e.g. OPEClarge economies of scale; e.g. local utility companies.
9. Pure MonopolySuppose that the monopolist seeks to maximize its economic profit,What output level y* maximizes profit?
10. Profit-MaximizationAt the profit-maximizing output level y*so, for y = y*,
11. y$R(y) = p(y)yProfit-Maximization
12. $R(y) = p(y)yc(y)Profit-Maximizationy
13. Profit-Maximization$R(y) = p(y)yc(y)yP(y)
14. Profit-Maximization$R(y) = p(y)yc(y)yP(y)y*
15. Profit-Maximization$R(y) = p(y)yc(y)yP(y)y*
16. Profit-Maximization$R(y) = p(y)yc(y)yP(y)y*
17. Profit-Maximization$R(y) = p(y)yc(y)yP(y)y*At the profit-maximizingoutput level the slopes ofthe revenue and total costcurves are equal; MR(y*) = MC(y*).
18. Marginal RevenueMarginal revenue is the rate-of-change of revenue as the output level y increases;
19. Marginal RevenueMarginal revenue is the rate-of-change of revenue as the output level y increases; dp(y)/dy is the slope of the market inversedemand function so dp(y)/dy < 0. Thereforefor y > 0.
20. Marginal RevenueE.g. if p(y) = a - by then R(y) = p(y)y = ay - by2and soMR(y) = a - 2by < a - by = p(y) for y > 0.
21. Marginal RevenueE.g. if p(y) = a - by then R(y) = p(y)y = ay - by2and soMR(y) = a - 2by < a - by = p(y) for y > 0.p(y) = a - byaya/bMR(y) = a - 2bya/2b
22. Marginal CostMarginal cost is the rate-of-change of totalcost as the output level y increases; E.g. if c(y) = F + ay + by2 then
23. Marginal CostFyyc(y) = F + ay + by2$MC(y) = a + 2by$/output unita
24. Profit-Maximization; An ExampleAt the profit-maximizing output level y*,MR(y*) = MC(y*). So if p(y) = a - by andc(y) = F + ay + by2 then
25. Profit-Maximization; An ExampleAt the profit-maximizing output level y*,MR(y*) = MC(y*). So if p(y) = a - by and ifc(y) = F + ay + by2 thenand the profit-maximizing output level is
26. Profit-Maximization; An ExampleAt the profit-maximizing output level y*,MR(y*) = MC(y*). So if p(y) = a - by and ifc(y) = F + ay + by2 thenand the profit-maximizing output level is causing the market price to be
27. Profit-Maximization; An Example$/output unityMC(y) = a + 2byp(y) = a - byMR(y) = a - 2byaa
28. Profit-Maximization; An Example$/output unityMC(y) = a + 2byp(y) = a - byMR(y) = a - 2byaa
29. Profit-Maximization; An Example$/output unityMC(y) = a + 2byp(y) = a - byMR(y) = a - 2byaa
30. Monopolistic Pricing & Own-Price Elasticity of DemandSuppose that market demand becomes less sensitive to changes in price (i.e. the own-price elasticity of demand becomes less negative). Does the monopolist exploit this by causing the market price to rise?
31. Monopolistic Pricing & Own-Price Elasticity of Demand
32. Monopolistic Pricing & Own-Price Elasticity of DemandOwn-price elasticity of demand is
33. Monopolistic Pricing & Own-Price Elasticity of DemandOwn-price elasticity of demand isso
34. Monopolistic Pricing & Own-Price Elasticity of DemandSuppose the monopolist’s marginal cost ofproduction is constant, at $k/output unit.For a profit-maximumwhich is
35. Monopolistic Pricing & Own-Price Elasticity of DemandE.g. if e = -3 then p(y*) = 3k/2, and if e = -2 then p(y*) = 2k. So as e rises towards -1 the monopolistalters its output level to make the marketprice of its product to rise.
36. Monopolistic Pricing & Own-Price Elasticity of DemandNotice that, since
37. Monopolistic Pricing & Own-Price Elasticity of DemandNotice that, since
38. Monopolistic Pricing & Own-Price Elasticity of DemandNotice that, sinceThat is,
39. Monopolistic Pricing & Own-Price Elasticity of DemandNotice that, sinceThat is,
40. Monopolistic Pricing & Own-Price Elasticity of DemandNotice that, sinceThat is,So a profit-maximizing monopolist alwaysselects an output level for which marketdemand is own-price elastic.
41. Markup PricingMarkup pricing: Output price is the marginal cost of production plus a “markup.”How big is a monopolist’s markup and how does it change with the own-price elasticity of demand?
42. Markup Pricingis the monopolist’s price.
43. Markup Pricingis the monopolist’s price. The markup is
44. Markup Pricingis the monopolist’s price. The markup isE.g. if e = -3 then the markup is k/2, and if e = -2 then the markup is k. The markup rises as the own-price elasticity of demand rises towards -1.
45. A Profits Tax Levied on a MonopolyA profits tax levied at rate t reduces profit from P(y*) to (1-t)P(y*).Q: How is after-tax profit, (1-t)P(y*), maximized?
46. A Profits Tax Levied on a MonopolyA profits tax levied at rate t reduces profit from P(y*) to (1-t)P(y*).Q: How is after-tax profit, (1-t)P(y*), maximized?A: By maximizing before-tax profit, P(y*).
47. A Profits Tax Levied on a MonopolyA profits tax levied at rate t reduces profit from P(y*) to (1-t)P(y*).Q: How is after-tax profit, (1-t)P(y*), maximized?A: By maximizing before-tax profit, P(y*).So a profits tax has no effect on the monopolist’s choices of output level, output price, or demands for inputs.I.e. the profits tax is a neutral tax.
48. Quantity Tax Levied on a MonopolistA quantity tax of $t/output unit raises the marginal cost of production by $t.So the tax reduces the profit-maximizing output level, causes the market price to rise, and input demands to fall.The quantity tax is distortionary.
49. Quantity Tax Levied on a Monopolist$/output unityMC(y)p(y)MR(y)y*p(y*)
50. Quantity Tax Levied on a Monopolist$/output unityMC(y)p(y)MR(y)MC(y) + tty*p(y*)
51. Quantity Tax Levied on a Monopolist$/output unityMC(y)p(y)MR(y)MC(y) + tty*p(y*)ytp(yt)
52. Quantity Tax Levied on a Monopolist$/output unityMC(y)p(y)MR(y)MC(y) + tty*p(y*)ytp(yt)The quantity tax causes a dropin the output level, a rise in theoutput’s price and a decline indemand for inputs.
53. Quantity Tax Levied on a MonopolistCan a monopolist “pass” all of a $t quantity tax to the consumers?Suppose the marginal cost of production is constant at $k/output unit.With no tax, the monopolist’s price is
54. Quantity Tax Levied on a MonopolistThe tax increases marginal cost to $(k+t)/output unit, changing the profit-maximizing price toThe amount of the tax paid by buyers is
55. Quantity Tax Levied on a Monopolistis the amount of the tax passed on tobuyers. E.g. if e = -2, the amount ofthe tax passed on is 2t.Because e < -1, e /(1+e) > 1 and so themonopolist passes on to consumers morethan the tax!
56. The Inefficiency of MonopolyA market is Pareto efficient if it achieves the maximum possible total gains-to-trade.Otherwise a market is Pareto inefficient.
57. The Inefficiency of Monopoly$/output unityMC(y)p(y)yep(ye)The efficient output levelye satisfies p(y) = MC(y).
58. The Inefficiency of Monopoly$/output unityMC(y)p(y)yep(ye)The efficient output levelye satisfies p(y) = MC(y).CS
59. The Inefficiency of Monopoly$/output unityMC(y)p(y)yep(ye)The efficient output levelye satisfies p(y) = MC(y).CSPS
60. The Inefficiency of Monopoly$/output unityMC(y)p(y)yep(ye)The efficient output levelye satisfies p(y) = MC(y).Total gains-to-trade ismaximized.CSPS
61. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)
62. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)CS
63. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)CSPS
64. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)CSPS
65. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)CSPS
66. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)CSPSMC(y*+1) < p(y*+1) so bothseller and buyer could gainif the (y*+1)th unit of outputwas produced. Hence the market is Pareto inefficient.
67. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)DWLDeadweight loss measuresthe gains-to-trade notachieved by the market.
68. The Inefficiency of Monopoly$/output unityMC(y)p(y)MR(y)y*p(y*)yep(ye)DWLThe monopolist produces less than the efficient quantity, making the market price exceed the efficient market price.
69. Natural MonopolyA natural monopoly arises when the firm’s technology has economies-of-scale large enough for it to supply the whole market at a lower average total production cost than is possible with more than one firm in the market.
70. Natural Monopolyy$/output unitATC(y)MC(y)p(y)
71. Natural Monopolyy$/output unitATC(y)MC(y)p(y)y*MR(y)p(y*)
72. Entry Deterrence by a Natural MonopolyA natural monopoly deters entry by threatening predatory pricing against an entrant.A predatory price is a low price set by the incumbent firm when an entrant appears, causing the entrant’s economic profits to be negative and inducing its exit.
73. Entry Deterrence by a Natural MonopolyE.g. suppose an entrant initially captures one-quarter of the market, leaving the incumbent firm the other three-quarters.
74. Entry Deterrence by a Natural Monopolyy$/output unitATC(y)MC(y)DIDEp(y), total demand = DI + DE
75. Entry Deterrence by a Natural Monopolyy$/output unitATC(y)MC(y)DIDEpEp(y*)An entrant can undercut theincumbent’s price p(y*) but ...p(y), total demand = DI + DE
76. Entry Deterrence by a Natural Monopolyy$/output unitATC(y)MC(y)p(y), total demand = DI + DEDIDEpEpIp(y*)An entrant can undercut theincumbent’s price p(y*) but the incumbent can then lower its price as far as pI, forcing the entrant to exit.
77. Inefficiency of a Natural MonopolistLike any profit-maximizing monopolist, the natural monopolist causes a deadweight loss.
78. y$/output unitATC(y)p(y)y*MR(y)p(y*)MC(y)Inefficiency of a Natural Monopoly
79. y$/output unitATC(y)MC(y)p(y)y*MR(y)p(y*)p(ye)yeProfit-max: MR(y) = MC(y) Efficiency: p = MC(y) Inefficiency of a Natural Monopoly
80. y$/output unitATC(y)MC(y)p(y)y*MR(y)p(y*)p(ye)yeProfit-max: MR(y) = MC(y) Efficiency: p = MC(y) DWLInefficiency of a Natural Monopoly
81. Regulating a Natural MonopolyWhy not command that a natural monopoly produce the efficient amount of output?Then the deadweight loss will be zero, won’t it?
82. y$/output unitATC(y)MC(y)p(y)MR(y)p(ye)yeRegulating a Natural MonopolyAt the efficient outputlevel ye, ATC(ye) > p(ye)ATC(ye)
83. y$/output unitATC(y)MC(y)p(y)MR(y)p(ye)yeRegulating a Natural MonopolyAt the efficient outputlevel ye, ATC(ye) > p(ye)so the firm makes aneconomic loss.ATC(ye)Economic loss
84. Regulating a Natural MonopolySo a natural monopoly cannot be forced to use marginal cost pricing. Doing so makes the firm exit, destroying both the market and any gains-to-trade.Regulatory schemes can induce the natural monopolist to produce the efficient output level without exiting.