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Lecture 8

Price taker demand curve

30
D

QD = 625 25P
QS = 175 + 15P
P = 45
Q = 400
100 firms, 4 units each
Suppose 1 firm increases output to 5(25% increase)
QS = 176 + 15P
P = 44.9
1000 firms?

P = MR

Producers decision

MC

Rs. 30

Quantity

Producers maximize profit by selling the


quantity for which marginal revenue equals
marginal cost

Long run equilibrium is attained where


MR=MC=ATC
Economic profit is zero and only normal return
is realized

Firm and market supply


price

price
ATC

Sshort run

AVC

quantity

quantity

Monopoly
Single seller that produces a good with no close
substitutes
Sources of monopoly
What could be the causes of monopoly to
exist

Barriers to entry
Legal barriers
Patents
Government granted franchises

Natural barriers
Economies of scale
Average cost of production is falling through the
relevant range of consumer demand

Is at the opposite extreme of perfect


competition. Monopolist is a price maker as
against perfect competitor is who price taker

Profit maximising under monopoly

Rs

AR
MR
O

Rs

MC

AR

AR
MR
O

Qm

Rs

MC

AC

AR

AC

AR
MR
O

Qm

Case Study
The Market Value of Monopoly Profits in the New York
City Taxi Industry
NY city requires a license (medallion) to operate a taxi. These are
limited in numbers and confer a monopoly power (I.e. ability to earn
economic profits) to owners. Value of medallion is the PV of future
streams of earnings from medallion. For example the # of
medallions in NY city have remained at 11787 since 1937 till 1996. In
1996 it was increased by only 400 to 12187 medallions. The value of
medallion has risen from $ 10 in 1937 to 250000 in 1999 (18% p.a.).
The price of medallion is lower in other cities (e.g. $ 90000 in
Boston, $ 25000 in Chicago) reflecting much lower capacity in these
cities.
Proposals to increase the # in NY blocked by Taxi Unions.

Case Study
The Market Value of Monopoly Profits in the New York
City Taxi Industry (Contd..)
If the city authorities could give freely the medallions then the price
of medallions could fall to zero. Alternatively the Municipality has
allowed sharp increase in the radio taxis - although they are much
less flexible.
As a result the profit of NY taxi operators has come down from 32%
to only about 11% in 1999.

Monopoly

Comparison of monopoly
with perfect competition:
(a) same industry MC curve

MC
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve

Rs

P1

AR = D
MR
O

Q1

Equilibrium of industry under perfect competition and


monopoly: with the same MC curve
MC

Rs

P1
P2

AR = D
MR
O

Q1

Q2

Equilibrium of industry under perfect competition and


monopoly: with the
MCunder
curve
MC same
( = supply

Rs

perfect competition)

P1
P2

AR = D
MR
O

Q1

Q2

Monopoly

Comparison of monopoly
with perfect competition:
(b) monopoly has lower MC curve (i.e. it
is experiencing economies of scale)

Equilibrium of industry under perfect competition and


monopoly: with different MC curves

Rs

MCmonopoly

P1

AR = D
MR
O

Q1

Equilibrium of industry under perfect competition and monopoly:


with different MC curves

MC ( = supply)perfect competition

Rs

MCmonopoly
P2
P1

AR = D

MR
O

Q2

Q1

Equilibrium of industry under perfect competition and monopoly:


with different MC curves

MC ( = supply)perfect competition

Rs

MCmonopoly
P2
P1

AR = D

MR
O

Q2

Q1

Equilibrium of industry under perfect competition and monopoly:


with different MC curves

MC ( = supply)perfect competition

Rs

MCmonopoly
P2
P1

P3

AR = D
MR
O

Q2

Q1

Q3

MONOPOLY
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate
X-inefficiency

Advantages of monopoly
economies of scale
profits can be used for investment

MONOPOLY
Disadvantages of monopoly

high prices / low output: short run


high prices / low output: long run
lack of incentive to innovate
X-inefficiency

Advantages of monopoly
economies of scale
profits can be used for investment
promise of high profits encourages risk taking

Deadweight loss under monopoly

Deadweight loss under monopoly

MC
(= S under perfect competition)

Consumer
surplus
a

Ppc
Producer
surplus

AR = D
O

Qpc

(a) Industry equilibrium under perfect competition

Deadweight loss under monopoly

MC
(= S under perfect competition)

Pm
Ppc

Consumer
surplus

Deadweight
welfare loss
b
a

Producer
surplus

AR = D

MR
O

Qpc

Qpc

(b) Industry equilibrium under monopoly