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P = LMC = LRAC
Normal profits or zero economic profits in
the long run
Large number of buyers and sellers
Homogenous product
Perfect information
Firm is a price taker
P0 P0
D = MR = P
Q0 Q q0 Q
Monopoly
1. One seller - many buyers
2. One product (no good substitutes)
3. Barriers to entry
4. Price Maker
2
Marginal
1 Revenue
0 1 2 3 4 5 6 7 Output
2005 Pearson Education, Inc. Chapter 10 11
Monopoly
Observations
1. To increase sales the price must fall
2. MR < P
3. Compared to perfect competition
No change in price to change sales
MR = P
P1
P*
AC
P2
Lost
profit
D = AR
Lost
MR profit
Q1 Q* Q2 Quantity
Cost C (Q ) 50 Q 2
C
MC 2Q
Q
Demand : P (Q ) 40 Q
R(Q ) P (Q )Q 40Q Q 2
R
MR 40 2Q
Q
2005 Pearson Education, Inc. Chapter 10 16
Monopoly: An Example
MC MR P (Q ) 40 Q
2Q 40 2Q P (Q ) 40 10
4Q 40 P (Q ) 30
Q 10
c
200 r
Profits
150
100
50
c
0 5 10 15 20 Quantity
2005 Pearson Education, Inc. Chapter 10 19
Example of Profit Maximization
$/Q
40 MC Profit = (P - AC) x Q
= ($30 - $15)(10) =
$150
P=30
Profit
AC
20
AR
AC=15
10
MR
0 5 10 15 20 Quantity
2005 Pearson Education, Inc. Chapter 10 20
Monopoly
4. Q
P
1
P Q E
d
1
5. MR P P
Ed
is maximized where MR MC
P P 1 MC
E D
P MC 1
P ED
MC
P
1 1 E D
2005 Pearson Education, Inc. Chapter 10 25
A Rule of Thumb for Pricing
Assume
Ed 4 MC 9
9 9
P $12
1 1
4
.75
MC Shift in demand
leads to change
in price but
same quantity
P1
P2 D2
D1
MR2
MR1
Q1= Q2 Quantity
MC Shift in demand
leads to change
in quantity but
same price
P1 = P2
D2
MR2
D1
MR1
Q1 Q2 Quantity
Increase in P:
P1
P0 to P1 > tax
P0 MC + tax
t D = AR
MC
MR
Q1 Q0 Quantity
P*
MR* D = AR
MR
Q1 Q2 QT Quantity
1.60 MCA
1.50 1.50
1.40
Market DA
1.00 Demand
1.00 MRA
MC
P
1 1 Ed
MC P* MC
P*
P*-MC
D
P*-MC
MR
D
MR
Q* Quantity Q* Quantity
Markup Pricing: Supermarkets &
Convenience Stores
Supermarkets
1. Several firms
2. Similar product
3. Ed 10 for individual stores
MC MC
4.P 1.11( MC )
1 1 .1 0.9
5. Prices set about 10 - 11% above MC.
Convenience Stores
1. Higher prices than supermarkets
2. Convenience differentiates them
3. Ed 5
MC MC
4.P 1.25(MC )
1 1 5 0.8
5. Prices set about 25% above MC.
A
B
PC
C
AR=D
MR
Qm QC Quantity
Example
In 1996, Archer Daniels Midland (ADM)
successfully lobbied for regulations requiring
ethanol to be produced from corn
Although ethanol is the same whether
produced from corn, potatoes, grain or
anything else, ADM had a near monopoly on
corn-based ethanol production
Pm MC
P1
P2 = P C
AC
P3
P4
AR
AnyIfprice
left alone,
below Pa4 monopolist
results
Ifthe
price
For
Ifinprice is
outputlowered
levels
is lowered
firm
produces incurring
Q to to
PCPoutput
above
a loss. 3 output
QP1 , .
m and charges m
decreases andmaximum
the original
increases to its aaverage
shortage
and
Q exists.
C and
marginal
there revenue
is no curves
deadweight apply.
loss. Qm Q1 Q3 Qc Q3 Quantity
2005 Pearson Education, Inc. Chapter 10 66
The Social Costs of Monopoly
Power
Natural Monopoly
A firm that can produce the entire output of
an industry at a cost lower than what it would
be if there were several firms
Usually arises when there are large
economies of scale
We can show that splitting the market into
two firms results in higher AC for each firm
than when only one firm was producing
AC
Pr
MC
PC
AR
MR
Qm Qr QC Quantity
Regulation in Practice
It is very difficult to estimate the firm's cost
and demand functions because they change
with evolving market conditions
An alternative pricing technique rate-of-
return regulation allows the firms to set a
maximum price based on the expected rate
or return that the firm will earn
Competitive Buyer
Price taker
P = Marginal expenditure = Average
expenditure
D = Marginal value
Graphically can compare competitive
buyer to competitive seller
ME = AE AR = MR
P* P*
MR = MC
ME = MV at Q* P* = MR
ME = P* P* = MC
P* = MV D = MV
Quantity Quantity
Q* Q*
Monopsonist Buyer
Buyer will buy until value from last unit equals
expenditure on that unit
The market supply curve is not the marginal
expenditure curve
Market supply shows how much must pay per unit as
a function of total units purchased
Supply curve is average expenditure curve
Upward sloping supply implies the marginal
expenditure curve must lie above it
Decision to buy extra unit raises price paid for all units
S = AE
Competitive
PC P = PC
P*m Q = QC
D = MV
Q*m QC Quantity
2005 Pearson Education, Inc. Chapter 10 78
Monopoly and Monopsony
Monopsony is easier to understand if we
compare to monopoly
We can see this graphically
Monopolist
Can charge price above MC because faces
downward sloping demand (average revenue)
MR < AR
MR = MC gives quantity less than competitive market
and price that is higher
MC
P*
PC
AR
MR
Q* QC Quantity
S = AE
PC
P*
MV
Q* QC Quantity
2005 Pearson Education, Inc. Chapter 10 81
Monopoly and Monopsony
Monopoly Monopsony
MR < P ME > P
P > MC P < MV
Qm < QC Qm < QC
Pm > PC Pm < PC
S = AE
P*
MV P*
MV
Q* Quantity Q* Quantity
Social Costs of Monopsony
Power
Since monopsony power gives lower prices and
lower quantities purchased, we would expect
sellers to be worse off and buyers better off
We can show the effects of monopsony power
using producer and consumer surplus
compared to competitive market
For sole monopsonist, quantity is where ME = MV
and price is from demand
For competitive market, quantity and price where
S=D
Deadweight Loss
Consumers
gain A-B S = AE
B
PC
A C
P*
MV
Lost Producer Surplus
Q* QC Quantity
Two Examples
American Airlines
Early80s president and CEO accused of
attempting to price fix
Microsoft
Monopoly power
Predatory actions
Collusion