Monopoly (managerial economics)
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The document discusses key concepts related to monopoly markets including: 1) Monopolies have a single seller, sell a unique product without close substitutes, and erect barriers to entry. 2) A profit-maximizing monopolist will produce where marginal revenue equals marginal cost. 3) Monopolies can engage in price discrimination by charging different prices to different consumer groups.
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Monopoly (managerial economics)
- 2. Review of Perfect CompetitionReview of Perfect Competition Large number of buyers and sellersLarge number of buyers and sellers Homogenous productHomogenous product Perfect informationPerfect information Firm is a price takerFirm is a price taker P = MC = ACP = MC = AC Normal profits or zero economicNormal profits or zero economic profits in the long runprofits in the long run
- 3. Review of Perfect CompetitionReview of Perfect Competition Q P Market D S Q0 P0 Q P Individual Firm P0 AR = MR = P q0 LRACLMC
- 4. MonopolyMonopoly MonopolyMonopoly 1.1. One seller - many buyersOne seller - many buyers 2.2. One product (no close substitutes) –One product (no close substitutes) – eg. Public utilities – electricityeg. Public utilities – electricity 3.3. Barriers to entryBarriers to entry 4.4. Price MakerPrice Maker
- 5. MonopolyMonopoly The monopolist is the supply-side of theThe monopolist is the supply-side of the market and has complete control over themarket and has complete control over the amount offered for saleamount offered for sale Monopolist controls price but mustMonopolist controls price but must consider consumer demandconsider consumer demand Profits will be maximized at the level ofProfits will be maximized at the level of output where marginal revenue equalsoutput where marginal revenue equals marginal cost (MR=MC)marginal cost (MR=MC)
- 6. Average and Marginal RevenueAverage and Marginal Revenue The monopolist’sThe monopolist’s average revenueaverage revenue,, price received per unit sold, is theprice received per unit sold, is the market demand curvemarket demand curve Monopolist also needs to findMonopolist also needs to find marginal revenuemarginal revenue, change in, change in revenue resulting from a unit changerevenue resulting from a unit change in outputin output
- 7. The demand curve for theThe demand curve for the monopolist is negatively sloped –monopolist is negatively sloped – monopolist must lower price to sellmonopolist must lower price to sell additional unitsadditional units MR<P = ARMR<P = AR MR is twice as steep as demandMR is twice as steep as demand curvecurve Average and Marginal RevenueAverage and Marginal Revenue
- 8. Average and Marginal RevenueAverage and Marginal Revenue Output1 2 3 4 5 6 70 1 2 3 $ per unit of output 4 5 6 7 Average Revenue (Demand) Marginal Revenue
- 9. MonopolyMonopoly ObservationsObservations 1.1. To increase sales the price must fallTo increase sales the price must fall 2.2. MR < PMR < P 3.3. Compared to perfect competitionCompared to perfect competition No change in price to change salesNo change in price to change sales MR = PMR = P
- 10. Monopolist’s Output DecisionMonopolist’s Output Decision 1.1. Profits maximized at the outputProfits maximized at the output level where MR = MClevel where MR = MC 2.2. Cost functions are the sameCost functions are the same MRMCor MRMCQCQRQ QCQRQ = −==∆∆−∆∆=∆∆ −= 0/// )()()( π π
- 11. MC AC Quantity Cost, Price D = AR MR P* Q* Monopolist’s Output DecisionMonopolist’s Output Decision AC Profit
- 12. Quantity Cost, Price Monopolist’s Output DecisionMonopolist’s Output Decision Loss MC AC P=AR MR
- 13. Quantity Cost, Price Shutdown DecisionShutdown Decision Loss MC AC P=AR MR AVC ATC>P<AVC, hence shutdown
- 14. Measuring Monopoly PowerMeasuring Monopoly Power Monopoly power could be measured by theMonopoly power could be measured by the extent to which price is greater than MC forextent to which price is greater than MC for each firmeach firm Lerner’s Index of Monopoly PowerLerner’s Index of Monopoly Power – L = (P - MC)/PL = (P - MC)/P The larger the value of L (between 0The larger the value of L (between 0 and 1) the greater the monopoly powerand 1) the greater the monopoly power – L is expressed in terms of EL is expressed in terms of Edd L = (P - MC)/P = -1/EL = (P - MC)/P = -1/Edd EEdd is elasticity of demand for a firmis elasticity of demand for a firm
- 15. Monopoly PowerMonopoly Power Monopoly power, however, does notMonopoly power, however, does not guarantee profitsguarantee profits Profit depends on average costProfit depends on average cost relative to pricerelative to price One firm may have more monopolyOne firm may have more monopoly power but lower profits due to highpower but lower profits due to high average costsaverage costs
- 16. Monopoly PowerMonopoly Power Pricing for any firm with monopolyPricing for any firm with monopoly power:power: – If EIf Edd is large, markup is smallis large, markup is small – If EIf Edd is small, markup is largeis small, markup is large
- 17. Elasticity of Demand and PriceElasticity of Demand and Price MarkupMarkup P* MR D $/Q Quantity MC Q* P*-MC The more elastic is demand, the less the markup. D MR $/Q Quantity MC Q* P* P*-MC
- 18. Price DiscriminationPrice Discrimination Selling the same or slightly differentiatedSelling the same or slightly differentiated product to different sections ofproduct to different sections of consumers at different pricesconsumers at different prices – E.g., railways charge lower fares fromE.g., railways charge lower fares from children/elderly peoplechildren/elderly people
- 19. Degree of Price DiscriminationDegree of Price Discrimination Refers of price discrimination refers toRefers of price discrimination refers to the extent to which a seller canthe extent to which a seller can divide the market or the consumersdivide the market or the consumers
- 20. Degree of Price DiscriminationDegree of Price Discrimination First Degree – when monopolist can charge differentFirst Degree – when monopolist can charge different price from each consumer as per the willingness toprice from each consumer as per the willingness to paypay e.g. - medical service – doctor charges fee as pere.g. - medical service – doctor charges fee as per patient’s ATPpatient’s ATP Second Degree- when monopolist divides the potentialSecond Degree- when monopolist divides the potential buyers into blocks and sells in blocks at differentbuyers into blocks and sells in blocks at different pricesprices e.g. utility services like electricity, water supplye.g. utility services like electricity, water supply Third Degree – when monopolist sets different pricesThird Degree – when monopolist sets different prices in different markets separated from each other andin different markets separated from each other and with different elasticity of demandwith different elasticity of demand e.g – selling the same organic apples in two differente.g – selling the same organic apples in two different marketsmarkets
- 21. RecapRecap CharacteristicsCharacteristics AR and MRAR and MR Profit and LossProfit and Loss Shutdown decisionShutdown decision Monopoly powerMonopoly power Price discriminationPrice discrimination