100Y
ECO ECO 100Y
Introduction to
Economics
Economics
Lecture 9:
Monopoly
Gustavo Indart
Slide 1
Characteristics of Monopoly
Characteristics of a Monopoly
!
There is only one supplier of a
commodity
!
The commodity has no close substitutes
!
There is a barrier to the entry of new
firms
Gustavo Indart
Slide 2
Barriers to Entry
Barriers to Entry
!
Barriers to entry are legal or natural impediments
protecting firm from competition from potential new
protecting a firm from competition from potential new
entrants
!
Legal barrier to entry
barrier to entry
" Public franchise
" Government licence
" Patent
!
Natural barriers to entry
barriers to entry
" Unique source of supply of a raw material
" Economies of scale
of scale
Gustavo Indart
Slide 3
Single-Price
Single-Price Unregulated
Monopoly
Monopoly
!
Most monopolies are regulated by government
" We will examine the case of an unregulated
monopoly
monopoly
" This will show why governments regulate
monopolies
monopolies
!
We will begin with the analysis of a single-price
monopol
ly
" That is, a monopoly that charges the same price for
each and every unit of its output
each and every unit of its output
Gustavo Indart
Slide 4
Short-Run
Short-Run Cost Schedule
$
MC
AC
AVC
Q
We will assume that the cost schedule of a monopolist is similar to that of a
competitive firm that is mainly that the average total cost curve
competitive firm, that is, mainly that the average total cost curve is U-shaped.
Gustavo Indart
Slide 5
Demand Curve Facing a
Monopolist
P
What distinguishes a monopoly firm
fr
from a firm that operates under perfect
firm th
competition is the firms demand
curve.
Since in a monopoly there is
only one firm, the demand
curve facing that firm is the
industry demand curve.
D
Q
Gustavo Indart
Slide 6
The Monopolists Revenue
Functions
!
Total Revenue (TR):
Note that the market
demand curve is the
monopolists AR curve.
TR = P*Q
!
Average Revenue (AR):
Revenue
AR =
!
TR
Q
=
P*Q
Q
Since the monopolists demand
curve is downward sloping, price
changes when output changes.
=P
Marginal Revenue (MR):
MR =
Gustavo Indart
!TR
!Q
=
!(P*Q)
!Q
=
P!Q + Q!P
!Q
=P+Q
!P
!Q
Slide 7
Effect on Revenue of an Increase
in Quantity
As we move from point A to
point B on the demand curve,
TR decreases as a result of the
decrease in P and increases as a
result of the increase in
result of the increase in Q.
P
A
P1
!P
B
P2
D
!Q
Q1
Gustavo Indart
Q2
Q
Slide 8
Marginal Revenue, Price, and
Elasticity of Demand
El
MR =
!TR
!Q
=
!(P*Q)
!Q
=
P!Q + Q!P
!Q
!P
=P+Q
!Q
" Where !P / !Q is the slope of the demand curve, which is
negative, and therefore MR < P
MR = P + Q
!P
= P (1 +
Q
!Q
P
" MR = 0 when ! = 1
" MR > 0 when ! > 1
" MR < 0 when ! < 1
when
Gustavo Indart
*
!P
!Q
) = P (1 +
!=
!Q / Q
!P / P
1
!
=
)
!Q
!P
*
P
Q
Slide 9
Exercise: Marginal Revenue
Exercise:
Suppose the demand curve is given by P = 20 2Q. What is the
expression for the marginal revenue curve?
MR = P + Q
!P
!Q
$
20
Slope = 2
= (20 2Q) + Q( 2)
Slope = 4
= 20 4Q
Note that the when the
that the when the
demand curve is a straight
line, the slope of the MR
curve is always twice as steep
as that of the demand curve.
Gustavo Indart
MR
5
D
10
Q
Slide 10
Average, Marginal,
and Total Revenue
P
If ! > then 1, %!Q > %!P.
In this case, an increase in Q
increases TR.
MR
AR = D
Q
TR
TR
If ! < 1, then %!Q < %!P.
In this case, an increase in Q
thi
decreases TR.
Note that TR is maximized
when MR = 0 (and ! = 1).
Q
Gustavo Indart
Slide 11
Short-Run
Short-Run Monopoly
Equilibrium
!
A monopolist, like any other producer, will produce the level of
monopolist, like any other producer, will produce the level of
output at which MR = MC
!
For a perfectly competitive firm P = MR, and thus the profitmaximizing condition MR = MC also implies that P = MC
!
For a monopolist, however, P > MR and thus the profit
maximizing condition MR = MC also implies that P > MC
!
Since a profit-maximizing monopolist produces the level of
output where MR = MC and MC > 0, the monopolist will
always produce an output where MR > 0, that is, where the
demand curve is elastic
Gustavo Indart
Slide 12
TC
C
B
TC
TR
A
TR
B
Revenue,
Cost and
Cost, and
Profit
Profit
At levels of output lower than
QA and greater than QC the
firm is making losses since TC
is greater than TR.
QA
QB
QC
Q
"
Q
"
Gustavo Indart
At levels of output between QA
and QC the firm is making
profits since TR is greater than
TC.
The firm maximizes profits at
QB where the distance between
TR and TC is the greatest
TR and TC is the greatest.
Slide 13
C
B
TC
TR
A
TC
TR
B
Short-Run
Short-Run
Monopoly
Equilibrium
$
MC
PB
QA
QB
QC
AC
Q
"
D
MR
Q
QA
QB
QC
Q
"
Gustavo Indart
Slide 14
Short-Run
Short-Run Profitability of the
Monopolist
Economic
Profits
Economic
Losses
Even
$
$
$
MC
MC
MC
AC
P1
P1
AC
P1
AC
MR
Q1
Gustavo Indart
D
MR
Q
Q1
D
Q
MR
Q1
D
Q
Slide 15
No
No Unique Price-Quantity
Price-Quantity
Supplied
Supplied Relationship
When an industry supply curve exists,
an industry supply curve exists
a change in demand causes both the
market price and the quantity supplied
of the good to change.
$
MC
In the case of a single-price
monopolist, a change in demand
does not necessarily translate into a
change in the quantity supplied.
change in the quantity supplied.
P2
P1
This means that there does not exist
a unique price-quantity supplied
relationship, i.e., monopolist does
relationship, i.e., a monopolist does
not have a supply curve.
MR2
Q1
Gustavo Indart
MR1
D2
D1
Q
Slide 16
Long-Run
Long-Run Monopoly
Equilibrium
Equilibrium
!
A monopolist making economic profits in the short run
will continue making economic profits in the long run
as long as P > AC
AC
!
A monopolist making economic losses in the short run
monopolist making economic losses in the short run
(but covering AVC) will exit the industry in the long
run (unless it can find a scale of operation at which it
can cover AC)
Gustavo Indart
Slide 17
Cartels
Cartels as Monopolies
!
Otherwise competitive firms could get together and act
as a monopolist in order to:
" Restrict the total industry output
" Set a higher market price for the good
" Increase the total and individual profits
!
Cartels face problems as well:
problems as well:
" Enforcement of output restrictions
# Cartels
maximize collective profits but not
individual profits
" Restrict entry into the industry
th
Gustavo Indart
Slide 18
Firms
Firms Incentive to Cheat
$
$
Industry
Firm
AC
MC
P1
P1
S
P0
P0
D
MR
Q1
Gustavo Indart
Q0
Q
q1
q0
q2
Q
Slide 19