Department of Economics

Lecture Notes for Chapter 22
Monopoly
ECON 210, Spring 2001
Dr. Edward L. Millner
Phone: 828-1717
email: elmillne@vcu.edu
URL: www.people.vcu.edu/~emillner/eco210

• Objectives
• Notes
• End-of-chapter problems and questions
• Answers to questions in the notes

• One seller
• No close substitute
• Barriers to entry
• The incumbent has an advantage over potential entrants
• Legal barriers
• Economies of scale
• Control of essential resource
• Imply that profit may exceed zero in the long run
• Questions 1 and 11,Chapter 22

• The law of demand applies to a monopoly
• Question 6, Chapter 22
• A monopoly is a price searcher
• A monopoly can raise price only by selling less and can sell more only by reducing price, all else equal
• P > MR for a monopoly
• If demand is elastic, then MR > 0 and vice versa
• P ¯ Þ Q ­ and TR ­
• D Q > 0 and D TR > 0 Þ D Q / D TR > 0
• If demand is inelastic, then MR < 0, and vice versa
• P ¯ Þ Q ­ and TR ¯
• D Q > 0 and D TR > 0 Þ D Q / D TR < 0
• Complete the following table

• Question 7, Chapter 22

• If P > AVC for some levels of output then produce the quantity that makes MR=MC
• If P is everywhere < AVC, then shut down
• Identify the quantity that makes MR = MC in Exhibit 5. What is P at this level of output? AVC? ATC? What is the profit maximizing level of output? the profit maximizing price? the maximum profit?

• If D intersects the ATC curve then (click here to see a graph or look at Exhibit 5)
• P > ATC > AVC where D is above the ATC curve
• Maximum p > 0
• The firm maximizes profit by producing where MR = MC
• Maximum p = the area of a rectangle between the firm's demand curve, the profit maximizing quantity, its ATC curve, and the vertical axis
• The length of the rectangle is the profit maximizing quantity, q
• The height is (P - ATC), the profit per unit
• The (P - ATC) x q = the area of the rectangle AND p
• Click here to see a graph
• If D is a tangent to the ATC curve (click here to see a graph) then
• P > AVC where D is above the ATC curve
• Maximum p = 0
• The firm maximizes profit by producing the quantity where MC = MR
• The quantity that makes MR = MC also makes P = ATC
• Click here to see a graph
• If D intersects the AVC curve but not the ATC curve (click here to see a graph or look at Exhibit 6) then
• P > AVC where D is above the AVC curve
• Maximum profit < 0
• The firm minimizes its loss by producing where MR = MC
• Minimum loss = the area of a rectangle between the firm's demand curve, the profit maximizing quantity, its ATC curve, and the vertical axis
• The length of the rectangle is the profit maximizing quantity, q
• The height is (ATC - P), the loss per unit
• The (ATC - P) x q = the area of the rectangle AND the loss
• Click here to see a graph
• If D is everywhere below the AVC curve (click here to see a graph) then
• P is everywhere > AVC
• Maximum p < 0
• The firm minimizes its loss by shutting down in the short run
• Minimum loss = FC
• Click here to see a graph
• Question 8, Chapter 22
• Problem 15, Chapter 22

• If p > 0 then other firms would like to entry but are stopped by barriers to entry
• Barriers to entry imply that a monopoly may earn economic profit in the long run
• If p < 0 then the monopoly will exit and the market ceases to exist

• Monopoly has distributive effects
• Profit redistributes income from consumers to producers
• Profit > 0 for the monopoly
• Profit = 0 for perfectly competitive firms in the long run
• Monopoly decreases the real income of consumers relative to perfect competition
• Monopoly increases the real income producers relative to perfect competition
• Whether this redistribution is good or bad depends upon the identify of the producers and consumers and normative value judgements regarding the benefits of the redistribution
• Q_Mono is allocationally inefficient
• Social welfare increases if output increases from Q_Mono to Q_PC
• Since P_Mono > MC, the marginal evaluation of an additional unit > its opportunity cost
• Other considerations
• A monopolist's ability to take advantage of economies of scale may reduce the welfare loss
• Having one producer instead of two or more may reduce production costs
• A possible justification for regulated monopolies
• Rent-seeking by the monopolist may increase the welfare loss
• WSJArticles\FedXvDHLwsj1-01.htm
• Firms lobby to create and maintain barriers to entry
• Since the resources used to lobby do not produce output, social welfare is reduced
• Excess production costs by the monopolist may increase the welfare loss
• A monopoly may not try as hard as a perfect competitor to keep costs down
• p may still exceed 0 even if the monopoly lets costs creep up
• Problem 16, Chapter 22

Price discrimination

• Firms often charge different prices for the same or similar goods
• Prices for movies shown in the afternoon or lower than movies shown in the evening
• Members of AARP often receive discounts at hotels, theaters, and pharmacies
• Price Discrimination occurs when P / MC ratios differ for similar products
• Different price for same good
• Different markups for essentially same goods
• The incentive to discriminate is an increase in profit
• First degree price discrimination
• WSJArticles\InternetPricing.htm
• Charge each consumer the maximum amount it is willing to pay for each unit purchased
• Personalized pricing
• Converts all consumer surplus into profit
• Examples (?)
• Negotiated contracts
• Direct mail solicitations and coupons
• Individualized Web sites
• Important to (really) know your customer
• WSJArticles\AirlineDiscounts3-01.htm
• Third degree price discrimination
• Charge different prices for different groups of consumers
• Profits are maximized when MR_A = MR_B = MC, where A and B refer to the groups of consumers
• Charge a higher price in the sub-market with the less elastic demand
• WSJArticles\AidsDrugs3-01.htm
• Preconditions
• Firm must possess market power and be a price searcher
• The firm must be able to segment buyers in to sub-markets
• Differences in demand and elasticity must exist
• Buyers must have limited ability to resell or engage in arbitrage
• Question 13, Chapter 22