Monopoly Example 2 - Haircuts
Quantity
Total
Price
demanded revenue
(P )
(Q)
(TR = P
(dollars (haircuts per
x Q)
per
haircut)
a
20
hour)
0
(dollars)
18
1
18
c
16
2
32
e
f
14
12
10
3
4
5
42
48
50
(dollars)
(dollars)
(dollars)
0
b
d
Marginal
Marginal
Profit
revenue Total cost cost
(TC)
(MC = (TR - TC)
(MR =
DTR/DQ) (dollars) DTC/DQ)
20
18
14
10
6
2
21
24
30
40
55
-20
1
3
6
10
15
-3
+8
+12
+8
-5
1
Price and cost (dollars per hour)
A Monopoly’s Output and Price
MC
20
Profit = $12
(P-ATC)XQ =
($4 x 3 units)
14
10
ATC
Economic
profit $12
D
MC=MR at Q=3 & P=$14
0
1
2
MR
3
4
5
Quantity (haircuts per hour)
2
Price and marginal revenue
(dollars per haircut)
Demand and Marginal Revenue Curves and
Elasticity
Elastic
20 Over the range
5 to 10 haircuts
d
an hour, a price
cut decreases
10 total revenue, so
f
demand is
inelastic.
0
–10
– 20
Unit elastic
Inelastic
5
Maximum
total revenue
D
Quantity
Profit maximizing
(haircuts
10
monopolies willper
never
hour)
produce an output in
the inelastic range of
the demand curve.
MR
3
Monopoly:
• “Supply”
• There is no “supply” as we know it in
monopoly
–The output decision is dependant on the
“demand” and there is no independent
“supply”
• Short Run Equilibria
• Profit
• Break even
• Loss minimization
• Shut down
4
Break Even
Loss Minimization
MC
MC
Losses
Price, Marginal Revenue,
and Cost per Unit
Price, Marginal Revenue,
and Cost per Unit
ATC
Pm
ATC
C1
Pm
AVC
E
D
Qm
MR
Output per Time Period
D
MR
Qm
Output per Time Period
Practice by drawing the SR Shut Down for a monopolist
5
Long-Run Equilibrium For the Monopolist
• In the long run:
– there are two possible equilibria for the
monopolist
• break even
• economic profit
• Otherwise the monopoly will simply shut
down (which generally means no market; if
a monopolist can’t make money the only
other option is for the government to
operate at a loss)
6
Summary & Conclusions
1. MR < P, production always takes place in the
elastic portion of D
2. Profit max rule MR  MC…..
3. Monopolist exercises market power, the ability to
set price (ability to raise price without losing all
sales).
4. Market forces constrain monopoly choices.
5. There is no “supply” as we know it.
6. Monopoly does not guarantee economic profit, but
if there is economic profit, it can persist in the long
run
7
Price Discrimination
• To maximize profit – a producer sells a
specific commodity to different buyers for
different prices for reasons not associated
with costs
»Only makes sense for a producer with
market power
• Ed asks: What about those empty seats?
– Return to original cost data.
Ed finds a way - Price Discrimination
Faculty & Staff
pay $6.50 and buy
qf =325
9
MRFS
6
and
buy qs=375
5
4
DFaculty&Staff
MRStudent
1
600
500
400
300
200
DStudent
Tickets per Week
1000
2
Profit:
900
3
800
7
TR $6.50x325
+ $3.50x375
= $3425.00
Students pay $3.50
TC: $2200.00
700
8
100
$ per Ticket
10
$1225
Price Discrimination
Summary
• Find low-cost, techniques for
distinguishing high-price from low-price
buyers
• Potential customers with elastic demands
are the targets for price reductions,
–Provided resale can be prevented.
Price Discrimination
Conclusions
1. Price discrimination is a rational strategy for
a profit maximizing monopolist facing a
downward sloping demand curve
2. For effective price discrimination
–
the seller must be able to distinguish, at
reasonable cost, different groups with different
abilities to pay; i.e., different elasticities of
demand.
Price Discrimination
Conclusions
3. For effective price discrimination
– the seller must be able to prevent resale from the
low price buyers to the high price buyers.
4. Justification for price discriminations can be
an important part of its success: prevents
resentment.
Efficiency of Monopoly
• Compare monopoly to “the standard”:
perfect competition.
• Assume:
– no technological advantage for a single
firm producer
– constant returns to scale
Efficiency of Monopoly
The Social Cost of Monopolies
Monopoly
S  MC
Price, Marginal Costs, and
Marginal Revenue per Unit ($)
Price per Unit
Perfect
Competition
E
P
e
S  MC
ATC
Pm
Pm > Pc
Pm > MCm
PmminATC
MCm
D
D
Value to society
Pe P>MinATC
Pm > MCm Quantity per Time Period
inefficient resource
therefore not
use
enough produced
Q m Q2
MR
Quantity per Time Period
14
Efficiency of Monopoly
Comparing the Competitive Market &
Monopoly Outcomes
• Monopolist charges a higher price,
produces a lower quantity.
• (could even earn an economic profit in
the long run.)
Efficiency of Monopoly
Loss in Efficiency From Monopoly (Social
Cost)
• Recall when P(MSB) = MC(MSC),
allocative efficiency is achieved.
–in monopoly the firm is underproducing P > MC,
–  MSB > MSC.
Efficiency of Monopoly
Loss in Efficiency From Monopoly (Social
Cost)
• Recall that productive efficiency is
achieved when P=Min ATC
–monopoly does not operate at
min ATC (even in the case of
zero economic profit)
Efficiency of Monopoly
Deadweight Loss: Measuring the Social
Costs of Monopoly
• The perfectly competitive equilibrium
maximizes total surplus: total economic well
being
• In monopoly, there is a loss of surplus
–”dead- weight loss”
Measuring the Social Costs of Monopoly: The
deadweight loss of a Monopoly
Efficiency of Monopoly
MC = Supply
Price
Redistributed
surplus
PM
Monopoly
Deadweight Loss
D=MSB
QM
QE
MR
Perfectly
Competitive
Efficient
Quantity!
Quantity
Public Policy Toward Monopolies
1. Try to make monopolized industries more
competitive through legislation….
2. Regulation: (Rate of Return)
– used in the case of natural monopolies.
• What price should the government set for such
monopolies?
• What about P = MC, the “allocatively” efficient price?
20
Profit Maximization Before Regulation
Economies of large-scale
production lead to a
single-firm industry:
Natural Monopoly
Dollars per Unit
-Produce 5,000, where MC =MR
-Price = $8: P > MR & MC
-Inefficient allocation of
resources, & productive
ineffiency
8
LATC
4
LMC
A
D
0
5,000
MR
Quantity per Time Period
21
Regulation Through Marginal Cost Pricing
Dollars per Unit
Marginal Cost Pricing
Regulatory Goal: P = MC
-Set price at $4, where MC = P
-Output = 9,000
-P = MC & P < LATC
-Losses will occur
-Monopolist will go out of
business
8
6
4
losses
LATC
LMC
MR
0
D
7,000 9,000
Quantity per Time Period
22
Natural Monopoly Regulation
• Natural monopolies have declining ATC,
 MC < ATC,
 at P = MC  firms will experience losses.
• Regulators could then subsidize the monopoly or
• choose P = ATC 
average-cost pricing or
fair return pricing
23
Regulation Through Average Cost Pricing
Average Cost Pricing
Regulatory Goal: P = LATC
Dollars per Unit
-Set price at $6, where LAC =D
-Output = 8,000
-P = LATC
--Monopolist is breaking even
8
6
LATC
4
LMC
MR
0
D
8,000
Quantity per Time Period
24
Natural Monopoly Regulation
 choosing a price is a problem
• any regulated price will result in a lack of
incentive on the part of the monopolist to
reduce costs: and perhaps an effort to hide
“true costs”.
• Capture Hypothesis
– Predicts that the regulators will eventually be captured by
the special interests of the industry being regulated
25
Public Policy Toward Monopolies
• 3. Public Ownership
– private vs public ownership
• loss of profit motive in public enterprise
can lead to higher costs.
• 4. Do nothing
26