Slide 1Knowledge RecapMonopolyMonopolyMonopolyMonopoly’s RevenuesMonopoly’s RevenuesMonopoly’s RevenuesMonopoly’s RevenuesMonopoly’s Profit MaximizationMonopoly’s Profit MaximizationMonopoly’s Profit MaximizationMonopolyECON 203: Principles of MicroeconomicsClass 16: Monopolies 1Knowledge Recap•Firms’ objective is to maximize profits.Profit = TR – TC = (P – ATC)*Q•In perfectly competitive markets, individual firms’ decisions to enter and exit the market lead to zero long-run economic profits.2Monopoly•Monopoly.–A firm that is the sole seller of a product without any close substitutes.–Examples: DWP, cable TV in some areas (Comcast SF), airlines on some routes, patented products (branded drugs).•Monopolies arise because of barriers to entry due to:–Monopoly resources (e.g. HBO series, UFC fights).–Government regulation (e.g. patented products, PEMEX).–Cost structure (high FC and low MC) leading to natural monopolies (e.g. DWP, cable TV, airlines).•These are different types of barriers to entry.–New firms cannot enter the market so that the monopolist has market power.3Monopoly•Monopoly vs perfect competition.4Perfect Competition MonopolyMany firms. One firm.Homogenous product (many substitutes).Unique product (no substitutes).No barriers to entry. Barriers to entry.Firms are price-takers. Firms are price-makers.Monopoly•Monopoly vs perfect competition.– Demand faced by a firm in perfect competition. • Individual firms’ decisions have no effect on market price. Firm Demand ≠ Market Demand• Demand faced by an individual firm is perfectly elastic and equal to the market price.•Each firm can sell as much as it wants at a given price.– Demand faced by a firm in monopoly.• The firms’ decisions have a direct effect on market price. Firm Demand = Market Demand•Demand faced by the firm is downward sloping. • To sell additional units firm needs to lower the price (effective constraint on market power).5Monopoly’s Revenues•Demand faced by monopoly (e.g. brand-name drug)–Price is affected by quantity supplied.6Quantity Price TR(P*Q)AR(TR/Q)MR(ΔTR/ΔQ)0 $25010 $22520 $20030 $17540 $15050 $12560 $100Monopoly’s Revenues•Demand faced by monopoly (e.g. brand-name drug)–Price is affected by quantity supplied.•AR = P7Quantity Price TR(P*Q)AR(TR/Q)MR(ΔTR/ΔQ)0 $250 $010 $225 $2,250 $22520 $200 $4,000 $20030 $175 $5,250 $17540 $150 $6,000 $15050 $125 $6,250 $12560 $100 $6,000 $100Monopoly’s Revenues•Demand faced by monopoly (e.g. brand-name drug)– Price is affected by quantity supplied.• AR = P• MR < P8Quantity Price TR(P*Q)AR(TR/Q)MR(ΔTR/ΔQ)0 $250 $010 $225 $2,250 $225 $22520 $200 $4,000 $200 $17530 $175 $5,250 $175 $12540 $150 $6,000 $150 $7550 $125 $6,250 $125 $2560 $100 $6,000 $100 -$25Monopoly’s Revenues•For a monopolist:– For first unit, MR = P.– For all other units, MR < P. • To increase production from 40 to 50 the monopolist must lower P of all 50 units, not just the last 10 units.–MR decreases at a quicker rate than P.•Effects of increasing Q for monopolist:– Output effect: more output is sold, so total revenue goes up.– Price effect: the price of all prior and additional units is lower, so total revenue goes down.9Monopoly’s Profit Maximization•Total profits are maximized when MC = MR.–When MC < MR, the revenue from producing one additional unit is higher than its cost, so firm will increase production.–When MC > MR, the cost of producing the last additional unit is higher than its revenue, so firm will decrease production.•In equilibrium P > MR = MC.–MR = MC determines equilibrium quantity (Q*)–The P charged by a monopolist in equilibrium is the P that corresponds Q*, or P*–In a market that has a monopoly, P* > MC, so society values the last unit supplied more than its cost of production.10Monopoly’s Profit Maximization•Example: brand-name drug.11Q P TR(P*Q)MR TC MC ATC Profit0 $250 $0 $1,00010 $225 $2,250 $225 $1,45020 $200 $4,000 $175 $1,90030 $175 $5,250 $125 $2,55040 $150 $6,000 $75 $3,30050 $125 $6,250 $25 $4,15060 $100 $6,000 -$25 $5,100Monopoly’s Profit Maximization•Example: brand-name drug.–Equilibrium:•MC = MR = $75•P* = $150 and Q* = 40• Profit = TR-TC = (P – ATC)*Q = $2,70012Q P TR(P*Q)MR TC MC ATC Profit0 $250 $0 $1,000 -$1,00010 $225 $2,250 $225 $1,450 $45 $145 $80020 $200 $4,000 $175 $1,900 $55 $95 $2,10030 $175 $5,250 $125 $2,550 $65 $85 $2,70040 $150 $6,000 $75 $3,300 $75 $82.5 $2,70050 $125 $6,250 $25 $4,150 $85 $83 $2,10060 $100 $6,000 -$25 $5,100 $95 $85 $900Monopoly•Conclusions– In a monopoly, there is only one firm selling a unique product for which there are no or few substitutes.– In a monopoly, the firm is the same as the market.• Firm is price-maker.•Firm faced downward sloping demand.•MR < P– When a market with a monopoly reaches equilibrium:• The monopolist makes economic profits which are maximized when MC = MR.• MC = MR and MR < P  P >