Monopoly Example 2 — Haircuts Quantity Total Price

Monopoly Example 2 - Haircuts Quantity Total Price demanded revenue (P ) (Q) (TR = P (dollars (haircuts per x Q) per haircut) hour) (dollars) a 20 0 0 b 18 1 18 c 16 2 32 d 14 3 42 e 12 4 48 f 10 5 50 Marginal Profit revenue Total cost (TC) (MC = (TR - TC) (MR = DTR/DQ) (dollars) DTC/DQ) 18 14 10 6 2 (dollars) 20 21 24 30 40 55 1 3 6 10 15 -20 -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 Marginal Revenue Curves and Elasticity Elastic 20 Over the range 5 10 0 – 10 – 20 to 10 haircuts an d hour, a price cut decreases total revenue, so demand is inelastic. Unit elastic Inelastic f 5 Maximum total revenue D Quantity Profit maximizing 10 will(haircuts monopolies never per 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 ATC Pm ATC C 1 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. 8

Ed finds a way - Price Discrimination Faculty & Staff pay $6. 50 and buy qf =325 9 MRFS 6 and buy qs=375 5 4 1 600 500 400 300 DStudent 200 0 $1225 DFaculty&Staff MRStudent Tickets per Week 1000 2 Profit: 900 3 800 7 TR $6. 50 x 325 + $3. 50 x 375 = $3425. 00 Students pay $3. 50 TC: $2200. 00 700 8 100 $ per Ticket 10 9

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. 10

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. 11

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. 12

Efficiency of Monopoly • Compare monopoly to “the standard”: perfect competition. • Assume: – no technological advantage for a single firm producer – constant returns to scale 13

Efficiency of Monopoly The Social Cost of Monopolies Monopoly Pe Price, Marginal Costs, and Marginal Revenue per Unit ($) Price per Unit Perfect Competition E ATC Pm Pm > Pc Pm > MCm Pm min. ATC MCm D D Value to society Pe P>Min. ATC Pm > MCm Quantity per Time Period inefficient resource therefore not use enough produced Qm Q 2 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. ) 15

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. 16

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) 17

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” 18

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 19

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 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