Principles of Microeconomics Chapter 10 PDF

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 10 Monopoly Prepared by Ifeanyi Uzoka, Sheridan College © 2024 McGraw Hill ...

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 10 Monopoly Prepared by Ifeanyi Uzoka, Sheridan College © 2024 McGraw Hill  CHAPTER 10 Monopoly Learning Objectives: 1. Explain how monopolies come into existence and why they must reduce their prices to sell more 2. Describe how the profit-maximizing output and price are determined by a monopolist 3. Explain five grounds on which monopolies can be criticized © 2024 McGraw Hill 10-2  CHAPTER 10 Monopoly Learning Objectives: 4. Explain the significant difference between monopoly and perfect competition 5. Explain three grounds on which monopolies can be defended 6. Discuss ways that governments can change the behaviour of monopolies © 2024 McGraw Hill 10-3  Monopoly Monopoly: A market in which a single firm (the monopolist) is the sole producer of a product for which there are no close substitutes The firm is the industry ©2024 McGraw-Hill 10-4  LO1: How Monopolies Come into Existence ©2024 McGraw-Hill 10-5  Main Monopoly Characteristic Monopolies are protected from new competitors by barriers to entry – Barriers to Entry are obstacles that make it difficult or impossible for new participants to enter a market ©2024 McGraw-Hill 10-6  Barriers to Entry Technical barriers: such as sole ownership of a resource Legal barriers: such as public franchise, licenses, patents, and copyrights Economic barriers: caused by ©2024 McGraw-Hill 10-7 Test Your Understanding Entry into the following industries is very difficult. What type of barrier to entry is involved? – Computer operating systems – Commercial aircraft manufacturing – West coast wild salmon fishing ©2024 McGraw-Hill 10-8 Test Your Understanding Entry into the following industries is very difficult. What type of barrier to entry is involved? – Computer operating systems Technical barrier (sole ownership of a resource) – Commercial aircraft manufacturing – West coast wild salmon fishing ©2024 McGraw-Hill 10-9 Test Your Understanding Entry into the following industries is very difficult. What type of barrier to entry is involved? – Computer operating systems Technical barrier (sole ownership of a resource) – Commercial aircraft manufacturing Economic barrier (economies of scale) ©2024 McGraw-Hill 10-10  Monopoly Able to set whatever price it wishes - price maker Can set either price or quantity sold, but not both ©2024 McGraw-Hill 10-11  Monopoly Since the monopolist is the industry, it faces the market demand for the product Demand is a downward-sloping curve – Must decrease the price in order to sell ©2024 McGraw-Hill 10-12  Total, Average, and Marginal Revenues of the Monopolist Table 10.1 Total, Average, and Marginal Revenues of the Monopolist Average Marginal Price (per Total Quantity Revenue (AR Revenue (MR case) Revenue = TR/Q) = (ΔTR/ΔQ)) 1 $20 $20 $20 $20 2 19 38 19 18 3 18 54 18 16 4 17 68 17 14 5 16 80 16 12 6 15 90 15 10 7 14 98 14 8 8 13 104 13 6 9 12 108 12 4 10 11 110 11 2 11 10 110 10 0 12 9 108 9 −2 ©2024 McGraw-Hill 10-13  Monopolist’s gains and losses To increase sales, a monopolist must reduce the price not just on the last unit sold, but on the whole of its output. As a result, it will gain by selling more units but will lose because it has to reduce the price. © 2024 McGraw Hill 2-14  Average Revenue and Marginal Revenue The extra (marginal) revenue of producing and selling the 6th unit is $10. The price of selling 6 units is $15. Therefore, the marginal revenue is less than the price. ©2024 McGraw-Hill 10-15 Total, Average and Marginal Revenues Total revenue increases as more units are sold, then starts to decline Average revenue is identical to the demand curve When marginal revenue is positive (or negative), total revenue is rising (or falling) Total revenue is a maximum when marginal revenue is zero ©2024 McGraw-Hill 10-16  Monopolist and Elasticity The top half of any demand curve is elastic, the bottom half is inelastic. This monopolist would never produce an output greater than 11, i.e., where the demand is inelastic. ©2024 McGraw-Hill 10-17 Test Your Understanding Suppose a monopolist charged a price of $50 for its product and sold 15 units. It then lowers its price to $48 and sells 16 units. −What is the marginal revenue (MR)? −What is the price elasticity of demand over ©2024 McGraw-Hill 10-18 Test Your Understanding Suppose a monopolist charged a price of $50 for its product and sold 15 units. It then lowers its price to $48 and sells 16 units. − AtWhat $50,isTR the = marginal revenue P X Q = $50 X 15 (MR)? = $750 At $48 TR = P X Q = $48 X 16 = $768 Marginal revenue of one more unit = ©2024 McGraw-Hill $768 - $750 = $18 10-19 Test Your Understanding Suppose a monopolist charged a price of $50 for its product and sold 15 units. It then lowers its price to $48 and sells 16 units. What is the price elasticity of demand over this price range? Elasticity: e = % Δ Q = 1/15.5 x 100 = 6.5% = 1.59 %ΔP 2/49 x 100 4.1 The lower price results in higher TR; ©2024 McGraw-Hill 10-20 Therefore, elastic demand LO2: Profit- Maximizing Output for the Monopolist ©2024 McGraw-Hill 10-21 Profit-Maximizing Output for Monopolist Profits are maximized (or losses minimized) at an output where MR = MC Being a monopolist does not guarantee profitability ©2024 McGraw-Hill 10-22  Calculating Total Profits of the Monopolist Table 10.2 Calculating Total Profits of the Monopolist Quantity Total Revenue (refills per Price (= AR) Total Cost (TC) Total Profit (Tπ) (TR) day) 1 $20 $20 $40 $−20 2 19 38 48 −10 3 18 54 54 0 4 17 68 56 14 5 16 80 62 18 6 15 90 72 18 7 14 98 87 11 8 13 104 104 0 9 12 108 124 −16 10 11 110 150 −40 ©2024 McGraw-Hill 10-23  Calculating Total Profits of the Monopolist Table 10.2 Calculating Total Profits of the Monopolist Quantity Total Revenue (refills per Price (= AR) Total Cost (TC) Total Profit (Tπ) (TR) day) 1 $20 $20 $40 $−20 2 19 38 48 −10 3 18 54 54 0 4 17 68 56 14 5 16 80 62 18 6 15 90 72 18 7 14 98 87 11 8 13 104 104 0 9 12 108 124 −16 10 11 110 150 −40 ©2024 McGraw-Hill 10-24 Profit-Maximizing Output for Monopolist Consider total profits – Maximized when TR – TC is greatest – Total profit curve (T is at its maximum when slope of TR = slope of TC (MR = MC) ©2024 McGraw-Hill 10-25  Calculating Total Profits Using the Marginal Approach Table 10.3 Calculating Total Profits of the Monopolist Using the Marginal Approach Price Total Total Average Marginal Marginal Total Quantit (= Revenu Cost Cost Cost Revenue Profit y AR) e (TR) (TC) (AC) (MC) (MR) (Tπ) 1 $20 $20 $40 $40.00 10 20 $−20 2 19 38 48 24.00 8 18 −10 3 18 54 54 18.00 6 16 0 4 17 68 56 14.00 2 14 14 5 16 80 62 12.40 6 12 18 6 15 90 72 12.00 10 10 18 7 14 98 87 12.44 15 8 11 8 13 104 104 13.00 17 6 0 9 12 108 124 13.78 20 4 −16 10 11 110 150 15.00 26 2 −40 ©2024 McGraw-Hill 10-26 Average and Marginal Costs and Revenues for the Monopolist Consider average and marginal revenue – Break-even when AR = AC – Anywhere that AR > AC will be profitable – Profits are maximized when MR = MC ©2024 McGraw-Hill 10-27 Test Your Understanding Complete the following table. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 $2060 21 98 2080 22 96 2112 23 94 2142 24 92 2177 25 90 2216 26 88 2257 27 86 2322 28 84 2417 29 82 2530 ©2024 McGraw-Hill 10-28 Test Your Understanding Complete the following table. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 2 000 $2060 ‑60 21 98 2 058 2080 ‑22 22 96 2 112 2112 0 23 94 2 162 2142 20 24 92 2 208 2177 31 25 90 2 250 2216 34 26 88 2 288 2257 31 27 86 2 322 2322 0 28 84 2 352 2417 ‑65 29 82 2 378 2530 ‑152 ©2024 McGraw-Hill 10-29 Test Your Understanding Indicate the break-even outputs. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 2 000 $2060 ‑60 21 98 2 058 2080 ‑22 22 96 2 112 2112 0 23 94 2 162 2142 20 24 92 2 208 2177 31 25 90 2 250 2216 34 26 88 2 288 2257 31 27 86 2 322 2322 0 28 84 2 352 2417 ‑65 29 82 2 378 2530 ‑152 ©2024 McGraw-Hill 10-30 Test Your Understanding Indicate the break-even outputs. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 2 000 $2060 ‑60 21 98 2 058 2080 ‑22 22 96 2 112 2112 0 23 94 2 162 2142 20 24 92 2 208 2177 31 25 90 2 250 2216 34 26 88 2 288 2257 31 27 86 2 322 2322 0 28 84 2 352 2417 ‑65 29 82 2 378 2530 ‑152 ©2024 McGraw-Hill 10-31 Test Your Understanding Indicate the profit maximizing output. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 2 000 $2060 ‑60 21 98 2 058 2080 ‑22 22 96 2 112 2112 0 23 94 2 162 2142 20 24 92 2 208 2177 31 25 90 2 250 2216 34 26 88 2 288 2257 31 27 86 2 322 2322 0 28 84 2 352 2417 ‑65 29 82 2 378 2530 ‑152 ©2024 McGraw-Hill 10-32 Test Your Understanding Indicate the profit maximizing output. Price Total Revenue Total Costs Total Profit Quantity (=AR) (TR) (TC) (Tπ) 20 $100 2 000 $2060 ‑60 21 98 2 058 2080 ‑22 22 96 2 112 2112 0 23 94 2 162 2142 20 24 92 2 208 2177 31 25 90 2 250 2216 34 26 88 2 288 2257 31 27 86 2 322 2322 0 28 84 2 352 2417 ‑65 29 82 2 378 2530 ‑152 ©2024 McGraw-Hill 10-33  LO3: What Is so Bad about Monopoly? ©2024 McGraw-Hill 10-34 Criticisms of Monopolies 1. Able to make economic profits indefinitely 2. Are productively inefficient 3. Are allocatively inefficient 4. Create a more unequal distribution of income and wealth within society 5. Use their power to practice price discrimination ©2024 McGraw-Hill 10-35  Price Discrimination Based on Differing Elasticities of Demand If two groups (A and B) have different elasticities of demand, a monopolist can charge different prices to each rather than offer the same price to both (C) (Higher for A, lower for B) – Consumer surplus drops and total revenue increases Fig A (adults- inelastic DD): If $18 is charged, TR =$810 Fig B (seniors- elastic DD): If $12 is charged, TR =$480 TR from A + B = $1250 Fig C (total ©2024 McGraw-Hill 10-36 demand): If $15 is  Price Discrimination There are two major forms of price discrimination: – discrimination among units purchased (e.g. lower price for higher volumes) and – discrimination among buying groups ©2024 McGraw-Hill 10-37 (different prices for different groups).  Perfect Price Discrimination A situation in which customers are charged the highest price they are willing to pay for each additional unit of a product bought. (As in an auction.) © 2024 McGraw Hill 2-38 Test Your Understanding The following table shows the demand for haircuts: Price Quantity $20 1 19 2 18 3 17 4 16 5 15 6 – If this was a single-price barber, what would be the total revenue for six haircuts? ©2024 McGraw-Hill 10-39 Test Your Understanding If this was a single-price barber, what would be the total revenue for six Price Quantity haircuts? $20 1 19 2 18 3 17 4 16 5 15 6 TR = $15 x 6 = $90 ©2024 McGraw-Hill 10-40 Test Your Understanding The following table shows the demand for haircuts: Price Quantity $20 1 19 2 18 3 17 4 16 5 15 6 – If this barber was able to practice perfect price discrimination by charging each customer the maximum they would pay, what would be the total ©2024 McGraw-Hill 10-41 revenue for six haircuts? Test Your Understanding If this barber was able to practice perfect price discrimination by charging each customer the maximum they would pay, what would be the total revenue for six haircuts? Price Quantity $20 1 19 2 18 3 17 4 16 5 15 6 TR = $20 + $19 + $18 + $17 + $16 + $15 = $105 ©2024 McGraw-Hill 10-42  LO4: Monopoly and Perfect Competition Contrasted ©2024 McGraw-Hill 10-43  Monopoly and Perfect Competition Contrasted ©2024 McGraw-Hill 10-44  Perfect Competition vs. Monopoly Unlike perfectly competitive firms, monopolies: – Charge higher prices – Produce lower outputs - below economic capacity – May make economic profits in the short run and in the long run ©2024 McGraw-Hill 10-45  Economic Surplus: Perfect Competition vs. Monopoly Monopoly results in less consumer surplus, more producer surplus and has a deadweight loss ©2024 McGraw-Hill 10-46 Test Your Understanding If this is a competitive market, what is the equilibrium price and quantity? If this a monopolist, ©2024 McGraw-Hill 10-47 Test Your Understanding If this is a competitive market, what is the equilibrium price and quantity? Price: $30; Quantity: 300 If this a monopolist, ©2024 McGraw-Hill 10-48 what is the  LO5: In Defence of Monopoly ©2024 McGraw-Hill 10-49 In Defence of Monopolies They capture large economies of scale in production They engage in extensive research and development into new techniques of production and new products They attract high-quality staff by offering relatively high wages and good working conditions ©2024 McGraw-Hill 10-50  Natural Monopoly A single producer who is able to produce at a lower cost than competing firms could - the cost for one firm producing 100 units ($1.50) is less than two firms producing 50 each ($2.50) Usually in a market with large economies of scale E.g., railroads ©2024 McGraw-Hill 10-51  Public Utilities Public Utilities: Are natural monopolies which provide goods or services that are regarded as essential and therefore usually provided by government Competition may well be costly ©2024 McGraw-Hill 10-52  LO6: Controlling the Monopolist ©2024 McGraw-Hill 10-53  Government Control There are options to change monopoly behaviour: – Taxing the monopolist – Lump-sum profits tax and monopoly sales tax – Government price setting – Nationalization ©2024 McGraw-Hill 10-54  Taxing the Monopolist Lump-sum Profits Tax: – Affects fixed cost but not variable cost – Increases Average Cost but Marginal Cost is unaffected – Output and price levels are unaffected – Lower after-tax profit ©2024 McGraw-Hill 10-55  Taxing the Monopolist Monopoly Sales Tax: – A tax on each unit sold, increasing marginal cost – Profit maximizing output shifts – Higher price shifts part of tax to the consumer – Lower quantity is produced ©2024 McGraw-Hill – Profit is reduced 10-56  Government Price Setting Socially Optimum Price – The price that produces the best allocation of products (and therefore resources) from society’s point of view, that is, P = MC Fair-Return Price – A price that guarantees that the firm will earn normal profits only, that is, where P = ©2024 McGraw-Hill AC 10-57  The Socially Optimum and Fair-Return Prices QUM will be produced with no government intervention QSO is the social optimum The government may set a price of PFR to provide a fair return to the monopolist ©2024 McGraw-Hill 10-58  Nationalization Nationalization: state acquires the monopoly reluctantly or eagerly, either by compulsory and uncompensated acquisition or by a buyout of the owners. – the enterprise is then known as a Crown corporation in Canada – It may or may not operate the enterprise to make a profit; it may or may not charge the socially optimum ©2024 McGraw-Hill 10-59  Test Your Understanding On the graph, indicate: – Price (PUM) and quantity (QUM) if monopolist is unregulated – Price (PSO) and quantity (QSO) if monopolist charges the socially optimum price – Price (PFR) and quantity (QFR) if monopolist charges fair-return©2024 priceMcGraw-Hill 10-60  Test Your Understanding On the graph, indicate: – Price (PUM) and quantity (QUM) if monopolist is unregulated – Price (PSO) and quantity (QSO) if monopolist charges the socially optimum price – Price (PFR) and quantity (QFR) if monopolist charges fair-return price ©2024 McGraw-Hill 10-61  CHAPTER 10 Key Concepts to Remember 1. What are monopolies 2. Barriers to entry encourage monopolies 3. How a monopolist maximizes profits 4. Criticism and defense of monopolies 5. The differences between monopolies and perfect competition 6. How governments can control monopolies ©2024 McGraw-Hill 10-62