CHAPTER 9 – MONOPOLY



CHAPTER 9 – MONOPOLY (6e)

Features of Monopoly:

One seller

Product has no close substitutes

Barriers to entry exist

The firm is a price searcher

Barriers to Entry

A monopoly exists because there are barriers to entry:

There are three kinds of barriers:

1 Legal Restrictions

2 Economies of Scale

3 Control of Essential Resources

Revenue for the Monopolist

The monopoly firm = the industry. Thus, the demand curve facing the monopolist = the market demand curve, which is downward sloping.

1 Demand and Marginal Revenue

The monopolist is subject to the law of demand: the price must fall in order for consumers to increase their quantity demanded of the product.

Ex. 2

Note that for QD to increase, the price must fall.

B. Revenue Schedules

Ex. 3

As P falls, QD rises.

TR = P x Q

TR rises over the range of 0 to 15 units, levels out at 15 to 16 units, and then begins to fall after 16 units.

MR = ∆TR ÷ ∆Q of output

MR declines over the entire range of output.

Note that for a monopolist, MR is NOT = P. Instead, MR < P and MR declines twice as fast as P. When graphed, the MR curve will fall below the D curve and will be twice as steep.

Revenue Curves

Ex. 4, panel (a):

The monopolist’s D and MR curves are shown.

When D is elastic, MR is positive because a decrease in P will increase TR.

When D is unit elastic, MR = zero because a decrease in P will not change TR.

When D is inelastic, MR is negative because a decrease in P will decrease TR.

[The relationship between price and total revenue for different elasticities of demand was first presented in Chapter 5. Go back and review this information on p. 92 and review Ex. 2 on p. 94. Also review the homework assignment from Ch. 5 to see how elasticity along a linear demand curve relates to total revenue.]

Ex. 4, panel (b):

The monopolist’s TR curve is shown.

When D is elastic, a decrease in P will increase TR; MR is positive though declining.

When D is unit elastic, a decrease in P will not change TR; MR is zero.

When D is inelastic, a decrease in P will decrease TR; MR is negative.

The Firm’s Costs and Profit Maximization

Like other firms, the monopolist seeks to maximize profit. Since the monopolist has some control over what price to charge, it is a price maker and will select the price-and-quantity combination that will maximize its profit.

1 Profit Maximization

(1) The “Total Approach:” Total Revenue minus Total Cost

Total profit = TR – TC

Total profit is maximized when TR > TC by the greatest amount.

Ex. 5, columns 1,2,3,5, and 8:

Column 8 shows the monopolist’s losses and profits. Total profit is maximized at 10 units, which is thus the profit-maximizing level of output for this firm. The price at 10 units is $5,250, meaning that if it wishes to sell 10 units, the firm will set a price of $5,250. [The monopolist “makes” the price rather than “takes” the price.]

Ex. 6, panel (b):

Graphical depiction of the “total approach”

TC curve has the shape we saw in Ch. 7

TR begins at zero; it rises as long as the price is falling and demand is elastic; it reaches a peak when demand is unit elastic; and then it falls as long as price is falling and demand is inelastic.

(Notice that total profit is maximized where TR>TC by the greatest amount, and not where TR is at its highest level. The goal of the firm is to maximize total profit, not maximize total revenue.)

The “Marginal Approach:” Marginal Revenue Equals Marginal Cost

Remember RULE #1: To maximize profit (or minimize loss), a firm should produce the output at which MR=MC.

Looking at Ex. 5, columns 4,6, and 8, we see that:

As long as MR>MC, the firm can move toward the maximum profit by increasing its output.

When MR=MC, profit is maximized. (This occurs at 10 units.) The firm should produce this level of output.

When MR zero, it must always intersect MR in the positive portion of the MR curve. This in turn corresponds to the elastic portion of the D curve.

3 Short-Run Losses and the Shutdown Decision

If TR ................
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