Monopoly Graph Review and Practice- Micro Topic 4.2

Introduction to Monopoly

• Monopoly: A market structure where a single firm dominates the market.

• Distinction from Perfect Competition: Monopolies set prices rather than accept the market price.

• Prevalent misconceptions about monopoly, such as its association with the board game.

Characteristics of Monopolies

• Unique Good: Only one provider without close substitutes.

• Price Maker: Monopolies have the power to influence prices.

• Barriers to Entry: High barriers prevent other firms from entering the market, maintaining monopoly dominance.

Demand and Revenue in Monopoly

• Graph Analysis:

  • Demand Curve: Downward sloping, unlike the horizontal demand curve in perfect competition.

  • Marginal Revenue (MR) is below the demand curve, due to price-setting behavior.

• Pricing Behavior:

  • Monopolies cannot price discriminate without lowering prices across all units.

  • Example: If a monopoly charges $100 and then lowers the price to $90, they must sell all units at $90.

• Marginal Cost (MC) and Average Total Cost (ATC):

  • These curves behave similarly as in perfect competition: MC curve decreases, then increases, while ATC decreases to a minimum before increasing.

Profit Maximization in Monopoly

• Finding Optimal Quantity:

  • Profit-maximizing quantity occurs where MR equals MC (at Q1 in the graph).

  • The price charged is based on the demand curve, at P2, not where MR intersects MC.

• Total Revenue Calculation:

  • Total Revenue = Price x Quantity, represented as a rectangle on the graph (PQ, A, Q1, Q0).

• Profit Determination:

  • Total costs found by moving from Q1 to ATC curve, with remaining revenue indicating profit.

  • High barriers to entry maintain monopoly profits in the long run.

Consumer Surplus and Total Revenue Test

• Consumer Surplus:

  • Difference between what consumers are willing to pay (demand curve) and the market price.

  • Represented in the triangle formed by P1, A, and PQ on the graph.

• Revenue Maximization:

  • Occurs at Q2, where marginal revenue equals zero.

  • Distinction between profit maximization (Q1) and revenue maximization (Q2).

• Elastic vs. Inelastic Demand Ranges:

  • Elastic range: MR > 0 (demand is elastic, price decrease increases revenue).

  • Inelastic range: MR < 0 (demand is inelastic, price decrease decreases revenue).

Socially Optimal Quantity and Market Efficiency

• Allocative Efficiency:

  • Occurs at Q3, where price equals marginal cost (MC).

  • Societal demand is not met when monopolies restrict quantity to Q1, causing deadweight loss.

  • Deadweight loss arises when monopoly production is below socially optimal levels.

• Government Regulation:

  • Regulation may impose price ceilings to encourage production of socially optimal quantity (Q3).

Breakeven and Tax Effects

• Breakeven Point:

  • Only occurs at Q4, where total revenue equals total costs, resulting in no economic profit.

• Impact of Taxes:

  • Per Unit Tax: Increases marginal costs, shifts MC upward, leading to a decrease in quantity and an increase in price.

  • Lump Sum Tax: Affects fixed costs without altering marginal costs; quantity and price remain unchanged.

Conclusion

• Further understanding of monopolies aids comprehension of market dynamics and strategies.

• Suggests viewing additional content on oligopolies and game theory for broader insights.