Monopoly Firms: Characteristics, Profit Maximization, and Price Discrimination

Posted on Aug 16, 2024 in Economy

April 18: The Monopoly Firm: The Polar Opposite of the Perfectly Competitive Firm

Unlike a perfectly competitive (PC) industry with its many producers, a monopoly industry has only one producer.

Why? Barriers to entry into the industry: natural (high fixed costs), legal (government granted/permitted), or resource constraints.

Let’s look at the graph of the monopoly firm maximizing profits….

April 16

Unlike the PC firm, if a monopoly firm wishes to sell more output (i.e., increase Q), it must lower its price. Thus, marginal revenue (MR) is LESS THAN price for the monopoly firm.

MR is always below the demand curve.

Profit maximizing level of output …

• don’t have enough yet


How does the monopoly firm maximize its profit????

  • Apply the Golden Rule! Choose the level of output where marginal benefit (MR) = marginal cost (MC).

  • Reading the graph

    o Determines quantity they are going to sell = 3
    o UP to the demand curve tells you the price they sell for = $15o Economic profit = Between 14 and 10 (14-10) * 3 = 12

    If the monopoly firm is making economic profits, π, what will happen in the long run? Is the above an equilibrium even though there are economic profits??

    • Monopoly
    o Is in equilibrium making economic profit because firms cannot enter due to barriers to entry, such as regulations, controlled resources, and patents.

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o Consumer surplus is smaller

  • Long run

    o They continue to make profit

  • If a tax of 12 was imputed

    o ATC curve would shift
    o No more economic profit
    o MC will not be affected
    o His best level of producing is still at quantity 3 for 14

    So raising his price isn’t an option (MR≠MC)

At quantity 2 with ⇑ $ …

How does the monopoly industry price and quantity compare to what would happen in a PC industry???

• MC = D
o Will produce more at a lower priceo Higher consumer surplus

What level of output would the perfectly competitive market produce? (remember for the PC firm, P = MR = MC)

SINGLE PRICE MONOPOLY

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Monopoly

  • Less quantity and high price

    Above Pm

  • Consumer Surplus

    o Additional amount consumers were willing to pay but didn’t have to payo Money they didn’t spend but were willing to spent

    ⇒Consumer surplus is ⇓ by Price Discrimination

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Monopoly you get a dead weight loss
• Your below the desired output of quantity

Consider the following firms. Would you regard any of them as a monopoly? Why or why not?the best restaurant in town- noyour barber or beautician- noyour local telephone company – no

your campus bookstore – noMicrosoft – yesAmtrak – yesthe United States Postal Service – yes

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Can a monopoly firm suffer an economic loss?

• Yes

Any firm will continue to operate in the short-run with economic losses IF total revenue (TR) > total variable cost (TVC)…

Let’s answer the following as either True or False.

  • Because there are no rivals selling the products of monopoly firms, they can charge whatever they want and maximize profits.

    o False (MC= MR)

  • Because there are no rivals selling the products of monopoly firms, they can charge

    whatever they want and maximize profits.

    o True (but they might not be maximizing profit)

  • Because monopoly firms have the market to themselves, they are guaranteed

    economic profits.

    o False

    Why might a monopoly firm choose not to maximize profits. And sell at a lower price and higher output than they could?

• So others don’t come up with substitutes for your product.

The Troll Road Company is considering building a toll road. It estimates that its demand curve is as shown below. Assume that the fixed cost of the road is $0.5 million per year. Maintenance costs, which are the only other costs of the road (hint: these are the VC), are also given in the table.

The Troll Road Company is a monopoly.

Toll per trip

$1.00

0.9

0.80

0.7

0.6

0.5

Number of trips per year (in millions)

1

2

3.00

4

5

6

Maintenance cost per year (in millions)

$0.70

1.2

1.80

2.9

4.2

6

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TVC

TC

$1.00

$1.80

2.40

$2.80

$3.00

$3.00

MC

$0.80

0.60

$0.40

$0.20

$0.00

MR

0.5

0.60

1.1

1.3

1.8

Determine the profit-maximizing level of output.

•3
What toll will the company charge?

• 0.8
What is marginal revenue at the profit-maximizing output level? How does marginal revenue compare to price?

•

A university football team estimates that it faces the demand schedule shown for tickets for each home game it plays. The team plays in a stadium that holds 100,000 fans. It estimates that its marginal cost of attendance, and thus for tickets sold, is zero.

Price

Quantity

TR

MR

Price per ticket

Tickets per game

100

0

0

80

80

20000

1600000

40

60

40000

2400000

0

40

60000

2400000

-40

20

80000

1600000

-80

0

100000

0

0

Compute the team’s profit-maximizing price and the number of tickets it will sell at that price.

• $40 for 60000
How much total revenue will the team earn?

• 2400000 7|Page

Now suppose the city in which the university is located imposes a $10,000 annual license fee on all suppliers of sporting events, including the University. How does this affect the price of tickets?

•

Suppose the team increases its spending for scholarships for its athletes. How will this affect ticket prices, assuming that it continues to maximize profit?

•

Now suppose that the city imposes a tax of $10 per ticket sold. How would this affect the price charged by the team?

•

Another Practice

Price

Quantity

TC

TR

MR

MC

20

0

1000

0

18

100

1600

1800

18

6

16

200

2200

3200

14

14

300

2800

4200

10

6

12

400

3400

4800

6

6

10

500

4000

5000

2

6

8

600

4600

4800

-2

6

6

700

5200

4200

-6

6

4

800

5800

3200

-10

6

2

900

6400

1800

-14

6

0

1000

7000

0

-18

6

Profit maximizing price is $12 at quantity 400

Price Discrimination

How to REALLY maximize profits…

First degree… charge every customer the highest price they are willing to pay… it’s a way to capture all the consumer surplus…
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Wrangler is a monopoly firm that is maximizing profit by selling 140 wild mustangs each month. They currently sell for $750 each. Dirk Shepherd, a ranching economist, has been brought in to see if it is possible to increase Wrangler’s revenues and profits by practicing first-degree price discrimination. Dirk has estimated that there are buyers for Wrangler’s mustangs up to a price of $1400 each.

If Wrangler successfully price discriminates, what will its TR be? (draw the graph!)

Spuds is a monopoly firm selling healthy potato chips made from non-Idaho tubers. It currently sells to Costco, Sam’s Club, etc., for $1.99 a bag. They sell 15,500 bags per month.

Spuds hires an intern who studied economics and remembered about first-degree price discrimination. He convinced the boss of Spuds, Mr. McKenzie, to try to increase his profit by 9|Page

pricing differently to different buyers. The student estimated that there were buyers of Spuds’ spuds up to a price of $3.99 per bag.

If Mr. McKenzie were to be successful in his first-degree price discrimination, what would be the additional revenues obtained from getting all the consumer surplus?

Hint: draw the demand curve and put the data above on it.