Monopolies Flashcards
What are the major problems which Monopolies cause?
- The Monopoly Firm produces less output than firms in a competitive industry.
- The Monopoly Firm sells its output at a higher price than if the industry was competitive.
- The Monopoly Firm’s output is produced less efficiently and at a higher cost than the output produced by firms in a competitive industry.
What causes the difference in outcomes between a competitive industry (previous chapter) and a monopoly industry?
The difference in outcomes are not caused by bad intentions.
It results from the fact that monopolies are free from the pressures that lead competitive industries to produce the socially optimal output level.
Without these pressures, monopoly firms can increase prices and restrict output to increase their profits - things that competitive firms would also love to do but can’t.
Where do bad outcomes generated by a monopoly derive from?
They all derive from the same source: unlike a competitive firm that faces a horizontal marginal revenue curve, the monopoly faces a downward-slpoing MR curve (MR: is the increase in total revenue that comes from selling each successive unit of a product).
This simple fact causes monopolies to charge more, produce less at higher costs than competitive firms.
What does a downward-sloping MR cuve imply?
It implies that each additional unit that the monopoly sells brings less revenue than the previous unit.
i.e. where the 10th unit brought £8 in revenue, the 11th unit only brings in £3.
Obviously, such a situation reduces the incentive to produce a lot of output.
In contrast, what type of MR curve do competitive firms face?
Competitive firms face horizontal MR curves, meaning that if they sell 11 units or 11,000, each unit brings in the same amount of money. Naturally, that’s much more of an inducement to produce a lot of output.
Why is there such a difference between the MR curves facing monoploies and competitive firms?
A monopoly firm can choose its price because, being the only firm in its industry, it contols all the output in that industry. A competitive firm on the other hand, has to take the market price as given.
What output level does a Monopoly firm want to produce?
It wants to produce at the profit-maximising output level: where the MR curve intersects the MC curve.
How is a Monopoly’s MR curve related to the Demand curve for the Monopoly’s output?
They have a very close relationship. The MR of each successive unit is less than the MR of the previous unit because the D curve is downward sloping.
If the D curve is a straight line, the slope of the MR curve is twice as steep as the slope of the D curve, meaning that MR falls quite quickly as output increases.
Graphically depict the MR curve for a Monopoly facing a straight line D curve.
Remember: the MR = the change in total revenue which happens as you increase output by one unit.

Using TR, explain why the MR curve falls so quickly.
TR = p x q
The important thing to notice is how total revenue changes as you move from A to B to C and output increases from one to two to three units. TR goes from £9 to £16 to £21. Obviously, TR increases.
But look more deeply. Moving from A to B, TR increases by £7 (from £9 to £16). By moving from B to C, it increases only by £5. Each successive increase in TR is smaller than the previous increase.

Explain how as Monopolies increase production, MR declines.
Look at points G and H.
G = Monopoly can sell 7 units for £3 each so TR = £21
But at H = 8 units are only sold for £2 each so TR = £16
Increasing output from 7 to 8 units means decreasing TR from £21 to £16. In other words, the MR is negative £5 as you move from 7 to 8 units of output.

What is the impact on MR as a result of the downward sloping demand curve?
MR keeps decling and even becomes negative because the d curve slopes downward, meaning that the only way to get people to buy more stuff is to offer them a lower price. You have to offer them a lower price not just on additional units, but on all previous units as well.
In other words, if the monopoly firm wants to sell only one unit it can get £9 for that unit. But if the monopoly wants to sell 2 units, it has to lower the price down to £8 per uni for both the first and the second unit
Using calculus, prove that the MR curve falls twice as fast as the demand curve.
- Take the equation of the demand curve which is: p = 10 - q
- Substitute this equation into the TR equation, TR = p x q
- Take the first derivative with respect to output, q.
- Because MR is dTR/dq, you find that MR = 10 - 2q, meaning that MR has the same vertical intercept as the demand curve but twice as steep a slope.
What output level do Monopolists choose to maximise profit?
A Monopoly firm is no different to a competitive firm when it comes to costs of producing output i.e. it has fixed, variable and marginal costs - which all act the same way as a competitive firm’s.
The key difference is that a Monopoly firm faces a downward sloping MR curve which causes a profit-maximising monopoly to produce less output than a profit-maximising competitive firm.
Graphically depict how a Monopolist goes about setting MR = MC to maximise profits and explain the concepts of ATC and MC.
The ATC curve gives the average total cost per unit of producing q units of output. This curve is U-shaped because ATC’s first fall due to increasing returns and then increase due to diminishing returns.
The MC curve gives the cost of producing one more unit of output; that is, it tells you how much TC’s rise if you increase output by one unit.

Using ‘low output, qL’ as an example, explain why qM is an optimal output level for the Monopoly to produce.
At output level qL, go up vertically and see that MR at that output exceeds MC, meaning if you produce and sell that unit, it brings in more revenue than it costs to produce.
Clearly this unit is a good one to produce. Because a similar relationaship holds true for all output levels less than qM, the monopoly should keep increasing output until it reaches qM.

Using ‘high output, qH’ as an example, explain why qM is an optimal output level for the Monopoly to produce.
On the other hand, the monopoly doesn’t want to increase output beyond qM. To see why, examine output level qH. At that output level, MC are much bigger than MR’s, meaning if you produce that unit of output, the cost of producing it exceeds the money you can get selling it.
In other words, if you produce that unit, you lose money.

How might the monopolist figure out which price to charge?
To figure out what the price of each unit of output needs to be, use the demand curve. Move up vertically from the monopoly’s profit-maximising output level to the demand curve and then head sideways - you can see that at output level qM the monopoly can charge price pM.

What does the monopoly’s profit look like on the graph?
The TR rectangle (O, pm, C, qm) is bigger than the TC rectangle (0, A, B, qm), meaning that the monopoly is earning a profit = shaded rectangle A, pm, C and B. Which represents the difference in areas between the TR and TC rectangles.

Does a monopoly guarantee profitability?
No.
If demand is too weak, prices are too low to make any money. In other words, because demand is weaker, the monopoly operates at a loss represented by the shaded rectangle (once again, compare the TR rectangle with the TC rectangle).

What is another way of understanding where a loss comes from when demand is too weak?
Compare the monopoly’s ATC per unit with the price per unit it gets when producing and sellng at output level qm1. At that output level, the price per unit, qm1, is found by starting on the horizontal axis at qm1, and then going up even farther to get to the ATC curve, meaning that the ATC per unit to make qm1 units exceeds the price per unit you get from selling these units.
This fact implies that the firm loses money producing at output level qm1

Graphicaly depict the scenario where a monopoly and a competitive firm have the same cost structure.
The monopoly produces less, which causes a DWL.
MRc = Competitive firm MR
MRm = Monopoly firm MR
Remember: both firms maximise profits by producing at the point where their MR intersects MC.

1)Why do competitive firms produce more than the monopoly?
Because the competitive firm doesn’t have to worry about reducing its revenue per unit if it increases output. No matter how much it produces the competitive firm always receives MRc = pc on every unit sold because its output is too small relative to total output to affect the market price.
2)Why do competitive firms produce more than the monopoly?
The monopoly faces the market demand curve, meaning that every additional unit it sells lowers the price per unit it receives on all units sold.
Geometrically, this fact implies the downward sloping MR, which leads the monopoly to restrict output because it knows that the more it produces, the less money per unit it gets.



