Monopoly Output Decisions

Short Run Output Decision

In the short run, a monopolist determines whether to produce a positive output by comparing marginal revenue and marginal cost, and ensuring price covers average variable cost.

• Profit Maximization Condition: The monopolist produces where .

• No Shut Down Condition: The monopolist only produces if .

• Shut Down: If no such exists, the monopolist shuts down production.

Long Run Output Decision

In the long run, the monopolist must cover all costs, including fixed costs, and chooses output accordingly.

• Profit Maximization Condition: .

• No Shut Down Condition: .

• Shut Down: If , the monopolist shuts down.

Worked Example: Short Run Monopoly

Given market demand and cost :

• Inverse Demand:

• Total Revenue:

• Marginal Revenue:

• Marginal Cost:

• Profit Maximizing Output: Set

• Price:

• No Shut Down Condition: (usually satisfied)

• Profit:

Worked Example: Long Run Monopoly

Given market demand , , and no fixed cost:

• Inverse Demand:

• Total Revenue:

• Marginal Revenue:

• Profit Maximizing Output:

• Price:

• No Shut Down Condition:

• Profit:

Pricing with Market Power

Welfare Analysis in Monopoly vs. Competitive Markets

Monopolists affect welfare differently than competitive firms, leading to changes in consumer surplus, producer surplus, and deadweight loss.

• Competitive Equilibrium: Output , price ; consumer surplus is the red triangle, producer surplus is the blue triangle, total welfare is the sum.

• Monopoly Equilibrium: Output , price ; consumer surplus shrinks, producer surplus increases, and deadweight loss appears.

Key Differences Between Monopoly and Competition

• Monopolists charge a higher price than competitive price level.

• Monopolists charge a price higher than marginal cost.

• Monopolists produce less than competitive equilibrium output.

• Monopolists earn higher profit than competitive firms.

• Monopoly leads to deadweight loss (loss of total welfare).

Price Discrimination

Definition and Types

Price discrimination occurs when a firm charges different prices to different consumers or for different units of a good, aiming to capture more consumer surplus and increase producer surplus.

• First-degree price discrimination: Each consumer is charged their maximum willingness to pay.

• Second-degree price discrimination: Different prices are charged for different quantities (e.g., quantity discounts).

• Third-degree price discrimination: Different prices are charged to different groups (e.g., student rates, gender-based pricing).

First-Degree Price Discrimination

Under first-degree price discrimination, the monopolist captures all consumer surplus, making output efficient but leaving consumers with no surplus.

• Producer Surplus:

• Consumer Surplus:

• Deadweight Loss:

• Profit:

• Increase in Producer Surplus: Compared to single-price case,

• Decrease in Consumer Surplus: Compared to single-price case,

Examples: Personalized discounts for cars, tax services.

Additional info: First-degree price discrimination is rare in practice due to information constraints.

Second-Degree Price Discrimination

Second-degree price discrimination involves charging different prices for different quantities, benefiting from consumers' diminishing marginal utility.

• Examples: Buy one get one 50% off, loyalty cards, family size discounts, group discounts.

Third-Degree Price Discrimination

Third-degree price discrimination divides consumers into groups with separate demand curves and charges different prices to each group.

• Examples: Hotel rates (weekends vs weekdays), economy vs business class, coupons, gender-based pricing, student rates.