1 00:00:00,040 --> 00:00:02,460 The following content is provided under a Creative 2 00:00:02,460 --> 00:00:03,870 Commons license. 3 00:00:03,870 --> 00:00:06,910 Your support will help MIT OpenCourseWare continue to 4 00:00:06,910 --> 00:00:10,560 offer high-quality educational resources for free. 5 00:00:10,560 --> 00:00:13,460 To make a donation or view additional materials from 6 00:00:13,460 --> 00:00:17,390 hundreds of MIT courses, visit MIT OpenCourseWare at 7 00:00:17,390 --> 00:00:18,640 ocw.mit.edu. 8 00:00:24,710 --> 00:00:27,110 JON GRUBER: All right, so today we are going to continue 9 00:00:27,110 --> 00:00:30,730 with our discussion of producer theory. 10 00:00:30,730 --> 00:00:34,310 And today we're going to move beyond the unrealistic case of 11 00:00:34,310 --> 00:00:37,460 perfect competition to the somewhat more realistic case 12 00:00:37,460 --> 00:00:39,570 of monopoly. 13 00:00:39,570 --> 00:00:42,310 Now, we've been discussing perfect competition thus far 14 00:00:42,310 --> 00:00:44,590 as a form of market organization, and that makes 15 00:00:44,590 --> 00:00:48,010 sense in some context like fast food and other things. 16 00:00:48,010 --> 00:00:50,910 But in most contexts, we think perfect composition is not the 17 00:00:50,910 --> 00:00:52,480 way the world works. 18 00:00:52,480 --> 00:00:55,080 There's some limits on competition. 19 00:00:55,080 --> 00:00:57,180 And we think that markets-- 20 00:00:57,180 --> 00:00:59,240 many markets, many of the goods we consume have only a 21 00:00:59,240 --> 00:01:05,450 few firms. Operating systems or cars or a lot of things we 22 00:01:05,450 --> 00:01:09,645 consume, typically have only a few firms in them. 23 00:01:09,645 --> 00:01:14,260 So the most realistic model of markets would be one which 24 00:01:14,260 --> 00:01:16,180 accounts for the fact that there's less than an infinite 25 00:01:16,180 --> 00:01:18,210 number of firms, there's only a few firms. 26 00:01:18,210 --> 00:01:20,530 That turns out also to be the hardest model. 27 00:01:20,530 --> 00:01:22,090 So what we do is we sort of iterate there. 28 00:01:22,090 --> 00:01:25,590 We started with one extreme, which is a competitive market 29 00:01:25,590 --> 00:01:27,890 where there's an infinite number of firms, that allows 30 00:01:27,890 --> 00:01:29,750 us to draw some interesting conclusions. 31 00:01:29,750 --> 00:01:32,540 Now we're going to reverse field and talk about the other 32 00:01:32,540 --> 00:01:35,962 extreme, monopoly, which is only one firm. 33 00:01:35,962 --> 00:01:38,080 We'll talk about monopoly markets with only one firm. 34 00:01:38,080 --> 00:01:41,020 Then we'll talk about oligopoly, that middle case, 35 00:01:41,020 --> 00:01:42,950 which is multiple firms. 36 00:01:42,950 --> 00:01:45,230 So let's talk about monopoly, a market where 37 00:01:45,230 --> 00:01:46,480 there's only one firm. 38 00:01:50,180 --> 00:01:52,300 The key thing to remember for monopolies is they're no 39 00:01:52,300 --> 00:01:56,080 longer price takers, they're now price makers. 40 00:01:56,080 --> 00:01:58,680 Competitive firms are price takers. 41 00:01:58,680 --> 00:02:00,730 They were given a price by the market and 42 00:02:00,730 --> 00:02:01,795 they reacted to that. 43 00:02:01,795 --> 00:02:04,790 And as we saw in the long run, that price settled at the 44 00:02:04,790 --> 00:02:08,440 minimum of average cost. So basically, they were given the 45 00:02:08,440 --> 00:02:10,320 price which dictated production efficiency. 46 00:02:10,320 --> 00:02:12,130 They reacted to that in how much they produced. 47 00:02:12,130 --> 00:02:13,970 You got a flat long run supply curve. 48 00:02:16,795 --> 00:02:19,480 However, in a monopoly market, we don't meet the conditions 49 00:02:19,480 --> 00:02:20,660 for perfect competition. 50 00:02:20,660 --> 00:02:24,120 In particular, one condition was that consumers had perfect 51 00:02:24,120 --> 00:02:26,850 substitutes between your good and other 52 00:02:26,850 --> 00:02:28,010 goods they could buy. 53 00:02:28,010 --> 00:02:30,530 That's not true in a monopoly market. 54 00:02:30,530 --> 00:02:36,850 So if we think about that era, sort of maybe, I don't know, I 55 00:02:36,850 --> 00:02:38,340 don't have my computer history isn't as good. 56 00:02:38,340 --> 00:02:42,420 Maybe 10 years ago when Macs were sort of at the nadir of 57 00:02:42,420 --> 00:02:44,580 their popularity. 58 00:02:44,580 --> 00:02:46,670 And really you had to be a pretty high tech guy to be 59 00:02:46,670 --> 00:02:48,390 using Linux and things like that. 60 00:02:48,390 --> 00:02:51,150 That Windows had virtually a monopoly on operating systems. 61 00:02:51,150 --> 00:02:52,700 Not really, but virtually. 62 00:02:52,700 --> 00:02:55,460 Certainly unless you were a high tech guy who could do 63 00:02:55,460 --> 00:02:57,880 Linux and things like that, pretty much if you wanted an 64 00:02:57,880 --> 00:02:59,090 operating system, you got Windows. 65 00:02:59,090 --> 00:03:01,440 Windows pretty much had a monopoly. 66 00:03:01,440 --> 00:03:03,420 And that's may be as close as we've come in the modern 67 00:03:03,420 --> 00:03:06,680 economy to thinking about an example of monopoly. 68 00:03:06,680 --> 00:03:10,540 In that case, Bill Gates had to decide-- 69 00:03:10,540 --> 00:03:13,210 wasn't given a price, he had to decide how much to charge 70 00:03:13,210 --> 00:03:14,450 for Windows. 71 00:03:14,450 --> 00:03:18,320 And that decision determined in turn how 72 00:03:18,320 --> 00:03:20,200 much he would produce. 73 00:03:20,200 --> 00:03:21,990 And that's exactly what we'll talk about today, is how does 74 00:03:21,990 --> 00:03:24,930 a monopolist decide both what to charge and how much to 75 00:03:24,930 --> 00:03:26,990 produce of their good? 76 00:03:26,990 --> 00:03:29,820 So to do that, we're going to turn to a new concept. 77 00:03:29,820 --> 00:03:32,340 Well, not a new concept, but a different way of looking at 78 00:03:32,340 --> 00:03:33,450 something we've talked about before, 79 00:03:33,450 --> 00:03:34,700 which is marginal revenue. 80 00:03:38,680 --> 00:03:41,640 If you remember, the profit maximizing condition that we 81 00:03:41,640 --> 00:03:44,470 derived when we started our competition lectures was that 82 00:03:44,470 --> 00:03:49,430 marginal revenue equals marginal cost. That was our 83 00:03:49,430 --> 00:03:51,630 profit maximizing condition, was that marginal revenue 84 00:03:51,630 --> 00:03:57,670 equals marginal cost. 85 00:03:57,670 --> 00:03:59,640 Now we're going go to-- 86 00:03:59,640 --> 00:04:01,050 in perfect competition. 87 00:04:04,810 --> 00:04:06,340 And the way we thought about this marginal revenue equals 88 00:04:06,340 --> 00:04:08,290 marginal cost, remember the logic was this notion of 89 00:04:08,290 --> 00:04:10,090 climbing this profit hill. 90 00:04:10,090 --> 00:04:12,780 You want to produce any unit. 91 00:04:12,780 --> 00:04:14,290 Think of yourself as climbing this profit hill. 92 00:04:14,290 --> 00:04:16,709 You're deciding, do I produce the next unit? 93 00:04:16,709 --> 00:04:18,920 And I produce the next unit as long as the money I make off 94 00:04:18,920 --> 00:04:21,630 that unit exceeds what it cost to produce that unit. 95 00:04:21,630 --> 00:04:22,990 So I climb that profit hill. 96 00:04:22,990 --> 00:04:26,010 If marginal revenue is greater than marginal cost, 97 00:04:26,010 --> 00:04:27,280 I keep going up. 98 00:04:27,280 --> 00:04:30,060 At the peak, marginal revenue will equal marginal cost. Once 99 00:04:30,060 --> 00:04:32,420 I go beyond that peak, marginal revenue will fall 100 00:04:32,420 --> 00:04:35,030 down below marginal cost and I'll stop producing. 101 00:04:35,030 --> 00:04:38,090 So the notion is I climb this hill, which in the peak is 102 00:04:38,090 --> 00:04:41,430 dictated by marginal revenue equals marginal cost. 103 00:04:41,430 --> 00:04:44,600 Now for a competitive firm, we said marginal 104 00:04:44,600 --> 00:04:47,630 revenue was just price. 105 00:04:47,630 --> 00:04:50,670 So in perfect competition, the rule was set price equal to 106 00:04:50,670 --> 00:04:55,090 marginal cost. But that was a particular 107 00:04:55,090 --> 00:04:56,440 case of marginal revenue. 108 00:04:56,440 --> 00:05:01,460 So for example, to see that, let's look at Figure 14-1. 109 00:05:01,460 --> 00:05:02,475 This is another way. 110 00:05:02,475 --> 00:05:04,125 Probably next year when I teach this, I'll put this in 111 00:05:04,125 --> 00:05:05,660 the lecture on competition. 112 00:05:05,660 --> 00:05:08,750 Just a way to think about how marginal revenue is priced. 113 00:05:08,750 --> 00:05:11,160 Remember, a perfectly competitive firm faces a 114 00:05:11,160 --> 00:05:14,720 perfectly elastic demand curve. 115 00:05:14,720 --> 00:05:17,160 They face a perfectly elastic demand curve. 116 00:05:17,160 --> 00:05:24,360 So they have to think about what the implications are of 117 00:05:24,360 --> 00:05:25,850 the marginal unit they sell. 118 00:05:25,850 --> 00:05:30,720 Well if they sell little q units, their revenue's a. 119 00:05:30,720 --> 00:05:34,390 If they sell one more unit, their revenue is b. 120 00:05:34,390 --> 00:05:38,950 And the marginal revenue is the height of that rectangle B 121 00:05:38,950 --> 00:05:39,650 times the base. 122 00:05:39,650 --> 00:05:42,740 The base is 1 because it goes from q plus 1. 123 00:05:42,740 --> 00:05:44,390 The height is p. 124 00:05:44,390 --> 00:05:46,240 So the marginal revenue is price. 125 00:05:46,240 --> 00:05:48,800 This is a pretty basic diagram. 126 00:05:48,800 --> 00:05:51,620 So marginal revenue is price for the 127 00:05:51,620 --> 00:05:53,430 perfectly competitive firm. 128 00:05:53,430 --> 00:05:56,270 Now let's look at the monopoly case. 129 00:05:56,270 --> 00:05:58,320 The difference with a monopolist, as you see in 130 00:05:58,320 --> 00:06:03,900 Figure 14-2, is they no longer face a perfectly elastic 131 00:06:03,900 --> 00:06:05,080 demand curve. 132 00:06:05,080 --> 00:06:07,840 They now face a downward-sloping demand curve. 133 00:06:07,840 --> 00:06:08,870 Why is that? 134 00:06:08,870 --> 00:06:13,150 Well remember, this is the graph for little q. 135 00:06:13,150 --> 00:06:15,690 The reason the graph for little q was perfectly elastic 136 00:06:15,690 --> 00:06:18,430 with a perfectly competitive case was not that we said the 137 00:06:18,430 --> 00:06:21,080 demand for the entire good was perfectly elastic. 138 00:06:21,080 --> 00:06:24,070 It's just that the residual demand facing anyway one firm 139 00:06:24,070 --> 00:06:26,050 was perfectly elastic. 140 00:06:26,050 --> 00:06:29,870 Well now, a monopolist is the only firm in the market. 141 00:06:29,870 --> 00:06:33,500 So their residual demand equals total demand. 142 00:06:33,500 --> 00:06:34,756 Their residual demand equals total demand. 143 00:06:34,756 --> 00:06:37,030 So as long as total demand is downward-sloping, as we 144 00:06:37,030 --> 00:06:39,080 typically think it is, then they'll face a 145 00:06:39,080 --> 00:06:42,120 downward-sloping demand curve. 146 00:06:42,120 --> 00:06:44,650 So unlike a perfectly competitive firm, which faces 147 00:06:44,650 --> 00:06:48,080 a perfectly elastic residual demand curve, a monopoly firm 148 00:06:48,080 --> 00:06:50,900 will face a downward-sloping market demand curve. 149 00:06:50,900 --> 00:06:52,632 They face the entire market demand curve. 150 00:06:52,632 --> 00:06:53,910 So this is demand curve. 151 00:06:53,910 --> 00:06:56,330 Now we're talking about big Q's not little q's anymore. 152 00:06:56,330 --> 00:06:58,110 Or we could say little q equals big Q. 153 00:06:58,110 --> 00:06:59,430 There's only one firm. 154 00:06:59,430 --> 00:07:01,290 So little q's and the big Q's are the same. 155 00:07:01,290 --> 00:07:04,370 So now the firm reacts not to its residual firm demand 156 00:07:04,370 --> 00:07:07,330 curve, which is flat, but the downward-sloping 157 00:07:07,330 --> 00:07:09,050 market demand curve. 158 00:07:09,050 --> 00:07:11,170 Now, we're going to make one assumption 159 00:07:11,170 --> 00:07:11,990 here that's very important. 160 00:07:11,990 --> 00:07:14,080 We'll come back to this at the end of the lecture. 161 00:07:14,080 --> 00:07:17,540 We're going to assume that the monopolist can only charge one 162 00:07:17,540 --> 00:07:20,310 price for their good to all consumers. 163 00:07:20,310 --> 00:07:23,500 So most of this lecture we're going to assume a non-price 164 00:07:23,500 --> 00:07:26,775 discriminating monopolist. We're going to say that Bill 165 00:07:26,775 --> 00:07:28,980 Gates can't look at you and say, look, you look like you 166 00:07:28,980 --> 00:07:29,700 really want Windows. 167 00:07:29,700 --> 00:07:31,460 I'm going to charge you more than her. 168 00:07:31,460 --> 00:07:32,180 He can't do that. 169 00:07:32,180 --> 00:07:32,910 He has one price. 170 00:07:32,910 --> 00:07:35,450 He sells it to the stores at one price. 171 00:07:35,450 --> 00:07:37,830 So it's a non-price discriminating monopolist 172 00:07:37,830 --> 00:07:41,520 we're going to work with for the first 2/3 of this lecture. 173 00:07:41,520 --> 00:07:44,910 That monopolist has to set one price. 174 00:07:44,910 --> 00:07:48,310 Now, for that monopolist, for Bill Gates with Windows circa 175 00:07:48,310 --> 00:07:53,900 10 years ago, let's think about his decision to produce 176 00:07:53,900 --> 00:07:55,260 another unit. 177 00:07:55,260 --> 00:08:00,660 He's originally producing at Q, big Q at a price p1. 178 00:08:00,660 --> 00:08:03,010 He's originally producing a big Q at a price p1. 179 00:08:03,010 --> 00:08:07,090 If he wants to sell one more unit, he's going to have to 180 00:08:07,090 --> 00:08:08,400 lower the price. 181 00:08:08,400 --> 00:08:11,350 Because he now faces a downward-sloping demand curve. 182 00:08:11,350 --> 00:08:13,640 So if he wants to sell one more unit, he's going to have 183 00:08:13,640 --> 00:08:15,070 to lower the price to P2. 184 00:08:18,350 --> 00:08:20,240 I have a big cockatoo at home. 185 00:08:20,240 --> 00:08:23,180 This is his feather. 186 00:08:23,180 --> 00:08:27,580 So he's going to have to lower the price to P2. 187 00:08:27,580 --> 00:08:28,750 What's that going to do? 188 00:08:28,750 --> 00:08:31,120 Well, on the one hand, what that's going to do is that's 189 00:08:31,120 --> 00:08:35,270 going to mean on that next unit he's going to make p2. 190 00:08:35,270 --> 00:08:38,850 So he's going to get the rectangle B. On the other 191 00:08:38,850 --> 00:08:43,400 hand, on all the units he was selling at p1, he now gets a 192 00:08:43,400 --> 00:08:45,000 lower price p2. 193 00:08:45,000 --> 00:08:51,080 So he loses the rectangle C. So the marginal revenue for 194 00:08:51,080 --> 00:08:57,490 this monopolist, the marginal revenue is equal to the 195 00:08:57,490 --> 00:09:05,360 rectangle B minus the rectangle C. The marginal 196 00:09:05,360 --> 00:09:08,020 revenue is rectangle B minus rectangle C. 197 00:09:08,020 --> 00:09:11,640 Or alternatively, you could say that if we just write that 198 00:09:11,640 --> 00:09:18,590 out, write out what that is, that's p2 minus p1 199 00:09:18,590 --> 00:09:21,670 minus p2 times Q1. 200 00:09:27,790 --> 00:09:33,550 Or rewriting, we could rewrite this then as marginal revenue 201 00:09:33,550 --> 00:09:42,260 equals p plus delta p delta q, how much the price changes 202 00:09:42,260 --> 00:09:44,640 when you change the quantity, times the 203 00:09:44,640 --> 00:09:46,010 original quantity Q1. 204 00:09:49,810 --> 00:09:53,780 Or one more time, for those of you who prefer calculus. 205 00:09:53,780 --> 00:09:59,950 If revenue equals p times q, and q is a function of p, then 206 00:09:59,950 --> 00:10:04,770 marginal revenue, differentiating that, is p 207 00:10:04,770 --> 00:10:13,300 plus dp dq times Q. So marginal revenue is the price 208 00:10:13,300 --> 00:10:16,440 plus the change in price from selling another unit times the 209 00:10:16,440 --> 00:10:17,690 initial quantity. 210 00:10:21,940 --> 00:10:24,860 Once again, the graphics are in this graph. 211 00:10:24,860 --> 00:10:25,550 The math is here. 212 00:10:25,550 --> 00:10:27,213 We just differentiate the revenue equation. 213 00:10:30,320 --> 00:10:32,210 This term is positive. 214 00:10:32,210 --> 00:10:35,450 Price is always greater than 0. 215 00:10:35,450 --> 00:10:38,150 But this term is negative because demand 216 00:10:38,150 --> 00:10:40,370 curves slope down. 217 00:10:40,370 --> 00:10:41,920 So there's now two effects. 218 00:10:41,920 --> 00:10:44,750 There's a positive effect, which is if I sell another 219 00:10:44,750 --> 00:10:46,700 unit, I make money on that other unit. 220 00:10:46,700 --> 00:10:49,200 There's a negative effect, which is to sell that other 221 00:10:49,200 --> 00:10:50,790 unit, I have to lower the price because I face 222 00:10:50,790 --> 00:10:54,170 downward-sloping demand. 223 00:10:54,170 --> 00:10:56,970 So there's two effects a monopolist as he thinks about 224 00:10:56,970 --> 00:10:59,790 wanting to sell another unit. 225 00:10:59,790 --> 00:11:02,700 There's the money from that unit, but the lower 226 00:11:02,700 --> 00:11:06,260 willingness to pay for all previous units. 227 00:11:06,260 --> 00:11:07,790 And that's what makes a monopolist a little more 228 00:11:07,790 --> 00:11:10,210 interesting. 229 00:11:10,210 --> 00:11:13,040 We basically think of the monopolist as basically having 230 00:11:13,040 --> 00:11:15,520 to work down the demand curve. 231 00:11:15,520 --> 00:11:17,230 With a perfectly competitive firm, they don't have to work 232 00:11:17,230 --> 00:11:17,730 down the demand curve. 233 00:11:17,730 --> 00:11:19,120 The demand's flat to them. 234 00:11:19,120 --> 00:11:21,040 They can sell as much as they want at that price because 235 00:11:21,040 --> 00:11:22,350 they don't affect the price. 236 00:11:22,350 --> 00:11:23,970 They want to sell 10 of that price or a million at that 237 00:11:23,970 --> 00:11:25,090 price, it doesn't matter. 238 00:11:25,090 --> 00:11:26,280 Their demand curve's flat. 239 00:11:26,280 --> 00:11:28,050 Not true for the monopolist. 240 00:11:28,050 --> 00:11:30,890 If the monopolist wants to sell more, he has to face the 241 00:11:30,890 --> 00:11:32,780 wrath of the market. 242 00:11:32,780 --> 00:11:34,832 And the wrath of the market is such that if he wants to sell 243 00:11:34,832 --> 00:11:36,370 more, he's going to have to lower the price to do so. 244 00:11:38,990 --> 00:11:40,940 Remember, once again assuming he has to charge the same 245 00:11:40,940 --> 00:11:42,520 price to everyone. 246 00:11:42,520 --> 00:11:44,355 Assuming he's going to charge the same price to everyone, if 247 00:11:44,355 --> 00:11:45,695 he wants to sell more, he's going to have to lower the 248 00:11:45,695 --> 00:11:46,945 price to do so. 249 00:11:49,340 --> 00:11:50,220 There's different ways of [UNINTELLIGIBLE] 250 00:11:50,220 --> 00:11:51,890 intuition on this. 251 00:11:51,890 --> 00:11:54,100 I like to call this the poisoning effect. 252 00:11:54,100 --> 00:11:55,620 That's how I like to think about it. 253 00:11:55,620 --> 00:11:58,470 That basically, if I want to sell another unit, I'm going 254 00:11:58,470 --> 00:12:01,820 to poison the money I made on all previous units. 255 00:12:01,820 --> 00:12:03,020 Because if I want to sell another unit, I have 256 00:12:03,020 --> 00:12:04,220 to lower the price. 257 00:12:04,220 --> 00:12:06,760 That's going to take away from the money I was making on my 258 00:12:06,760 --> 00:12:07,380 previous units. 259 00:12:07,380 --> 00:12:08,990 So it's sort of a poisoning effect is how I like 260 00:12:08,990 --> 00:12:09,630 to think about it. 261 00:12:09,630 --> 00:12:13,260 But you can have your own intuition for it. 262 00:12:13,260 --> 00:12:16,470 And basicallly, this poisoning effect did not exist for the 263 00:12:16,470 --> 00:12:20,610 perfectly competitive firm because they couldn't affect 264 00:12:20,610 --> 00:12:22,000 the price with their action. 265 00:12:22,000 --> 00:12:24,030 They could sell however many units they wanted at that flat 266 00:12:24,030 --> 00:12:26,130 price and their actions did not affect that price. 267 00:12:26,130 --> 00:12:28,270 The poisoning effect only exists with monopolists 268 00:12:28,270 --> 00:12:29,880 because to sell that next unit, they have 269 00:12:29,880 --> 00:12:31,130 to lower the price. 270 00:12:33,670 --> 00:12:37,890 Now, basically what that means is to find equilibrium for a 271 00:12:37,890 --> 00:12:40,640 monopolist, it's going to be a little bit trickier. 272 00:12:40,640 --> 00:12:43,380 And so let's go to Figure 14-3 and slowly walk 273 00:12:43,380 --> 00:12:46,120 through Figure 14-3. 274 00:12:46,120 --> 00:12:48,230 And we'll start walking through. 275 00:12:48,230 --> 00:12:52,770 What the monopolist is going to want to do is draw a 276 00:12:52,770 --> 00:12:55,810 marginal revenue curve. 277 00:12:55,810 --> 00:12:58,160 With the perfectly competitive firm, marginal revenue curve 278 00:12:58,160 --> 00:12:59,590 was just a price, it was given to them. 279 00:12:59,590 --> 00:13:01,420 There was no marginal revenue curve. 280 00:13:01,420 --> 00:13:03,280 For a monopolist, there is a marginal revenue curve. 281 00:13:03,280 --> 00:13:05,155 So here I have a demand curve. 282 00:13:05,155 --> 00:13:07,160 The demand curve I've drawn here in this example. 283 00:13:09,880 --> 00:13:15,410 The demand curve I've drawn here is q equals 24 minus p. 284 00:13:15,410 --> 00:13:18,310 That's a typical demand curve, downward-sloping. 285 00:13:18,310 --> 00:13:20,250 As the price goes up, people want less of it. 286 00:13:20,250 --> 00:13:21,610 And now we're in market demands. 287 00:13:21,610 --> 00:13:24,520 Because remember, little q equals pq. 288 00:13:24,520 --> 00:13:28,160 There's only one firm in the market. 289 00:13:28,160 --> 00:13:31,870 Now, here's the trick with monopoly: mathematics. 290 00:13:31,870 --> 00:13:33,150 The first thing you're going to want to do is you're going 291 00:13:33,150 --> 00:13:34,780 to want to invert this. 292 00:13:34,780 --> 00:13:37,330 You're going to want say, OK, that takes q, but what takes 293 00:13:37,330 --> 00:13:39,490 the price a monopolist is going to charge? 294 00:13:39,490 --> 00:13:41,560 The price a monopolist is going to charge is therefore 295 00:13:41,560 --> 00:13:43,850 going to be 24 minus q. 296 00:13:43,850 --> 00:13:45,500 That's going to be the price that the 297 00:13:45,500 --> 00:13:46,750 monopolist is going to charge. 298 00:13:49,960 --> 00:13:58,370 Therefore, revenues, pq, is 24q minus q squared. 299 00:13:58,370 --> 00:14:00,880 So we inverted the demand equation. 300 00:14:00,880 --> 00:14:03,160 We do this because we want to write down a revenue equation. 301 00:14:03,160 --> 00:14:04,050 So that's the trick. 302 00:14:04,050 --> 00:14:05,970 This is the mathematical trick here is to invert this, so 303 00:14:05,970 --> 00:14:07,870 then you can write down a revenue equation. 304 00:14:07,870 --> 00:14:10,780 We then differentiate this revenue equation to get that 305 00:14:10,780 --> 00:14:15,430 marginal revenues equals 24 minus 2q. 306 00:14:15,430 --> 00:14:17,080 That's marginal revenues. 307 00:14:17,080 --> 00:14:22,940 The next unit you sell, you make 24 minus 2 times the 308 00:14:22,940 --> 00:14:24,190 amount you're now selling. 309 00:14:26,360 --> 00:14:32,890 And that's the marginal revenue curve graphed here. 310 00:14:32,890 --> 00:14:36,990 Now, basically what you see is in this case the marginal 311 00:14:36,990 --> 00:14:39,450 revenue curve starts at the same point as the demand curve 312 00:14:39,450 --> 00:14:41,840 on the y-axis and lies everywhere 313 00:14:41,840 --> 00:14:44,150 below the demand curve. 314 00:14:44,150 --> 00:14:47,060 Now that first fact, that it starts at the same intercept, 315 00:14:47,060 --> 00:14:49,870 is not always true. 316 00:14:49,870 --> 00:14:51,940 That is true because in this case we assumed a linear 317 00:14:51,940 --> 00:14:52,510 demand curve. 318 00:14:52,510 --> 00:14:55,180 With a nonlinear demand curve, marginal revenue curves can 319 00:14:55,180 --> 00:14:57,550 start at different points on the y-axis. 320 00:14:57,550 --> 00:14:59,810 The second point about the marginal revenue curve always 321 00:14:59,810 --> 00:15:02,700 being below the demand curve is always true regardless of 322 00:15:02,700 --> 00:15:03,590 the function. 323 00:15:03,590 --> 00:15:07,840 The marginal revenue is always below demand. 324 00:15:07,840 --> 00:15:10,380 Marginal revenue is always below demand. 325 00:15:10,380 --> 00:15:12,350 So that marginal revenue curve will always be below the 326 00:15:12,350 --> 00:15:14,660 demand curve because of this poisoning effect. 327 00:15:17,450 --> 00:15:20,030 Now, what I want to highlight here is this means there's a 328 00:15:20,030 --> 00:15:24,410 very important relationship between marginal revenue and 329 00:15:24,410 --> 00:15:27,170 the elasticity of demand. 330 00:15:27,170 --> 00:15:31,860 So let's take our marginal revenue equation and put it 331 00:15:31,860 --> 00:15:41,530 back in change terms. p plus delta p over delta q times Q. 332 00:15:41,530 --> 00:15:45,250 And let's multiply and divide by p. 333 00:15:45,250 --> 00:15:52,620 So marginal revenue you can rewrite as p plus p times 334 00:15:52,620 --> 00:16:01,240 delta p over delta q times Q over p. 335 00:16:01,240 --> 00:16:03,350 So I just took this second term, multiplied and divided 336 00:16:03,350 --> 00:16:06,540 by p, the second term. 337 00:16:06,540 --> 00:16:09,230 I just multiplied and divided by p. 338 00:16:09,230 --> 00:16:11,060 The reason I did that is because that means you can 339 00:16:11,060 --> 00:16:12,400 rewrite this. 340 00:16:12,400 --> 00:16:15,245 This now starts to look like an elasticity expression. 341 00:16:15,245 --> 00:16:17,820 Remember the expression for elasticity. 342 00:16:17,820 --> 00:16:20,420 This looks like the inverse of an elasticity expression. 343 00:16:20,420 --> 00:16:22,690 Remember what elasticity of demand was, delta q delta p 344 00:16:22,690 --> 00:16:25,400 times p over Q. So that's the inverse to 345 00:16:25,400 --> 00:16:26,950 the elasticity demand. 346 00:16:26,950 --> 00:16:30,620 So we can rewrite this as marginal revenue equals p 347 00:16:30,620 --> 00:16:35,720 times 1 plus 1 over the elasticity of demand. 348 00:16:35,720 --> 00:16:39,800 Marginal revenue equals p times 1 plus 1 over the 349 00:16:39,800 --> 00:16:42,870 elasticity of demand. 350 00:16:42,870 --> 00:16:45,520 Think about what this means for a second. 351 00:16:45,520 --> 00:16:49,070 What is the marginal revenue in a 352 00:16:49,070 --> 00:16:51,460 perfectly competitive firm? 353 00:16:51,460 --> 00:16:53,430 Well, as a perfectly competitive firm, what's the 354 00:16:53,430 --> 00:16:56,670 elasticity of demand facing a perfectly competitive firm? 355 00:16:56,670 --> 00:16:58,110 Infinity. 356 00:16:58,110 --> 00:16:59,210 Perfectly elastic. 357 00:16:59,210 --> 00:17:02,061 So marginal revenue by L'Hopital's rule equals p. 358 00:17:04,740 --> 00:17:06,849 So for a perfectly competitive firm where elasticity is 359 00:17:06,849 --> 00:17:11,470 infinity, marginal revenue equals p. 360 00:17:11,470 --> 00:17:16,900 Now instead, if we took a firm where the elasticity of demand 361 00:17:16,900 --> 00:17:21,250 was minus 1, the electricity demand was minus 1, the 362 00:17:21,250 --> 00:17:24,950 marginal revenue would be 0. 363 00:17:24,950 --> 00:17:25,589 Why is that? 364 00:17:25,589 --> 00:17:27,550 What that says is, if you're a monopolist facing an 365 00:17:27,550 --> 00:17:30,820 elasticity of demand of minus 1, then you make no money by 366 00:17:30,820 --> 00:17:32,420 selling the next unit. 367 00:17:32,420 --> 00:17:36,020 Because these two effects exactly cancel. 368 00:17:36,020 --> 00:17:38,790 It turns out with elasticity of demand of negative 1, these 369 00:17:38,790 --> 00:17:40,110 two effects exactly cancel. 370 00:17:40,110 --> 00:17:43,010 Exactly what you make by selling one more unit is 371 00:17:43,010 --> 00:17:45,170 offset by how much you have to lower the price on all your 372 00:17:45,170 --> 00:17:47,090 previous units. 373 00:17:47,090 --> 00:17:49,430 So an elasticity of demand of minus 1, marginal 374 00:17:49,430 --> 00:17:51,650 revenue equals 0. 375 00:17:51,650 --> 00:17:53,820 And as you can see as the elasticity of demand gets 376 00:17:53,820 --> 00:17:57,820 below minus 1, as it approaches 0 from below. 377 00:17:57,820 --> 00:18:00,500 As the elasticity of demand approaches 0 from below-- 378 00:18:00,500 --> 00:18:02,130 OK, I should have said perfect competition, I'm sorry, was 379 00:18:02,130 --> 00:18:03,500 negative infinity, not infinity. 380 00:18:03,500 --> 00:18:04,990 Negative infinity. 381 00:18:04,990 --> 00:18:09,300 As the elasticity of demand approaches 0 from below, then 382 00:18:09,300 --> 00:18:12,100 you're going to see that the marginal revenue-- 383 00:18:12,100 --> 00:18:14,830 as you approach 0 from below, marginal revenue is going to 384 00:18:14,830 --> 00:18:16,800 become negative. 385 00:18:16,800 --> 00:18:19,270 So for example, if the elasticity of demand equals 386 00:18:19,270 --> 00:18:23,090 minus 0.5, then the marginal revenue equals minus p. 387 00:18:23,090 --> 00:18:26,700 So if this is minus 0.5, then this becomes minus 2. 388 00:18:26,700 --> 00:18:28,240 So marginal revenue equals minus p. 389 00:18:28,240 --> 00:18:30,260 You lose money. 390 00:18:30,260 --> 00:18:34,270 So as that elasticity of demand approaches 0, you're 391 00:18:34,270 --> 00:18:37,740 going to have a negative marginal revenue from selling 392 00:18:37,740 --> 00:18:40,310 the next unit. 393 00:18:40,310 --> 00:18:41,280 And why is that? 394 00:18:41,280 --> 00:18:46,370 With a very inelastic good, you have to push the price 395 00:18:46,370 --> 00:18:49,940 down so much to sell the next unit that you lose money. 396 00:18:49,940 --> 00:18:52,850 Think about a very elastic versus very inelastic good. 397 00:18:52,850 --> 00:18:56,580 With a very elastically demanded good, to sell another 398 00:18:56,580 --> 00:18:59,710 unit you don't have to change the price much. 399 00:18:59,710 --> 00:19:02,580 Because the demand curve's very flat. 400 00:19:02,580 --> 00:19:05,440 So there's not much of a poisoning effect. 401 00:19:05,440 --> 00:19:09,490 dp dq is small, or dq dp is big. 402 00:19:09,490 --> 00:19:10,810 OK, this is the inverse. 403 00:19:10,810 --> 00:19:14,560 So dq dp is big with elasticity, so dp dq is small. 404 00:19:14,560 --> 00:19:18,290 With a very inelastically demanded good, to sell one 405 00:19:18,290 --> 00:19:21,680 more unit you're going to lower the price a ton, which 406 00:19:21,680 --> 00:19:23,570 is going to poison the revenues you get from selling 407 00:19:23,570 --> 00:19:26,820 that extra unit. 408 00:19:26,820 --> 00:19:35,840 So that's why marginal revenue will be higher, or will be a 409 00:19:35,840 --> 00:19:40,330 larger fraction of p as this elasticity 410 00:19:40,330 --> 00:19:41,580 becomes more negative. 411 00:19:44,630 --> 00:19:45,902 Yeah. 412 00:19:45,902 --> 00:19:46,388 AUDIENCE: [UNINTELLIGIBLE PHRASE] 413 00:19:46,388 --> 00:19:50,762 elastic that means [UNINTELLIGIBLE PHRASE] 414 00:19:50,762 --> 00:19:52,220 irrespective of the price. 415 00:19:52,220 --> 00:19:55,622 So couldn't you just charge a higher price and get marginal 416 00:19:55,622 --> 00:19:57,580 revenue [UNINTELLIGIBLE]. 417 00:19:57,580 --> 00:19:58,910 JON GRUBER: No, because here's the thing. 418 00:19:58,910 --> 00:20:01,460 You should have already been charging that high price. 419 00:20:01,460 --> 00:20:03,030 The point this is the margin. 420 00:20:03,030 --> 00:20:05,920 So you go into a market for insulin. 421 00:20:05,920 --> 00:20:07,552 You say, look, these guys are going to die without it. 422 00:20:07,552 --> 00:20:11,120 I'm going to charge $500,000 a shot. 423 00:20:11,120 --> 00:20:15,090 But now the question we're asking about marginal revenue. 424 00:20:15,090 --> 00:20:17,600 And at $500,000, you sell to everyone who can afford it and 425 00:20:17,600 --> 00:20:20,100 everyone else dies. 426 00:20:20,100 --> 00:20:22,270 Now you want to ask, what's the marginal revenue as you're 427 00:20:22,270 --> 00:20:25,720 trying to sell that 500,000 and first unit? 428 00:20:25,720 --> 00:20:29,560 Well to sell that, since it's inelastically demanded, if 429 00:20:29,560 --> 00:20:31,690 that person could afford anything like $500,000, they 430 00:20:31,690 --> 00:20:33,320 would have bought it already. 431 00:20:33,320 --> 00:20:33,960 They can't. 432 00:20:33,960 --> 00:20:36,450 They can only afford $400,000. 433 00:20:36,450 --> 00:20:38,280 We have to lower the price to $400,000. 434 00:20:38,280 --> 00:20:40,720 You're going to sell one more unit at $400,000 but lose 435 00:20:40,720 --> 00:20:43,090 $500,000 on all those other units you were going to sell 436 00:20:43,090 --> 00:20:44,710 at $500,000. 437 00:20:44,710 --> 00:20:46,870 The point is it's about the margin not the level. 438 00:20:46,870 --> 00:20:50,010 Yes, monopolists make a huge profit when it's inelastic. 439 00:20:50,010 --> 00:20:51,160 I'll talk about that in a minute. 440 00:20:51,160 --> 00:20:53,630 But that next unit they're going to lose money on. 441 00:20:59,180 --> 00:21:02,190 So that's actually a good point to segue to now, let's 442 00:21:02,190 --> 00:21:04,880 talk about with this in place, let's talk about how 443 00:21:04,880 --> 00:21:07,310 monopolists maximize profits. 444 00:21:07,310 --> 00:21:10,970 Let's talk about monopoly profit maximization. 445 00:21:10,970 --> 00:21:16,960 Let's go to Figure 14-4. 446 00:21:16,960 --> 00:21:18,630 Profit Maximization for a Monopolist. 447 00:21:18,630 --> 00:21:20,510 Now, this is a lot more confusing than perfectly 448 00:21:20,510 --> 00:21:22,310 competitive firms, so let's follow along here. 449 00:21:24,950 --> 00:21:27,300 This is a case the cost function here 450 00:21:27,300 --> 00:21:29,760 is 12 plus q squared. 451 00:21:29,760 --> 00:21:31,200 So I'm doing the cost function, which 452 00:21:31,200 --> 00:21:34,440 is 12 plus q squared. 453 00:21:34,440 --> 00:21:35,710 That's the cost function. 454 00:21:35,710 --> 00:21:38,990 And the demand function, as before, is Q 455 00:21:38,990 --> 00:21:42,120 equals 24 minus p. 456 00:21:42,120 --> 00:21:43,370 So that's what's graphed here. 457 00:21:45,800 --> 00:21:49,840 Now, recall the rule that profit is maximized where 458 00:21:49,840 --> 00:21:52,390 marginal revenue equals marginal cost. Well, we know 459 00:21:52,390 --> 00:21:54,540 marginal revenue. 460 00:21:54,540 --> 00:21:56,100 We know marginal revenue-- 461 00:21:56,100 --> 00:21:57,570 we derived that above-- 462 00:21:57,570 --> 00:22:01,660 is 24 minus 2Q. 463 00:22:01,660 --> 00:22:07,110 What's marginal cost with this expression? 464 00:22:07,110 --> 00:22:09,030 Well, marginal cost, differentiation of the cost 465 00:22:09,030 --> 00:22:10,280 equation, which is 2Q. 466 00:22:13,350 --> 00:22:16,220 So the optimization term for a monopolist is going to where 467 00:22:16,220 --> 00:22:19,300 marginal revenue, which is 24 minus 2Q, equals marginal 468 00:22:19,300 --> 00:22:20,560 cost, which is 2Q. 469 00:22:20,560 --> 00:22:24,190 Or Q equals 6. 470 00:22:24,190 --> 00:22:27,460 That's going to be the optimal production level for the 471 00:22:27,460 --> 00:22:30,600 monopolist. 472 00:22:30,600 --> 00:22:36,120 So we can see that graphically that's where the marginal cost 473 00:22:36,120 --> 00:22:39,400 curve hits the marginal revenue curve. 474 00:22:39,400 --> 00:22:42,490 If you go downward from that point, you get that the sales 475 00:22:42,490 --> 00:22:44,730 are 6 units. 476 00:22:44,730 --> 00:22:47,200 So marginal revenue equals marginal cost at 6. 477 00:22:47,200 --> 00:22:48,740 You should be able to see that graphically, it's just where 478 00:22:48,740 --> 00:22:50,060 the curves intersect. 479 00:22:50,060 --> 00:22:51,235 Mathematically I just did it here. 480 00:22:51,235 --> 00:22:52,840 It's actually pretty straightforward. 481 00:22:52,840 --> 00:22:54,270 Here's the hard part. 482 00:22:54,270 --> 00:22:56,180 What's the price? 483 00:22:56,180 --> 00:22:58,640 We might say, well, gee, marginal cost and marginal 484 00:22:58,640 --> 00:22:59,590 revenue intersect at 6. 485 00:22:59,590 --> 00:23:00,660 I'm going to draw the dashed line over. 486 00:23:00,660 --> 00:23:03,530 That means the price is going to be 12. 487 00:23:03,530 --> 00:23:05,150 Why can that not be the price? 488 00:23:05,150 --> 00:23:08,320 Why is that wrong? 489 00:23:08,320 --> 00:23:10,070 What would that violate if the price was 12? 490 00:23:10,070 --> 00:23:12,880 If you tried to sell 6 at a price of 12? 491 00:23:12,880 --> 00:23:13,270 Yeah. 492 00:23:13,270 --> 00:23:14,290 AUDIENCE: [INAUDIBLE]. 493 00:23:14,290 --> 00:23:15,550 JON GRUBER: It's not on the the demand curve. 494 00:23:15,550 --> 00:23:19,460 The monopolist still has to respect the demand curve. 495 00:23:19,460 --> 00:23:22,370 So monopolists in setting their quantity, gets the 496 00:23:22,370 --> 00:23:24,580 intersection of marginal revenue and marginal cost. But 497 00:23:24,580 --> 00:23:26,740 then in setting the price, they still have to read off 498 00:23:26,740 --> 00:23:27,340 the demand curve. 499 00:23:27,340 --> 00:23:29,440 They can't change consumer tastes. 500 00:23:29,440 --> 00:23:33,740 So they charge a price of 18. 501 00:23:33,740 --> 00:23:37,010 That's where you sell a quantity of 6. 502 00:23:37,010 --> 00:23:39,270 So monopolists it's a little bit trickier in a perfectly 503 00:23:39,270 --> 00:23:40,990 competitive firm. 504 00:23:40,990 --> 00:23:44,380 You set marginal revenue equal marginal cost to derive Q. But 505 00:23:44,380 --> 00:23:47,330 then to get p, you've got to go back and plug that into the 506 00:23:47,330 --> 00:23:48,540 demand curve. 507 00:23:48,540 --> 00:23:52,250 So with a Q of 6, I have my Q of 6. 508 00:23:52,250 --> 00:23:53,410 Well, what's the p? 509 00:23:53,410 --> 00:23:54,900 Well, to get that p, I've got to go back and 510 00:23:54,900 --> 00:23:56,690 plug this in here. 511 00:23:56,690 --> 00:24:05,310 At Q equals 6, p is 24 minus q, or 18. 512 00:24:05,310 --> 00:24:07,210 So I've got to respect the demand curve. 513 00:24:07,210 --> 00:24:10,320 The monopolist has to respect the demand curve. 514 00:24:10,320 --> 00:24:14,480 The monopolist picks both price and quantity, but he has 515 00:24:14,480 --> 00:24:18,150 to pick them such that you get a point on the demand curve. 516 00:24:18,150 --> 00:24:19,890 And the way we solve it, is the monopolist chooses a 517 00:24:19,890 --> 00:24:22,230 quantity to set marginal revenue equal to marginal 518 00:24:22,230 --> 00:24:24,980 cost, and then chooses the price that's consistent with 519 00:24:24,980 --> 00:24:26,230 demand for that quantity. 520 00:24:30,190 --> 00:24:32,630 Questions about that? 521 00:24:32,630 --> 00:24:34,270 Now one last thing. 522 00:24:34,270 --> 00:24:36,950 In the short run, we still have another condition for 523 00:24:36,950 --> 00:24:39,740 profit maximization, which is the shutdown rule. 524 00:24:39,740 --> 00:24:41,340 Remember the shutdown rule we talked about perfectly 525 00:24:41,340 --> 00:24:44,530 competitive firms in the short run, which is even if profits 526 00:24:44,530 --> 00:24:47,390 are negative, you might not shut down. 527 00:24:47,390 --> 00:24:50,770 You only shut down if price is less than average variable 528 00:24:50,770 --> 00:24:53,450 cost. So there's still the shutdown rule. 529 00:24:57,890 --> 00:25:01,590 So you only shutd own if price is less than average variable 530 00:25:01,590 --> 00:25:03,920 cost. 531 00:25:03,920 --> 00:25:06,840 Now in this case, what's the monopolist profits? 532 00:25:06,840 --> 00:25:10,430 Well, the monopolist made a profit of 60. 533 00:25:10,430 --> 00:25:11,660 How do we see that? 534 00:25:11,660 --> 00:25:17,530 Well that's graphically the box, the rectangle, that's the 535 00:25:17,530 --> 00:25:19,320 difference between the average cost curve and 536 00:25:19,320 --> 00:25:20,420 the price they get. 537 00:25:20,420 --> 00:25:23,130 So they're charging 18. 538 00:25:23,130 --> 00:25:24,980 Now once again, marginal revenue is gone. 539 00:25:24,980 --> 00:25:27,870 Think about marginal revenue like an imaginary concept. 540 00:25:27,870 --> 00:25:29,610 Marginal revenue isn't something that actually exists 541 00:25:29,610 --> 00:25:30,390 in the market. 542 00:25:30,390 --> 00:25:32,920 Marginal revenue is just something the monopolist draws 543 00:25:32,920 --> 00:25:34,420 to pick what they're going to do. 544 00:25:34,420 --> 00:25:36,400 But then it disappears. 545 00:25:36,400 --> 00:25:38,920 What the monopolist cares about then is price. 546 00:25:38,920 --> 00:25:44,640 They're charging 18. 547 00:25:44,640 --> 00:25:47,580 Their average cost for that unit is only 8. 548 00:25:47,580 --> 00:25:51,000 So they're making a profit of 10 per unit on 6 units. 549 00:25:51,000 --> 00:25:53,660 So they're making a profit of 60. 550 00:25:53,660 --> 00:25:55,660 And what you can see, what you should be able to demonstrate 551 00:25:55,660 --> 00:26:00,040 to yourself is, if a monopolist sold 5 units. 552 00:26:00,040 --> 00:26:01,325 I'm sorry, selling 6 units. 553 00:26:01,325 --> 00:26:04,650 If the monopoly sold that seventh unit, what you'll be 554 00:26:04,650 --> 00:26:07,640 able to see is they would lose money on the seventh unit. 555 00:26:07,640 --> 00:26:10,890 Because yes, if they sold that seventh unit, what happened if 556 00:26:10,890 --> 00:26:11,670 they sold the seventh unit? 557 00:26:11,670 --> 00:26:13,470 Well then their price would have to be what if they wanted 558 00:26:13,470 --> 00:26:16,130 to sell a seventh unit? 559 00:26:16,130 --> 00:26:18,520 The price would have to be 17. 560 00:26:18,520 --> 00:26:21,080 The price would have to be 17. 561 00:26:21,080 --> 00:26:22,970 So to sell a seventh unit, they'd have to 562 00:26:22,970 --> 00:26:30,760 have a price of 17. 563 00:26:30,760 --> 00:26:35,040 So basically at a price of 17, the price was 17. 564 00:26:35,040 --> 00:26:36,650 Then what would happen? 565 00:26:36,650 --> 00:26:38,570 Well, they'd sell one more unit at 17. 566 00:26:38,570 --> 00:26:39,710 That'd be good. 567 00:26:39,710 --> 00:26:42,470 But they'd lose $1 on the previous 6 568 00:26:42,470 --> 00:26:44,760 units, which is bad. 569 00:26:44,760 --> 00:26:47,000 So how much revenues would they make? 570 00:26:47,000 --> 00:26:48,550 What would be their marginal revenue? 571 00:26:48,550 --> 00:26:52,170 Well, the marginal revenue would be they make 17 minus 572 00:26:52,170 --> 00:26:55,020 the 6 poisoning effect. 573 00:26:55,020 --> 00:26:58,730 So marginal revenue equals 11. 574 00:26:58,730 --> 00:27:01,240 What's their marginal cost? 575 00:27:01,240 --> 00:27:03,640 Their marginal cost is 2Q. 576 00:27:03,640 --> 00:27:07,090 Marginal cost is 14. 577 00:27:07,090 --> 00:27:10,060 So they lose money. 578 00:27:10,060 --> 00:27:11,290 So you should be able to walk through 579 00:27:11,290 --> 00:27:13,770 this exercise yourself. 580 00:27:13,770 --> 00:27:17,340 You might say, gee, the marginal cost of that next 581 00:27:17,340 --> 00:27:18,140 unit is only 14. 582 00:27:18,140 --> 00:27:19,800 They sell it for 17. 583 00:27:19,800 --> 00:27:21,620 Gosh, they should do it. 584 00:27:21,620 --> 00:27:23,840 What you're missing is by selling it for 17, they've 585 00:27:23,840 --> 00:27:26,160 lost the dollar extra they make on each of 586 00:27:26,160 --> 00:27:27,610 the previous 6 units. 587 00:27:27,610 --> 00:27:28,880 And that poisoning effect makes it 588 00:27:28,880 --> 00:27:30,630 unprofitable to do this. 589 00:27:30,630 --> 00:27:33,700 And that's why the monopolists stop short of what would be 590 00:27:33,700 --> 00:27:35,790 the perfectly competitive outcome. 591 00:27:35,790 --> 00:27:38,580 What would the perfectly competitive firm do? 592 00:27:38,580 --> 00:27:40,390 The perfectly competitive firm would set marginal 593 00:27:40,390 --> 00:27:42,520 cost equal to demand. 594 00:27:42,520 --> 00:27:44,370 And they would end up producing where marginal cost 595 00:27:44,370 --> 00:27:45,190 equals demand. 596 00:27:45,190 --> 00:27:48,270 So demand here is 24 minus p. 597 00:27:48,270 --> 00:27:52,040 Marginal cost is 2Q. 598 00:27:52,040 --> 00:27:56,530 So they would end up producing where marginal cost equals 599 00:27:56,530 --> 00:27:58,080 demand at a much higher level charging a 600 00:27:58,080 --> 00:27:59,860 slightly lower price. 601 00:27:59,860 --> 00:28:04,230 So what you see is the monopolist ends up selling 602 00:28:04,230 --> 00:28:08,490 fewer units at a higher price. 603 00:28:08,490 --> 00:28:09,296 Questions about that? 604 00:28:09,296 --> 00:28:10,230 Yeah. 605 00:28:10,230 --> 00:28:11,755 AUDIENCE: How does this work for Microsoft where their 606 00:28:11,755 --> 00:28:15,100 marginal costs are very low or nonexistent? 607 00:28:15,100 --> 00:28:16,640 JON GRUBER: Well, then what would happen, if their 608 00:28:16,640 --> 00:28:18,360 marginal costs were very low or nonexistent. 609 00:28:18,360 --> 00:28:19,990 Think of that marginal cost curve then as 610 00:28:19,990 --> 00:28:22,140 being much, much flatter. 611 00:28:22,140 --> 00:28:25,860 It would intersect demand at a much higher quantity. 612 00:28:25,860 --> 00:28:29,110 Or it'd intersect marginal revenue at a 613 00:28:29,110 --> 00:28:29,820 somewhat higher quantity. 614 00:28:29,820 --> 00:28:31,060 Not that much higher. 615 00:28:31,060 --> 00:28:33,540 So if marginal cost is very low, they produce more but 616 00:28:33,540 --> 00:28:35,770 they make even more profits. 617 00:28:35,770 --> 00:28:37,120 So it's a good question actually, a good comparative 618 00:28:37,120 --> 00:28:37,860 statics exercise. 619 00:28:37,860 --> 00:28:39,520 You bring that marginal cost curve down, 620 00:28:39,520 --> 00:28:40,530 what's going to happen? 621 00:28:40,530 --> 00:28:43,260 Quantity is going to go up, but not as quickly as profits 622 00:28:43,260 --> 00:28:44,390 are going to go up. 623 00:28:44,390 --> 00:28:47,230 That's why Bill Gates is the richest man in the world. 624 00:28:47,230 --> 00:28:48,280 That's what happens. 625 00:28:48,280 --> 00:28:50,540 You get really rich. 626 00:28:50,540 --> 00:28:52,650 So basically, when you're a monopoly, low marginal cost 627 00:28:52,650 --> 00:28:53,900 you get really rich. 628 00:28:56,930 --> 00:28:58,920 But that's a great thought exercise to understand how 629 00:28:58,920 --> 00:29:00,640 this monopoly example works. 630 00:29:00,640 --> 00:29:02,920 Other questions about that? 631 00:29:02,920 --> 00:29:04,770 So this is a good opportunity to introduce an important 632 00:29:04,770 --> 00:29:09,550 concept with monopolists, the concept of market power. 633 00:29:09,550 --> 00:29:14,040 What monopolists have, what Bill Gates has that my local 634 00:29:14,040 --> 00:29:18,830 McDonald's does not is market power. 635 00:29:18,830 --> 00:29:23,720 Or what he had, has less of now, is market power. 636 00:29:23,720 --> 00:29:29,010 Market power is the ability to charge price above marginal 637 00:29:29,010 --> 00:29:33,210 cost. The summary statistic of how much power a monopolist 638 00:29:33,210 --> 00:29:36,690 has is how much they can drive their price above marginal 639 00:29:36,690 --> 00:29:37,190 cost. 640 00:29:37,190 --> 00:29:39,870 When Bill Gates marginal cost dwindles to 0, his market 641 00:29:39,870 --> 00:29:42,240 power gets bigger. 642 00:29:42,240 --> 00:29:44,720 Price above marginal cost. 643 00:29:44,720 --> 00:29:47,010 Now to think about this, remember the condition for 644 00:29:47,010 --> 00:29:48,540 profit maximization. 645 00:29:48,540 --> 00:29:53,130 It was that marginal revenue, which we wrote as p times 1 646 00:29:53,130 --> 00:29:59,340 plus 1 over epsilon equals marginal cost. So we can 647 00:29:59,340 --> 00:30:05,430 rewrite this as marginal cost over price equals 1 plus 1 648 00:30:05,430 --> 00:30:06,680 over epsilon. 649 00:30:09,670 --> 00:30:11,810 Now let's define the markup. 650 00:30:11,810 --> 00:30:17,060 Let's define the markup as price minus marginal cost, how 651 00:30:17,060 --> 00:30:18,900 much money you make on the next unit. 652 00:30:18,900 --> 00:30:21,080 You sell for p, you get marginal cost. It's money you 653 00:30:21,080 --> 00:30:22,010 make the next unit. 654 00:30:22,010 --> 00:30:25,700 If you define the markup, p minus MC over p, that's the 655 00:30:25,700 --> 00:30:27,370 percentage markup. 656 00:30:27,370 --> 00:30:28,810 It's how much you make on the next unit, 657 00:30:28,810 --> 00:30:30,340 the percentage markup. 658 00:30:30,340 --> 00:30:34,660 Then you can see that that markup equals 659 00:30:34,660 --> 00:30:37,580 minus 1 over epsilon. 660 00:30:37,580 --> 00:30:40,000 So the markup for a monopoly firm equals 661 00:30:40,000 --> 00:30:41,000 minus 1 over epsilon. 662 00:30:41,000 --> 00:30:42,840 This comes to the question before about the insulin 663 00:30:42,840 --> 00:30:44,430 example's sort of confusing. 664 00:30:44,430 --> 00:30:47,180 Here we see your intuition on insulin. 665 00:30:47,180 --> 00:30:51,310 The lower its elasticity, the more the monopolists can mark 666 00:30:51,310 --> 00:30:53,170 up their price. 667 00:30:53,170 --> 00:30:54,740 So your intuition is shown here. 668 00:30:54,740 --> 00:30:56,350 Yes, the monopolist will charge an 669 00:30:56,350 --> 00:30:58,550 incredible price for insulin. 670 00:30:58,550 --> 00:31:00,820 They'll still lose a lot of money if they try to raise 671 00:31:00,820 --> 00:31:02,960 that price, if they try to sell one more unit. 672 00:31:02,960 --> 00:31:05,700 But the first initial price they'll set will 673 00:31:05,700 --> 00:31:07,170 be incredibly high. 674 00:31:07,170 --> 00:31:11,850 Basically, what is the constraint on Bill Gates? 675 00:31:11,850 --> 00:31:13,040 What is the constraint on Bill Gates? 676 00:31:13,040 --> 00:31:15,640 It's Steve Jobs. 677 00:31:15,640 --> 00:31:17,660 It's substitutes. 678 00:31:17,660 --> 00:31:20,430 The only constraint on a monopolist is the extent to 679 00:31:20,430 --> 00:31:22,320 which people can sub-- 680 00:31:22,320 --> 00:31:23,980 actually, let me go back, that's not a good example. 681 00:31:23,980 --> 00:31:24,410 Let's [UNINTELLIGIBLE] 682 00:31:24,410 --> 00:31:26,560 Bill Gates circa 10 years ago. 683 00:31:26,560 --> 00:31:29,940 The constraint on Bill Gates circa 10 years ago was a 684 00:31:29,940 --> 00:31:34,650 mainframe or some other form of doing a set of-- 685 00:31:34,650 --> 00:31:36,920 or 20 years ago it was a typewriter. 686 00:31:36,920 --> 00:31:39,790 It was basically the fact that there was some other way to do 687 00:31:39,790 --> 00:31:42,370 what Bill Gates was letting you do. 688 00:31:42,370 --> 00:31:44,680 If there was no other way to do what Bill Gates was letting 689 00:31:44,680 --> 00:31:48,460 you do, he would charge an infinite price. 690 00:31:48,460 --> 00:31:51,080 Clearly if there's some other way-- 691 00:31:51,080 --> 00:31:53,200 and also, elasticity of course, comes from substitutes 692 00:31:53,200 --> 00:31:55,240 or one substitute is just not to compute. 693 00:31:55,240 --> 00:31:57,580 So if Bill Gates tried to charge infinity for Windows, 694 00:31:57,580 --> 00:31:59,500 people just wouldn't own computers. 695 00:31:59,500 --> 00:32:02,103 So the reason Bill Gates can't charge infinity, and the 696 00:32:02,103 --> 00:32:04,520 reason he can't charge infinity for insulin is that 697 00:32:04,520 --> 00:32:05,720 there's some elasticity of demand. 698 00:32:05,720 --> 00:32:07,180 People at some point will just stop buying. 699 00:32:07,180 --> 00:32:08,980 Either because they'll choose to use a typewriter instead or 700 00:32:08,980 --> 00:32:10,060 they just won't compute. 701 00:32:10,060 --> 00:32:13,140 They'll write by hand or something. 702 00:32:13,140 --> 00:32:15,770 So basically at some point, there is some elasticity 703 00:32:15,770 --> 00:32:17,550 because there's a market demand curve. 704 00:32:17,550 --> 00:32:19,870 And basically what's going to determine how much market 705 00:32:19,870 --> 00:32:22,940 power the monopolist has is going to be how elastic it is. 706 00:32:22,940 --> 00:32:27,200 Basically, how close the substitutes are for that good. 707 00:32:27,200 --> 00:32:29,880 If there's close substitutes, the monopolist won't be able 708 00:32:29,880 --> 00:32:31,510 to charge a very high markup. 709 00:32:31,510 --> 00:32:33,900 If there's not close substitutes as of Window circa 710 00:32:33,900 --> 00:32:38,020 10 years ago, the monopolist can charge a very high markup 711 00:32:38,020 --> 00:32:40,910 and become very, very rich. 712 00:32:40,910 --> 00:32:41,690 Yeah. 713 00:32:41,690 --> 00:32:43,990 AUDIENCE: But if there are substitutes for the market, 714 00:32:43,990 --> 00:32:46,750 then it's not a monopoly anymore. 715 00:32:46,750 --> 00:32:48,190 JON GRUBER: No, no, this is the key thing. 716 00:32:48,190 --> 00:32:51,080 Substitutes for that producer. 717 00:32:51,080 --> 00:32:53,140 So basically, that's why I said Steve Jobs 718 00:32:53,140 --> 00:32:53,980 is not a good example. 719 00:32:53,980 --> 00:32:55,670 Because then it's not a monopoly anymore. 720 00:32:55,670 --> 00:32:57,390 But the typewriter is a good example. 721 00:32:57,390 --> 00:32:59,760 That's a different good, that's a different market, 722 00:32:59,760 --> 00:33:00,740 different good that substitutes. 723 00:33:00,740 --> 00:33:05,650 So my point is any given good, insulin being an exception, 724 00:33:05,650 --> 00:33:07,220 but any good there's always something you can do instead. 725 00:33:07,220 --> 00:33:08,410 Insulin there is something you can do 726 00:33:08,410 --> 00:33:10,340 instead, you can be sick. 727 00:33:10,340 --> 00:33:12,710 There's always something you can do instead. 728 00:33:12,710 --> 00:33:14,200 We don't have only one thing in life. 729 00:33:14,200 --> 00:33:17,170 So the elasticity of demand is never perfectly inelastic. 730 00:33:20,450 --> 00:33:22,830 It seems silly 10 years ago, but 20 years ago it actually 731 00:33:22,830 --> 00:33:25,700 was a legitimate decision whether to have a PC or not. 732 00:33:25,700 --> 00:33:27,770 A lot of people just didn't have computers. 733 00:33:27,770 --> 00:33:29,300 You could always just not have one. 734 00:33:29,300 --> 00:33:31,720 That gives you inelasticity of demand. 735 00:33:31,720 --> 00:33:34,465 So basically, it's important to recognize when we talk 736 00:33:34,465 --> 00:33:36,740 about substitutes, I'm talking about here not substitutes 737 00:33:36,740 --> 00:33:39,790 within the market, but substitutable activities, 738 00:33:39,790 --> 00:33:42,970 other things you could do with your money. 739 00:33:42,970 --> 00:33:45,360 And the more other things are you could do with your money, 740 00:33:45,360 --> 00:33:48,360 the less markup that Bill Gates can make on his Windows 741 00:33:48,360 --> 00:33:51,110 operating system. 742 00:33:51,110 --> 00:33:53,590 Questions about that? 743 00:33:53,590 --> 00:33:58,570 OK, now we can ask, OK, gee, John, this is all good and 744 00:33:58,570 --> 00:34:00,186 interesting, but why did you just waste the last lecture 745 00:34:00,186 --> 00:34:01,576 and a half teaching us about welfare if you're just going 746 00:34:01,576 --> 00:34:03,150 to go back to producer theory? 747 00:34:03,150 --> 00:34:05,050 Well, the reason is because now we come to what the 748 00:34:05,050 --> 00:34:06,720 welfare effects of monopoly. 749 00:34:06,720 --> 00:34:09,480 And ask, what effects do monopoly have on society? 750 00:34:09,480 --> 00:34:12,170 And in fact, we can show you that there's a deadweight loss 751 00:34:12,170 --> 00:34:14,350 on society imposed by monopoly. 752 00:34:14,350 --> 00:34:18,659 To see that, let's go to Figure 14-5. 753 00:34:18,659 --> 00:34:21,900 And here we can show the deadweight loss of monopoly. 754 00:34:21,900 --> 00:34:23,830 And here's the same example we were using. 755 00:34:23,830 --> 00:34:29,489 Demand is Q equals 24 minus p. 756 00:34:29,489 --> 00:34:31,139 Marginal cost is 2Q. 757 00:34:31,139 --> 00:34:33,340 The cost function is 12 plus Q squared. 758 00:34:33,340 --> 00:34:35,480 So marginal cost is 2Q. 759 00:34:35,480 --> 00:34:38,880 As we saw before, the monopolist chose to sell 6 760 00:34:38,880 --> 00:34:43,460 units at a price of 18. 761 00:34:43,460 --> 00:34:47,820 6 units at a price of 18. 762 00:34:47,820 --> 00:34:54,420 The perfectly competitive firm sets demand, which is 24 minus 763 00:34:54,420 --> 00:35:00,540 Q, sets price, I'm sorry, equal to marginal cost. Well, 764 00:35:00,540 --> 00:35:03,230 price comes to demand curve as 24 minus Q. 765 00:35:03,230 --> 00:35:05,830 Marginal cost is 2Q. 766 00:35:05,830 --> 00:35:09,310 So the perfectly competitive firm sets Q equal to 8. 767 00:35:09,310 --> 00:35:13,400 The perfectly competitive firm sets q equal to 8. 768 00:35:13,400 --> 00:35:16,850 They choose to sell 8 units at a price of 16. 769 00:35:16,850 --> 00:35:20,680 So you get the competitive quantity Q sub c is eight and 770 00:35:20,680 --> 00:35:23,380 the competitive price piece p sub c is 16. 771 00:35:23,380 --> 00:35:26,830 That's where graphically demand equals marginal cost. 772 00:35:26,830 --> 00:35:29,960 Or price equals marginal cost. 773 00:35:29,960 --> 00:35:35,320 The monopoly firm sells 6 units at a price of 18. 774 00:35:35,320 --> 00:35:38,350 So what is the welfare effects of monopoly? 775 00:35:38,350 --> 00:35:40,600 What we see is we know that the competitive 776 00:35:40,600 --> 00:35:42,770 firm maximizes welfare. 777 00:35:42,770 --> 00:35:44,490 We learned that last time. 778 00:35:44,490 --> 00:35:47,650 We know that the best you can do is to sell 8 units at a 779 00:35:47,650 --> 00:35:49,180 price of 16. 780 00:35:49,180 --> 00:35:52,780 What happens when you sell 6 units at a price of 18? 781 00:35:52,780 --> 00:35:58,120 What happens is consumer surplus falls from A plus B 782 00:35:58,120 --> 00:36:07,770 plus C. So with perfect competition, consumer surplus 783 00:36:07,770 --> 00:36:14,980 is A plus B plus C. With a monopoly, consumer surplus 784 00:36:14,980 --> 00:36:21,330 falls to the area A. So you lose B plus C with monopoly. 785 00:36:21,330 --> 00:36:26,730 Producer surplus under perfect competition was the area D 786 00:36:26,730 --> 00:36:32,510 plus E. Now under a monopolist, the producer 787 00:36:32,510 --> 00:36:47,060 surplus is equal to D plus E plus B. The monopolist , in 788 00:36:47,060 --> 00:36:51,680 this case, gained the rectangle B, but gave up the 789 00:36:51,680 --> 00:36:55,760 rectangle E. The consumer lost the rectangle B, that was a 790 00:36:55,760 --> 00:36:59,180 transfer to the monopolist. So there was a transfer of the 791 00:36:59,180 --> 00:37:02,880 rectangle B from the consumer to the monopolist. But C plus 792 00:37:02,880 --> 00:37:04,260 E have disappeared. 793 00:37:04,260 --> 00:37:07,060 They're a deadweight loss. 794 00:37:07,060 --> 00:37:09,250 They're deadweight loss because in the perfectly 795 00:37:09,250 --> 00:37:10,840 competitive equilibrium these are trades that would have 796 00:37:10,840 --> 00:37:13,570 made both parties better off. 797 00:37:13,570 --> 00:37:16,930 That is, these are trades which socially should happen. 798 00:37:16,930 --> 00:37:20,070 They are trades where the value to the consumer exceeds 799 00:37:20,070 --> 00:37:22,640 the cost of producing that unit. 800 00:37:22,640 --> 00:37:25,240 Those seventh and eighth units are units-- 801 00:37:25,240 --> 00:37:26,940 so take the seventh unit. 802 00:37:26,940 --> 00:37:28,700 What's that worth to someone? 803 00:37:28,700 --> 00:37:31,380 Well, it's worth 17. 804 00:37:31,380 --> 00:37:32,320 We can read that off the demand curve. 805 00:37:32,320 --> 00:37:34,260 That's a willingness to pay curve. 806 00:37:34,260 --> 00:37:36,950 People are willing to pay 17 for that seventh unit. 807 00:37:36,950 --> 00:37:38,610 What's it cost to produce? 808 00:37:38,610 --> 00:37:40,270 It cost 14. 809 00:37:40,270 --> 00:37:44,210 So you have a unit which people want more than it costs 810 00:37:44,210 --> 00:37:47,180 to produce, yet it's not getting sold. 811 00:37:47,180 --> 00:37:49,890 That's deadweight loss. 812 00:37:49,890 --> 00:37:52,190 So monopolists induce deadweight loss because units 813 00:37:52,190 --> 00:37:53,690 that people value above their marginal 814 00:37:53,690 --> 00:37:54,940 cost doesn't get sold. 815 00:38:00,500 --> 00:38:03,110 Units people value above their marginal cost don't get sold. 816 00:38:03,110 --> 00:38:05,180 And that's because this poisoning effect. 817 00:38:05,180 --> 00:38:08,060 Because while it's socially optimal to sell those units, 818 00:38:08,060 --> 00:38:12,690 while society is better off, it's privately sub-optimal. 819 00:38:12,690 --> 00:38:14,740 From the monopolist's perspective, it's bad to sell 820 00:38:14,740 --> 00:38:17,620 that unit because of this poisoning effect. 821 00:38:17,620 --> 00:38:19,800 So basically, the monopolist is underselling, 822 00:38:19,800 --> 00:38:20,730 underproducing. 823 00:38:20,730 --> 00:38:24,320 In general, monopolists will underproduce goods. 824 00:38:24,320 --> 00:38:27,560 They'll sell too few goods because to sell the right 825 00:38:27,560 --> 00:38:29,810 amount would not be profit maximizing. 826 00:38:29,810 --> 00:38:32,260 Because remember, what's the profits for the perfectly 827 00:38:32,260 --> 00:38:34,246 competitive firm? 828 00:38:34,246 --> 00:38:36,060 Profits for the perfectly competitive firm? 829 00:38:36,060 --> 00:38:38,820 Well, we know the profits of perfectly competitive firm. 830 00:38:38,820 --> 00:38:41,500 We know cost if they sell 8 units. 831 00:38:41,500 --> 00:38:45,500 We know the cost function is, the cost here 832 00:38:45,500 --> 00:38:47,700 is 12 plus Q squared. 833 00:38:47,700 --> 00:38:52,650 So if they sell 8 units, their costs are 12 plus 64, 834 00:38:52,650 --> 00:38:55,800 which equals 76. 835 00:38:55,800 --> 00:38:59,620 Their revenues if they sell 8 units are 8 units times the 836 00:38:59,620 --> 00:39:04,730 price of 16. 837 00:39:04,730 --> 00:39:11,280 8 units time the price of 16, which is 128. 838 00:39:11,280 --> 00:39:12,560 So what are their profits? 839 00:39:12,560 --> 00:39:15,770 Their profits are 52. 840 00:39:15,770 --> 00:39:17,940 So their profits are 52. 841 00:39:17,940 --> 00:39:21,380 The monopolist's profits are 60. 842 00:39:21,380 --> 00:39:23,330 So the monopolist is better off than the 843 00:39:23,330 --> 00:39:24,620 competitive firm would be. 844 00:39:24,620 --> 00:39:27,330 The competitive firm would only make profits of 52. 845 00:39:27,330 --> 00:39:28,060 Obviously the short run. 846 00:39:28,060 --> 00:39:29,670 The long run they make no profits. 847 00:39:29,670 --> 00:39:32,220 But in the short run they make profits of 52. 848 00:39:32,220 --> 00:39:35,180 The monopolist makes profits of 60. 849 00:39:35,180 --> 00:39:38,440 So the monopolist is better off than the competitive firm. 850 00:39:38,440 --> 00:39:41,220 The difference of course, is to do so they cause a social 851 00:39:41,220 --> 00:39:44,020 deadweight loss. 852 00:39:44,020 --> 00:39:45,950 Questions about that? 853 00:39:45,950 --> 00:39:46,930 Yeah. 854 00:39:46,930 --> 00:39:49,870 AUDIENCE: Is that what the OPEC is doing right now? 855 00:39:49,870 --> 00:39:51,340 JON GRUBER: I'm going to come to that actually. 856 00:39:51,340 --> 00:39:51,780 Time out on that. 857 00:39:51,780 --> 00:39:53,060 Because OPEC is more of an oligopoly. 858 00:39:53,060 --> 00:39:54,286 And we'll come to that when we talk about that 859 00:39:54,286 --> 00:39:56,380 in a couple of lectures. 860 00:39:56,380 --> 00:39:58,610 But I want to talk about one more thing before we stop, 861 00:39:58,610 --> 00:40:00,880 which is I want to talk about the key assumption we made 862 00:40:00,880 --> 00:40:05,130 here, which was the monopolist could only charge 863 00:40:05,130 --> 00:40:07,210 one price to everyone. 864 00:40:07,210 --> 00:40:09,080 In fact, we know that's not true. 865 00:40:09,080 --> 00:40:12,880 In fact, we know in the world, there's a large amount of what 866 00:40:12,880 --> 00:40:15,730 we call price discrimination. 867 00:40:15,730 --> 00:40:17,510 There's a large amount of price discrimination. 868 00:40:17,510 --> 00:40:20,185 We know that for many goods, different prices get charged 869 00:40:20,185 --> 00:40:21,390 to different consumers. 870 00:40:21,390 --> 00:40:23,210 If you ever tried to book an airline ticket the last 871 00:40:23,210 --> 00:40:26,370 minute, you know exactly what I mean. 872 00:40:26,370 --> 00:40:29,570 Basically, different prices in many, many contexts get 873 00:40:29,570 --> 00:40:31,020 charged different consumers. 874 00:40:31,020 --> 00:40:34,440 Everything from discounts for senior citizens, to higher 875 00:40:34,440 --> 00:40:37,110 price last-minute flights, to 876 00:40:37,110 --> 00:40:38,770 specials, two for one specials. 877 00:40:38,770 --> 00:40:41,770 People who buy two get a special price on 878 00:40:41,770 --> 00:40:43,410 the third, et cetera. 879 00:40:43,410 --> 00:40:45,320 There's all sorts of price discrimination just out there 880 00:40:45,320 --> 00:40:45,870 in the world. 881 00:40:45,870 --> 00:40:47,480 And in fact, there's very few goods that are 882 00:40:47,480 --> 00:40:48,760 sold at just one price. 883 00:40:48,760 --> 00:40:51,330 McDonald's hamburger is typically 884 00:40:51,330 --> 00:40:52,340 sold at just one price. 885 00:40:52,340 --> 00:40:56,820 They don't say like, fat people got to pay more for 886 00:40:56,820 --> 00:40:59,240 McDonald's hamburgers or something. 887 00:40:59,240 --> 00:41:03,190 But many, many goods we buy in the real world are sold at 888 00:41:03,190 --> 00:41:04,920 many prices. 889 00:41:04,920 --> 00:41:07,580 And that's an example of a price-discriminating firm. 890 00:41:07,580 --> 00:41:09,810 And here's the crazy part. 891 00:41:09,810 --> 00:41:10,990 Here's the crazy part. 892 00:41:10,990 --> 00:41:13,530 It turns out that a price-discriminating 893 00:41:13,530 --> 00:41:17,220 monopolist maximizes social welfare. 894 00:41:17,220 --> 00:41:19,690 A price-discriminating monopolist is as good as a 895 00:41:19,690 --> 00:41:20,786 competitive outcome. 896 00:41:20,786 --> 00:41:22,470 How can that be? 897 00:41:22,470 --> 00:41:27,210 Let's go to Figure 14-6. 898 00:41:27,210 --> 00:41:28,280 Here's the price-discriminating 899 00:41:28,280 --> 00:41:31,380 monopolist. Now, the price-discriminating 900 00:41:31,380 --> 00:41:33,550 monopolist, what does he do? 901 00:41:33,550 --> 00:41:35,900 This is a perfectly price-discriminating 902 00:41:35,900 --> 00:41:39,300 monopolist, someone who can charge a different price to 903 00:41:39,300 --> 00:41:41,180 every single consumer. 904 00:41:41,180 --> 00:41:42,440 Well, if you were a price-discriminating 905 00:41:42,440 --> 00:41:44,410 monopolist, perfectly price-discriminating 906 00:41:44,410 --> 00:41:46,390 monopolist and you could charge a different price to 907 00:41:46,390 --> 00:41:49,310 every consumer, what do you charge the first consumer? 908 00:41:52,550 --> 00:41:53,360 24. 909 00:41:53,360 --> 00:41:56,350 What do you charge the second consumer? 910 00:41:56,350 --> 00:41:57,390 23. 911 00:41:57,390 --> 00:41:58,700 Third consumer, 22. 912 00:41:58,700 --> 00:42:02,050 You literally charge them their willingness to pay. 913 00:42:02,050 --> 00:42:04,660 If you're perfectly price-discriminating, then 914 00:42:04,660 --> 00:42:07,960 what you do is literally charge every consumer exactly 915 00:42:07,960 --> 00:42:09,210 their willingness to pay. 916 00:42:09,210 --> 00:42:11,235 You say look, I know your willingness to pay function. 917 00:42:13,830 --> 00:42:21,560 Your willingness pay function is p is 24 minus Q. That's 918 00:42:21,560 --> 00:42:23,120 your willingness to pay function. 919 00:42:23,120 --> 00:42:26,260 So I'm going to literally charge you that. 920 00:42:26,260 --> 00:42:29,650 I know that about you, it's stamped on your head. 921 00:42:29,650 --> 00:42:32,850 So I'm going to say, ah, you're willing to pay 24 for 922 00:42:32,850 --> 00:42:35,690 the first unit, 23 for the second, et cetera. 923 00:42:35,690 --> 00:42:39,990 In that case, what will the perfectly price-discriminating 924 00:42:39,990 --> 00:42:40,810 monopolist do? 925 00:42:40,810 --> 00:42:44,140 Will they stop at 6 units? 926 00:42:44,140 --> 00:42:45,380 No, they won't. 927 00:42:45,380 --> 00:42:47,980 Because for that guy, there's no poisoning effect. 928 00:42:47,980 --> 00:42:49,970 There's no reason to stop at 6 units. 929 00:42:49,970 --> 00:42:52,910 That seventh unit, as we just did the math, there's money to 930 00:42:52,910 --> 00:42:54,490 be made on that seventh unit. 931 00:42:54,490 --> 00:42:57,220 Because that seventh unit is worth 17, but it only costs 14 932 00:42:57,220 --> 00:42:58,460 to produce. 933 00:42:58,460 --> 00:43:00,310 So the perfectly discriminating monopolist will 934 00:43:00,310 --> 00:43:02,460 sell it at 17. 935 00:43:02,460 --> 00:43:06,720 Likewise the eighth unit, people willing to pay 16 and 936 00:43:06,720 --> 00:43:07,930 it cost 16 to produce. 937 00:43:07,930 --> 00:43:08,780 So they'll sell it or not. 938 00:43:08,780 --> 00:43:10,260 They're basically indifferent. 939 00:43:10,260 --> 00:43:12,720 So we typically say they'll sell it. 940 00:43:12,720 --> 00:43:15,155 The point is, the perfectly price-discriminating 941 00:43:15,155 --> 00:43:19,380 monopolist will work all the way down the demand curve to 942 00:43:19,380 --> 00:43:22,160 the competitive outcome. 943 00:43:22,160 --> 00:43:24,810 They will move to the competitive market outcome 944 00:43:24,810 --> 00:43:27,560 because there's no poisoning effect. 945 00:43:27,560 --> 00:43:30,560 There's no reason not to. 946 00:43:30,560 --> 00:43:33,020 No reason not to sell as many units. 947 00:43:33,020 --> 00:43:36,410 No reason not to climb the same hill the competitive firm 948 00:43:36,410 --> 00:43:39,930 climbs and sell any unit where the price exceeds the marginal 949 00:43:39,930 --> 00:43:41,950 cost. 950 00:43:41,950 --> 00:43:45,110 Well, what's interesting is let's ask what's happened to 951 00:43:45,110 --> 00:43:47,730 social welfare with this perfectly price-discriminating 952 00:43:47,730 --> 00:43:53,260 monopolist. Well, consumer surplus is what? 953 00:43:53,260 --> 00:43:54,670 What's consumer surplus with the perfectly 954 00:43:54,670 --> 00:43:55,890 price-discriminating monopolist? 955 00:43:55,890 --> 00:43:56,540 Somebody raised their hand. 956 00:43:56,540 --> 00:43:57,150 Yeah. 957 00:43:57,150 --> 00:43:58,050 AUDIENCE: Zero. 958 00:43:58,050 --> 00:43:58,380 JON GRUBER: Zero. 959 00:43:58,380 --> 00:44:00,066 Why is it zero? 960 00:44:00,066 --> 00:44:01,726 AUDIENCE: Because they're charged exactly 961 00:44:01,726 --> 00:44:02,560 how the value is. 962 00:44:02,560 --> 00:44:03,070 JON GRUBER: Exactly. 963 00:44:03,070 --> 00:44:05,490 Consumer surplus is defined as willingness 964 00:44:05,490 --> 00:44:06,790 to pay minus price. 965 00:44:06,790 --> 00:44:08,980 But your price is set equal to your willingness to pay. 966 00:44:08,980 --> 00:44:11,470 So by definition, consumer surplus is 0. 967 00:44:11,470 --> 00:44:12,505 With a perfectly price-discriminating 968 00:44:12,505 --> 00:44:14,210 monopolist, there's no consumer surplus. 969 00:44:14,210 --> 00:44:16,060 But what's producer surplus? 970 00:44:16,060 --> 00:44:18,360 Same person, what's producer surplus? 971 00:44:18,360 --> 00:44:20,500 AUDIENCE: Everything else. 972 00:44:20,500 --> 00:44:21,340 JON GRUBER: Everything else. 973 00:44:21,340 --> 00:44:25,870 A plus B plus C plus D plus E. There's no deadweight loss. 974 00:44:25,870 --> 00:44:30,850 You get exactly the same social welfare as you got with 975 00:44:30,850 --> 00:44:31,810 perfect competition. 976 00:44:31,810 --> 00:44:33,760 It's just divided differently. 977 00:44:33,760 --> 00:44:37,600 With perfect competition, consumers got A plus B plus C. 978 00:44:37,600 --> 00:44:39,840 Producers got D plus E. 979 00:44:39,840 --> 00:44:41,140 With a perfectly price-discriminating 980 00:44:41,140 --> 00:44:44,220 monopolist, the monopolist gets everything. 981 00:44:44,220 --> 00:44:48,890 But the total shaded area is the same. 982 00:44:48,890 --> 00:44:51,970 So really fascinating because here we have the ultimate 983 00:44:51,970 --> 00:44:53,570 screw on consumers. 984 00:44:53,570 --> 00:44:55,570 We think about competition as being the 985 00:44:55,570 --> 00:44:56,940 best thing for consumers. 986 00:44:56,940 --> 00:44:59,380 Lots of firms selling goods at a competitive market where you 987 00:44:59,380 --> 00:45:01,420 can shop and do what's best for you. 988 00:45:01,420 --> 00:45:03,870 It's not surprising intuitively that that's the 989 00:45:03,870 --> 00:45:05,120 best thing for society. 990 00:45:07,410 --> 00:45:09,700 What's very surprising intuitively is having a 991 00:45:09,700 --> 00:45:12,160 producer who can screw every single consumer out of every 992 00:45:12,160 --> 00:45:17,680 penny they value something is equally good for society. 993 00:45:17,680 --> 00:45:18,750 And why is that? 994 00:45:18,750 --> 00:45:21,390 That's because we've made a particular assumption, which 995 00:45:21,390 --> 00:45:23,840 is social welfare is the sum of producer surplus and 996 00:45:23,840 --> 00:45:25,430 consumer surplus. 997 00:45:25,430 --> 00:45:26,570 The linear sum. 998 00:45:26,570 --> 00:45:29,240 Since it's is sum, we don't care in that function who gets 999 00:45:29,240 --> 00:45:30,130 the dollars. 1000 00:45:30,130 --> 00:45:32,540 We just care about the total amount of dollars, the total 1001 00:45:32,540 --> 00:45:33,740 size of the pie. 1002 00:45:33,740 --> 00:45:35,900 We don't care who gets what slice of the pie, we just care 1003 00:45:35,900 --> 00:45:37,310 about the total size of the pie. 1004 00:45:37,310 --> 00:45:40,280 And the total size of the pie is the same with a perfectly 1005 00:45:40,280 --> 00:45:41,680 price-discriminating monopolist and 1006 00:45:41,680 --> 00:45:44,030 a competitive firm. 1007 00:45:44,030 --> 00:45:46,550 What this highlights is that that's a pretty stupid way to 1008 00:45:46,550 --> 00:45:49,400 think about social welfare. 1009 00:45:49,400 --> 00:45:53,210 Clearly, we don't feel the same way about a market where 1010 00:45:53,210 --> 00:45:54,430 people get everything they want and a 1011 00:45:54,430 --> 00:45:54,910 market where people-- 1012 00:45:54,910 --> 00:45:57,080 all they're willing to pay is sucked out of them by a greedy 1013 00:45:57,080 --> 00:45:59,160 monopolist. Clearly we don't. 1014 00:45:59,160 --> 00:46:01,550 And that's why we're going to need to think more richly 1015 00:46:01,550 --> 00:46:04,280 about equity and think more richly about the division of 1016 00:46:04,280 --> 00:46:06,170 resources in society. 1017 00:46:06,170 --> 00:46:09,790 Because it turns out that you can have equally good outcomes 1018 00:46:09,790 --> 00:46:13,020 from an efficiency perspective that are very, very different 1019 00:46:13,020 --> 00:46:15,400 from an equity perspective. 1020 00:46:15,400 --> 00:46:18,590 And this is the first example we'll see of that. 1021 00:46:18,590 --> 00:46:21,960 What we'll do when we get towards the end of the course 1022 00:46:21,960 --> 00:46:24,933 lectures, like 23, 24, lectures like that, we're 1023 00:46:24,933 --> 00:46:26,230 going to start talking about equity. 1024 00:46:26,230 --> 00:46:28,570 And what are different rules we can think of for dividing 1025 00:46:28,570 --> 00:46:31,200 this pie that might give us a different answer? 1026 00:46:31,200 --> 00:46:34,790 OK, questions about that? 1027 00:46:34,790 --> 00:46:36,040 All right. 1028 00:46:39,380 --> 00:46:42,130 OK, so anyway, we'll stop here then. 1029 00:46:42,130 --> 00:46:44,770 Let's remember that perfectly price-discriminating 1030 00:46:44,770 --> 00:46:47,440 monopolist is obviously also a silly concept just like a 1031 00:46:47,440 --> 00:46:49,140 perfectly competitive firm's a silly concept. 1032 00:46:49,140 --> 00:46:51,090 What we're going to do next time is come back and talk 1033 00:46:51,090 --> 00:46:53,670 about price discrimination in reality and what firms do to 1034 00:46:53,670 --> 00:46:55,830 try to approximate this golden outcome.