By:

MUHAMMAD SHAHID IQBAL

 Monopoly

 A firm is considered a monopoly if

 it is the sole seller of its product.
 its product does not have close substitutes
 A monopoly occurs when something prevents
more than one firm from entering the market.
 Barriers to entry have three sources:
 Ownership of a key resource.
 The government gives a single firm the exclusive right to
produce some good.
 Costs of production make a single producer more
efficient than a large number of producers
 Monopoly Resources
 Although exclusive ownership of a key resource
is a potential source of monopoly, in practice
monopolies rarely arise for this reason.
 Governments may restrict entry by giving a
single firm the exclusive right to sell a particular
good in certain markets
 Patent and copyright laws are two important
examples of how government creates a
monopoly to serve the public interest.
 Natural Monopolies

 An industry is a natural
monopoly when a single firm
can supply a good or service
to an entire market at a
smaller cost than could two or
more firms.
 A natural monopoly arises
when there are economies of
scale over the relevant range
of output.
 HOW MONOPOLIES MAKE PRODUCTION
AND PRICING DECISIONS
 Monopoly versus Competition
 Monopoly
 Is the sole producer

 Faces a downward-sloping demand curve

 Is a price maker

 Reduces price to increase sales

 Competitive Firm
 Is one of many producers

 Faces a horizontal demand curve

 Is a price taker

 Sells as much or as little at same price

 Demand Curves for Competitive and Monopoly

(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve

Price Price

Demand

Demand

0 Quantity of Output 0 Quantity of Output

 The Demand Curve and
the Marginal-Revenue Curve
 Total Revenue
TR = P  Q
 Average Revenue
TR/Q = AR = P
The price function or average revenue function is given as
P = a - bQ
 Marginal Revenue

∆TR/ ∆Q = MR
MR = a - 2bQ
A monopolist’s MR is always less than the price of its good.

 The demand curve is downward sloping.

 When a monopoly drops the price to sell one more unit, the
revenue received from previously sold units also decreases.
 A Monopoly’s Revenue

 A Monopoly’s Marginal Revenue

 When a monopoly increases the
amount it sells, it has two effects on
total revenue (P  Q).
 The output effect—more output is sold, so
Q is higher.
 The price effect—price falls, so P is lower.
 The Demand Curve and
the Marginal-Revenue Curve
 Marginal revenue is equal to
the price for the first unit sold,
but is less than the price for all
other units sold. To increase
the quantity sold, a firm cuts its
price and receives less
revenue on the units that could
have been sold at the higher
price.
 Therefore, beyond the first unit
sold, the marginal revenue
curve lies below the demand
curve.
 Profit Maximization

 A monopoly maximizes profit by producing the

quantity at which marginal revenue equals marginal
cost.
 It then uses the demand curve to find the price that
will induce consumers to buy that quantity.
 Profit Maximization
Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity
Copyright © 2004 South-Western
 Profit Maximization

 Comparing Monopoly and Competition

 For a competitive firm, price equals marginal cost.
P = MR = MC
 For a monopoly firm, price exceeds marginal cost.
P > MR = MC
 Profit equals total revenue minus total costs.
 Profit = TR - TC
 Profit = (TR/Q - TC/Q)  Q
 Profit = (P - ATC)  Q
 The monopolist will receive economic profits as
long as price is greater than average total cost.
Profit Maximization
 Profit Maximization
Costs and
Revenue

Marginal cost

E B

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue
 Algebra of Profit Maximization: A Numerical
Illustration
 What’s the MR if a firm faces a linear demand curve for its
product?
 P(Q) = a + bQ
 MR = a + 2bQ
 Given estimates of
 P = 10 - Q
 C(Q) = 6 + 2Q
 Optimal output?
 MR = 10 - 2Q
 MC = 2
 10 - 2Q = 2
 Q = 4 units
 Optimal price?
 P = 10 - (4) = $6
 Maximum profits?
 PQ - C(Q) = (6)(4) - (6 + 8) = $10

Exercise: Demand function: Q= 100 – 0.2P

Cost Function: TC = 50 + 20Q + Q2
Find Profit maximizing output and price, also calculate profit
 The Deadweight Loss

 Because a monopoly sets its price above

marginal cost, it places a wedge between
the consumer’s willingness to pay and
the producer’s cost.
 This wedge causes the quantity sold to fall
short of the social optimum.
 The Deadweight Loss
Price
Deadweight Marginal cost
loss

Marginal
revenue Demand
 The Deadweight Loss

 The Inefficiency of Monopoly

 The monopolist produces less than the socially
efficient quantity of output
 The deadweight loss caused by a
monopoly is similar to the deadweight
loss caused by a tax.
 The difference between the two cases is
that the government gets the revenue
from a tax, whereas a private firm gets
the monopoly profit.
 Arguments for Monopoly

 The beneficial effects of economies

of scale, economies of scope, and
cost complementarities on price and
output may outweigh the negative
effects of market power
 Encourages innovation
 PRICE DISCRIMINATION

 Price discrimination is the business practice

of selling the same good at different prices
to different customers, even though the
costs for producing for the two customers
are the same.
 A firm has an opportunity for price
discrimination if three conditions are met:
1. Market power
2. Different consumer groups
3. Resale is not possible.
 PRICE DISCRIMINATION
 Price discrimination is not possible when a good is
sold in a competitive market since there are many
firms all selling at the market price. In order to price
discriminate, the firm must have some market power.
 Perfect Price Discrimination
 Perfect price discrimination refers to the situation
when the monopolist knows exactly the willingness
to pay of each customer and can charge each
customer a different price.
 PRICE DISCRIMINATION
 Here are some examples of price discrimination with
discounts for certain groups of consumers:
 Discounts on airline tickets.
 Discount coupons for groceries and restaurant
food.
 Manufacturers’ rebates for appliances.
 Senor-citizen discounts on airline tickets,
restaurant food, drugs, and entertainment.
 Student discounts on movies and concerts.
 Two important effects of price discrimination:
 It can increase the monopolist’s profits.
 It can reduce deadweight loss.
 Welfare with and without Price
Discrimination

(a) Monopolist with Single Price

Price

Consumer
surplus

Monopoly Deadweight
price loss
Profit
Marginal cost

Marginal Demand
revenue

0 Quantity sold Quantity

 Welfare with and without Price
Discrimination

(b) Monopolist with Perfect Price Discrimination

Price

Profit
Marginal cost

Demand

0 Quantity sold Quantity