Monopoly

Chapter 15
 Monopoly

While a competitive firm is a

price taker, a monopoly firm is
a price maker.
 Monopoly

 A firm is considered a monopoly if . . .

it is the sole seller of its product.
its product does not have close
substitutes.
 Why Monopolies Arise

The fundamental cause of

monopoly is barriers to entry.
 Why Monopolies Arise
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.
 Government-Created Monopolies

Governments may restrict entry by giving a

single firm the exclusive right to sell a
particular good in certain markets.
Government-Created Monopolies

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.
 Natural Monopolies

A natural monopoly arises when there

are economies of scale over the relevant
range of output.
 Economies of Scale as a Cause of
Monopoly...
Cost

Average
total
cost

0 Quantity of Output
 The Four Types of Market Structure
Number of Firms?

Many
firms
One Type of Products?
firm Few
firms Differentiated Identical
products products

Monopoly Oligopoly Monopolistic Perfect

Competition Competition

• Tap water • Tennis balls • Novels • Wheat

• Cable TV • Crude oil • Movies • Milk
 Monopoly versus Competition

Monopoly
 Is the sole producer
 Has a downward-sloping demand curve
 Is a price maker
 Reduces price to increase sales
 Competition versus Monopoly

Competitive Firm
 Is one of many producers
 Has a horizontal demand curve
 Is a price taker
 Sells as much or as little at same price
 Demand Curves for Competitive and
Monopoly Firms...

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

Demand Curve Demand Curve
Price Price

Demand

Demand

0 Quantity of 0 Quantity of
Output Output
 A Monopoly’s Revenue

 Total Revenue
P x Q = TR
 Average Revenue
TR/Q = AR = P
 Marginal Revenue
TR/Q = MR
 A Monopoly’s Total, Average, and
Marginal Revenue

Average
Quantity Price Total Revenue Revenue Marginal Revenue
(Q) (P) (TR=PxQ) (AR=TR/Q) (MR=TR / Q )
0 $11.00 $0.00
1 $10.00 $10.00 $10.00 $10.00
2 $9.00 $18.00 $9.00 $8.00
3 $8.00 $24.00 $8.00 $6.00
4 $7.00 $28.00 $7.00 $4.00
5 $6.00 $30.00 $6.00 $2.00
6 $5.00 $30.00 $5.00 $0.00
7 $4.00 $28.00 $4.00 -$2.00
8 $3.00 $24.00 $3.00 -$4.00
 A Monopoly’s Marginal Revenue

A monopolist’s marginal revenue 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 Marginal Revenue

When a monopoly increases the

amount it sells, it has two effects on
total revenue (P x Q).
 The output effect—more output is
sold, so Q is higher.
 The price effect—price falls, so P is
lower.
Demand and Marginal Revenue Curves
for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
Profit Maximization of a Monopoly

 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 for a Monopoly...
2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
 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
 A Monopoly’s Profit

Profit equals total revenue minus total costs.

Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
 The Monopolist’s Profit...
Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro

Average total cost

on f
op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 The Monopolist’s Loss...
Costs and
Revenue Marginal cost Average total cost

Average D
Total cost
Monopoly B
price E

Demand

Marginal revenue

0 QMAX Quantity
 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 Inefficiency of Monopoly...
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
The Inefficiency of Monopoly

The monopolist produces less

than the socially efficient
quantity of output.
 The Deadweight Loss

 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.
Public Policy Toward Monopolies

Government responds to the problem of

monopoly in one of four ways.
 Making monopolized industries more
competitive.
 Regulating the behavior of monopolies.
 Turning some private monopolies into public
enterprises.
 Doing nothing at all.
 Price Discrimination

Price discrimination is the 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.
 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.
Examples of Price Discrimination

 Movie tickets
 Airline prices
 Discount coupons
 Financial aid
 Quantity discounts
 Summary

 A monopoly is a firm that is the sole

seller in its market.
 It faces a downward-sloping demand
curve for its product.
 A monopoly’s marginal revenue is
always below the price of its good.
 Summary

 Like a competitive firm, a monopoly

maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.
 Unlike a competitive firm, its price
exceeds its marginal revenue, so its
price exceeds marginal cost.
 Summary

 A monopolist’s profit-maximizing level

of output is below the level that
maximizes the sum of consumer and
producer surplus.
 A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.
 Summary

 Policymakers can respond to the

inefficiencies of monopoly behavior with
antitrust laws, regulation of prices, or by
turning the monopoly into a
government-run enterprise.
 If the market failure is deemed small,
policymakers may decide to do nothing
at all.
 Summary

 Monopolists can raise their profits by

charging different prices to different
buyers based on their willingness to
pay.
 Price discrimination can raise
economic welfare and lessen
deadweight losses.
Graphical
Review
 Economies of Scale as a Cause of
Monopoly...
Cost

Average
total
cost

0 Quantity of Output
 Demand Curves for Competitive and
Monopoly Firms...
(a) A Competitive Firm’s (b) A Monopolist’s
Demand Curve Demand Curve
Price Price

Demand

Demand

0 Quantity of 0 Quantity of
Output Output
Demand and Marginal Revenue Curves
for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
 Profit-Maximization for a Monopoly...
2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
 The Monopolist’s Profit...
Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro

Average total cost

on f
op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 The Inefficiency of Monopoly...
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity