Intermediate

Microeconomics

Instructor ： Yang, Wan-Ru

高雄大學金融管理學系
 Chapter 11

Monopoly and Monopsony

David Besanko and Ronald Braeutigam

Sixth edition
WILEY

高雄大學金融管理學系 2
Chapter Eleven Overview
1. Profit Maximization by a Monopolist
2. The Importance of Price Elasticity of Demand
3. Comparative Statistics for Monopolists
4. Monopoly with Multiple Plants and Markets

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5. The Welfare Economics of Monopoly

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A Monopoly
• A monopoly market consists of a single seller facing many
buyers
• The monopolist's profit maximization problem:
– Max (Q) = TR(Q) - TC(Q)
– where: TR(Q) = QP(Q) and P(Q) is the (inverse) market demand

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curve
• The monopolist's profit maximization condition:
– TR(Q)/Q = TC(Q)/Q
– MR(Q) = MC(Q)
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The Monopolist’s Demand Curve Is the Market
Demand Curve
• Along the demand curve,
different revenues for different
quantities.
• Profit maximization problem is
the optimal trade-off between
volume (number of units sold)

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and margin (the differential
between price).

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A Monopoly – Profit Maximizing
• Table 11.1 Demand curve: P(Q) = 12 – Q
• Total revenue: TR(Q) = Q x P(Q) = 12Q – Q2
• Total cost (given):
• Profit-maximization: MR = MC

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A Monopoly – Profit Maximizing
• As Q increases TC increases,
TR increases first and then
decreases.
• Profit maximization is at
MR = MC.

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Marginal Revenue
• Competitive firm : P= MR
• Monopolist: PMR, the MR
curve lies below the demand
curve.

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The Change in Total Revenue When the Monopolist
Increases Output
• To sell more units, a
monopolist has to lower the
price.
• Increase in profit is Area III
while revenue sacrificed at a
higher price is Area I.

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• Change in TR equals Area III
– Area I.

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The Change in Total Revenue When the Monopolist
Increases Output
• Area III = price x change in
quantity
– P(ΔQ)
• Area I = - quantity x change in
price

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– -Q (ΔP)
• Change in monopolist
revenue: = P(ΔQ) + Q (ΔP)

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Marginal Revenue
• Marginal revenue has two parts:
1. P: increase in revenue due to higher volume-the marginal
units.
2. Q(ΔP/ΔQ): decrease in revenue due to reduced price of the
inframarginal units. (This part is negative.)

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• The marginal revenue is less than the price the
monopolist can charge to sell that quantity for any Q>0.
, MR < P
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Average Revenue
• Since
• The price a monopolist can charge to sell quantity Q is
determined by the market demand curve. ( 獨佔廠商仍需考慮市場需
求再決定價格 ). The monopolists’ average revenue curve is the
market demand curve.

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• , .

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Marginal Revenue and Average Revenue

• MR
• Conclusions if Q > 0:

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– MR < P
– MR < AR
• MR lies below the demand
curve.
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Marginal Revenue and Average Revenue
• Exercise 11.1: Given the demand curve, what are the
average and marginal revenue curves?

• and

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• Vertical intercept is a
• Horizontal intercept is
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Profit Maximization
• Exercise 11.1 (continued): Given the inverse demand and
MC, what is the profit maximizing Q and P for the
monopolist?
• and
• Here,

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The Monopolist’s Profit-Maximization Condition
• Profit Maximizing output is at
MR=MC.
• Monopolist will make 4 million
ounces and sells at $8 per
ounce.
• TR = Areas B + E + F

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• Profit (TR-TC) is B + E
• Consumer surplus is area A.

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Shutdown Condition
• In the short run, the monopolist shuts down if the most
profitable price does not cover AVC.
• In the long run, the monopolist shuts down if the most
profitable price does not cover AC.

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Positive Profits for Monopolist
• Monopoly profits are positive.
– Why?
• Because the monopolist takes into account the price-reducing
effect of increased output so that the monopolist has less
incentive to increase output than the perfect competitor.

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• Profit can remain positive in the long run.
– Why?
• Because we are assuming that there is no possible entry in this
industry, so profits are not competed away.
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Equilibrium
• A monopolist does not have a supply curve because price
is endogenously-determined by demand: the monopolist
picks a preferred point on the demand curve.
– An optimal output for any exogenously-given price
• One could also think of the monopolist choosing output to

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maximize profits subject to the constraint that price be
determined by the demand curve.

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How Price Elasticity of Demand Affects Monopoly
Pricing
• Market A profit maximizing
price is PA.
• Market B profit maximizing
price is PB.
• Demand is less elastic in

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Market B.

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Inverse Elasticity Pricing Rule
• We can rewrite the MR curve • When demand is elastic
MR = P + Q(P/Q) ( < -1), MR > 0

= P(1 + (Q/P)(P/Q)) • When demand is inelastic

( > -1), MR < 0
= P(1 + 1/)
• When demand is unit elastic
– where:  is the price elasticity of
( = -1), MR= 0

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demand, (P/Q)(Q/P)

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Inverse Elasticity Pricing Rule
Suppose that MC(y)=k, constant.
For a profit-maximum,
if ε= -3, p(y*) = 3k/2 ； if ε= -2, p(y*) = 2k
so as ε rises towards -1 the monopolist alter its output level
to make the market price to rise.

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Since that is, 1/ ε > -1 → ε < -1.
So a profit-maximizing monopolist always selects an output
level for which the market demand is own-price elastic.
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Marginal Revenue and Price Elasticity of Demand for
a Linear Demand Curve
• Where demand is elastic,
marginal revenue is positive.
• Where demand is unitary
elastic, marginal revenue is
zero.
– MR crosses the horizontal axis.

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• Where demand is inelastic,
marginal revenue is negative.

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Marginal Cost and Price Elasticity Demand
• Profit maximizing condition is MR = MC with P* and Q*.

• Rearranging and setting MR(Q*) = MC(Q*)

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• Monopolist’s optimal markup of price above marginal cost
expressed as a percentage of price is equal to minus the
inverse of the price elasticity of demand.
– Inverse elasticity pricing rule
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Marginal Cost and Price Elasticity Demand
• Markup Pricing : output price is the marginal cost of production plus a
“markup”.
1 k k
p(y)(1  ) k  p( y*)   is the monopolist ' s price.
 1 1 
1

k k
the markup is p( y*)  k   k 
1  1 

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Ex : if ε= -3 then the markup is k/2 and if ε= -2 then the markup is k. The
markup rises as the own-price elasticity of demand rises towards -1

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Why a Profit-Maximizing Monopolist Will Not Operate
on the Inelastic Region
• Monopolist operates at the
elastic region of the market
demand curve.
• Increasing price from PA to
PB, TR increases by Area I –
Area II and total cost goes

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down because monopolist is
producing less.

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Elasticity Region of the Demand Curve
• The monopolist will always operate on the elastic region of
the market demand curve.
• As demand becomes more elastic at each point, marginal
revenue approaches price.
•  , MRP, competitive market

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MR = P + Q(P/Q)
= P(1 + (Q/P)(P/Q))
= P(1 + 1/)
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Elasticity Region of the Demand Curve
• Suppose that QD = 100P-b and MC = c (constant)
• What is the monopolist's optimal price now?
– P(1+1/-b) = c
– P* = cb/(b-1)
• We need the assumption that b > 1 ("demand is everywhere

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elastic") to get an interior solution
• As b -> 1 (demand becomes everywhere less elastic), P* -> infinity
and P - MC, the "price-cost margin" also increases to infinity
• As b -> , the monopoly price approaches marginal cost
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Market Power
• An agent has Market Power if s/he can affect, through
his/her own actions, the price that prevails in the market.
• Sometimes this is thought of as the degree to which a firm
can raise price above marginal cost.

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The Lerner Index of Market Power
• The Lerner Index of market • Restating the monopolist's
power is the price-cost margin, profit maximization condition,
(P*-MC)/P*. we have:
• This index ranges between 0 – P*(1 + 1/) = MC(Q*)…or…
(for the competitive firm) and – [P* - MC(Q*)]/P* = -1/
1, for a monopolist facing a • In words, the monopolist's

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unit elastic demand. ability to price above marginal
cost depends on the elasticity
of demand.

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The Lerner Index of Market Power
• Exercise 11.3
• Exercise 11.4
• Application 11.2

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Multi-Plant Monopoly
• Recall:
– In the perfectly competitive model, we could derive firm outputs
that varied depending on the cost characteristics of the firms.
– The analogous problem here is to derive how a monopolist would
allocate production across the plants under its management.

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• Assume:
– The monopolist has two plants: one plant has marginal cost
MC1(Q) and the other has marginal cost MC2(Q).

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Multi-Plant Monopoly – Production Allocation
• Whenever the marginal costs of the two plants are not equal, the
firm can increase profits by reallocating production towards the
lower marginal cost plant and away from the higher marginal cost
plant.
• Suppose the monopolist wishes to produce 6 units.
• 3 units per plant with

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• MC1 = $6
• MC2 = $3

• Reducing plant 1's units and increasing plant 2's units raises profits.

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Profit Maximization by a Multiplant Monopolist
• The monopolist’s multiplant marginal
cost curve MCT is the horizontal sum
of the individual plant’s marginal cost
curves MC1 and MC2.
• The monopolist’s optimal total output
of 3.75 million units (F) per year
occurs at MR=MCT

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• Plant 1 produces 1.25 million units
(F) of the total output.
• Plant 2 produces 2.5 million units (I).
• Exercise 11.6

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Cartel
• A cartel is a group of firms that collusively determine the price and output in a market.
• In other words, a cartel acts as a single monopoly firm that maximizes total industry
profit.
• The problem of optimally allocating output across cartel members is identical to the
monopolist's problem of allocating output across individual plants.
• Therefore, a cartel does not necessarily divide up market shares equally among
members.

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– Higher marginal cost firms produce less.
– MR(Q*)=MC1(Q1*), MR(Q*)=MC2(Q2*),
• Figure 11.5 (Figure 11.4)
• Application 11.6

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The Welfare Economies of Monopoly
• Since the monopoly equilibrium
output does not, in general,
correspond to the perfectly
competitive equilibrium it entails
a dead-weight loss.
• Suppose that we compare a

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monopolist to a competitive
market, where the supply curve
of the competitors is equal to the
marginal cost curve of the
monopolist.
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Natural Monopolies
• A market is a natural monopoly if the total
cost incurred by a single firm producing
output is less than the combined total cost
of two or more firms producing this same
level of output among them.
• A single firm’s total cost:
9000*AC(9000)=9000
• Two firms’ total cost:

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4500*AC(4500)*2=10800
• Benchmark: Produce where
P = AC

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Barriers to Entry
• Factors that allow an incumbent firm to earn positive economic profits
while making it unprofitable for newcomers to enter the industry.
1. Structural barriers to entry – occur when incumbent firms have cost or
demand advantages that would make it unattractive for a new firm to
enter the industry. Ex: eBay auction site v.s. Yahoo and Amazon
2. Legal barriers to entry – exist when an incumbent firm is legally

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protected against competition.
3. Strategic barriers to entry – result when an incumbent firm takes
explicit steps to deter entry. Ex: start a price war

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Homework
• Problem 11.2, 11.7, 11.8, 11.9, 11.11, 11.17, 11.19, 11.22

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