Chapter 11: Monopoly

Monopoly market
 single seller for a product with no
close substitutes
 barriers to entry
Barriers to entry
 economies of scale
 actions by firms
 actions by government
 Economies of scale –
natural monopolies

 Natural
monopolie
s are often
regulated
monopolie
s
Actions by firms to create
and protect monopoly
power
 patents and copyrights,
 high advertising expenditures
result in high sunk costs (costs
that are not recoverable on exit),
and
 illegal actions designed to restrict
competition
Monopolies created by
government action
 patents and copyrights,
 government created franchises,
and
 licensing.
Local monopoly
 Local monopoly – a monopoly that
exists in a local geographical area
(e.g., local newspapers)
Price elasticity and MR
 As noted earlier, since the demand
curve facing a monopoly firms is
downward sloping, MR < P
 MR > 0 when demand is elastic
 MR = 0 when demand is unit
elastic
 MR < 0 when demand is inelastic
Average revenue
 As in all other market structures,
AR=P (note that AR = TR/Q =
(PxQ) / Q = P)
 The price given by the demand
curve is the average revenue that
the firm receives at each level of
output.
Monopolist receiving
positive profits
Zero-profit monopolist
Monopolist receiving
economic loss
Monopolist that shuts
down in the short run
Monopoly price setting
 There is a unique profit-maximizing
price and output level for a monopoly
firm.
 It is optimal to produce at the level of
output at which MR = MC and to charge
the price given by the demand curve at
this output level.
 Charging a higher (or lower) price
results in lower profits.
Price discrimination
 In imperfectly competitive markets, firms
may increase their profits by engaging in
price discrimination (charging higher
prices to those customers with the most
inelastic demand for the product).
 Necessary conditions for price
discrimination:
 the firm must not be a price-taker
 firms must be able to sort customers by their
elasticity of demand
 resale must not be feasible
Example: air travel
Dumping
 If firms practice price discrimination by
charging different prices in different
countries, they are often accused of
dumping in the low-price country.
 Predatory dumping occurs if a country
charges a low price initially in an attempt
to drive out domestic competitors and then
raises prices once the domestic industry is
destroyed.
 There is little evidence of the existence of
predatory dumping.
Today’s slides, 11/6
 Based on Dr. Kane’s, with added
detail
 Available today at
 www.oswego.edu/~edunne
 I will ask Dr. Kane to post them on
his site next week.
Deadweight loss due to
monopoly
Deadweight loss due to
monopoly
 competition

P, MR consumer
S=MC
surplus

Pc

producer Q
Qc
surplus
 monopoly

P, MR consumer
surplus S=MC

Pm deadweight
loss

D
Transfer from MR
Consumer
to producer Q
Qm
Is monopoly efficient?
 No
 output too low
 deadweight loss
 Society loses the benefit of that extra
output
 Monopoly leads to market failure
Other costs associated
with monopoly
 X-inefficiency
 Without competition, no incentive to
produce efficiently or at least cost
 Example: Microsoft

What is the incentive to fix software
bugs?
Other costs associated
with monopoly
 Rent-seeking behavior
 incur costs to acquire, maintain
monopoly power.

Lawyers, lobbyists, etc.
 This does not benefit society and
diverts resources away from
productive activities.
Why allow monopolies?
 Two potential benefits:
 Encourage innovation

Patents encourage the development of
new drugs

Copyright encourages the development
of new software
 Economies of scale

One producer meets the market demand
at the lowest average cost

Natural monopoly
 Regulation of natural
monopoly
Pm, Qm is
P, MR
Monopoly
outcome Pmc, Qmc is the
Efficient outcome

Pm
Pf, Qf is the
Pf MC “fair” rate of
Pmc ATC return
D
MR
Q
Qm Qf Qmc
Regulation of natural
monopoly
 monopoly
outcome:
P(m), Q(m)
 marginal-cost
pricing:
P(mc), Q(mc)
 “fair-rate of
return”
pricing
system: P(f),
Q(f)
summary: monopoly

 unique good, barriers to entry