ECO104- Introduction to Economics

Lecture-10
 Monopoly
⬥ A monopoly is a market with a single
firm that produces a good or service for
which no close substitute exists and in
which there is one supplier that is
protected from competition by a barrier
preventing the entry of new firms.
 Two main features of Monopoly
⬥ No close substitutes

⬥ High barriers of entry- 3 types of barriers:


1. Natural barriers to entry- when economies of scale
allows a firm ( a natural monopoly) to supply the market at
the lowest possible cost

2. Ownership barriers to entry- when a firm owns a
significant portion of a resource

3. Legal barriers to entry - when a firm is granted a
monopoly franchise, a government license, a patent or a
copyright which restricts entry and competition in a market
 Examples of Monopoly
⬥ Examples of monopolies include:
▪ Airbus/Boeing- aircraft manufacturer
▪ Electric Supplier
▪ Microsoft (?)
▪ Google(?)
▪ Facebook (?)
▪ eBay (?)
Examples of “Monopoly”
 Monopolies are Regulated
⬥ Most monopolies are regulated in some
way by one or more government agencies.
⬥ In the case of unregulated monopolies, the
government must either break up the
monopoly or make some other change to
promote competition and economic
efficiency.
⬥ First, we study the operation of
unregulated monopoly and how it differs
from the operation of competitive markets.
⬥ Then we discuss pricing strategies for
regulated monopolies.
 Monopoly Price-

Setting Strategies
⬥ Major difference between Monopoly and Perfect
Competition is- 

Perfect Competition are Price takers

Monopoly are Price setters



There are 2 pricing strategies adopted by Monopolies:
⬥ Price discrimination is the practice of selling different
units of a good or service for different prices. (e.g.
Microsoft selling softwares to different groups)
⬥ Single-price monopoly is a firm that must sell each
unit of its output for the same price. (e.g. DeBeers)
 Single-Price Monopoly
⬥Because there is only one firm, the
firm’s demand curve is the market
demand curve.
⬥ Marginal revenue is not the same as the
market price, because price is lowered to
increase sales. And two opposing forces
affect total revenue. Lower prices
decreases total revenue but increased
quantity sales raises total revenue
 Demand and Marginal Revenue

Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue ( MR = ΔTR / ΔQ)
(dollars per (haircuts (TR=P× Q) (dollars per
haircut) per hour) (dollars additional haircut)

a 20 0 0 -
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
 Demand and Marginal Revenue

Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue ( MR = ΔTR / ΔQ)
(dollars per (haircuts (TR=P× Q) (dollars per
haircut) per hour) (dollars additional haircut)

a 20 0 0 -
b 18 1 18 18
c 16 2 32 14
d 14 3 42 10
e 12 4 48 6
f 10 5 50 2
Demand and Marginal Revenue
Price & marginal revenue
(dollars per haircut)

MR D

Quantity (haircuts per hour)

Demand and Marginal Revenue
Price & marginal revenue
(dollars per haircut)
20 Total revenue loss $4
c
16 d
14 Total revenue gain $14

10 Marginal revenue $10

Price falls from

$16 to $14
Quantity rises from
MR D 2 to 3

2 3
Quantity (haircuts per hour)
MR and Elasticity
⬥ Remember!

If demand is ELASTIC then 1% fall in

Price brings a A MORE then 1% rise in

Demand

⬥ A Monopoly will NEVER produce an output


in the Inelastic range of its demand curve. 

Because a Monopoly will always target

to produce a smaller Q and charge a higher

Price and raise its Economic Profit

⬥ Therefore, Demand is always Elastic in a 


Monopoly
 A Monopoly’s Output 

and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue ( MR = ΔTR / ΔQ) cost ( MC = ΔTC / ΔQ) Profit
(dollars (Q) (TR = P × Q) (dollars per (TC)(dollars per (TR – TC)
per haircut)(haircuts/hour) (dollars) add. haircut) (dollars)add. haircut) (dollars)

20 0 0 -
18 1 18 18
16 2 32 14
14 3 42 10
12 4 48 6
10 5 50 2
 A Monopoly’s Output 

and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue ( MR = ΔTR / ΔQ) cost ( MC = ΔTC / ΔQ) Profit
(dollars (Q) (TR = P × Q) (dollars per (TC)(dollars per (TR – TC)
per haircut)(haircuts/hour) (dollars) add. haircut) (dollars)add. haircut) (dollars)

20 0 0 - 20
18 1 18 18 21
16 2 32 14 24
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
 A Monopoly’s Output 

and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue ( MR = ΔTR / ΔQ) cost ( MC = ΔTC / ΔQ) Profit
(dollars (Q) (TR = P × Q) (dollars per (TC)(dollars per (TR – TC)
per haircut)(haircuts/hour) (dollars) add. haircut) (dollars)add. haircut) (dollars)

20 0 0 - 20 -
18 1 18 18 21
16 2 32 14 24
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
 A Monopoly’s Output 

and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue ( MR = ΔTR / ΔQ) cost ( MC = ΔTC / ΔQ) Profit
(dollars (Q) (TR = P × Q) (dollars per (TC)(dollars per (TR – TC)
per haircut)(haircuts/hour) (dollars) add. haircut) (dollars)add. haircut) (dollars)

20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6 +12
12 4 48 6 40 10 +8
10 5 50 2 55 15 -5
A Monopoly’s Output and Price
Price and cost (dollars per hour)

20

14

10
D = AR = P

0 1 2 3 4 5
Quantity (haircuts per hour)
A Monopoly’s Output and Price
Price and cost (dollars per hour)

20

14

10
D = AR = P

MR
0 1 2 3 4 5
Quantity (haircuts per hour)
 Monopoly’s Profit-Maximising
Price and cost (dollars per hour)
output is again MC=MR
MC
20

14

10
D = AR = P

MR
0 1 2 3 4 5
Quantity (haircuts per hour)
 Monopoly’s Profit-Maximising output is again MC=MR

A Monopoly produces a profit-maximising quantity (MC=MR) but sells

that quantity for the highest price it can get.
Price and cost (dollars per hour)
MC
20

14
ATC

D = AR = P

MR
0 1 2 3 4 5
Quantity (haircuts per hour)
 Comparing Monopoly

and Competition
⬥ How do the quantities produced,
prices, and profits of a monopoly
compare with those of a perfectly
competitive industry?
⬥ Consider a hypothetical example of a
perfectly competitive industry which
suddenly becomes a monopoly.
 Price and Output
⬥ A perfectly competitive industry will
produce the quantity of output and
charge the price at the equilibrium point
where the industry MC curve intersects
the demand curve.
⬥ But a monopoly will produce the quantity
of output dictated by the intersection of
the MR and MC curves but charging a
price set by the demand curve.
 Monopoly
Vs

Price Perfect Competition
PA Single-price
monopoly
restricts output,
raises price (MR=MC)
S,MC
PM
Equilibrium
PC in competitive
industry (P=MC)

MR D=AR=P

0 QM QC Quantity
 The comparison
So at last we can say:


Compared to a perfectly competitive
market, a Monopoly produces a 

Smaller Output

&

Charges Higher Price
Essential Readings for Today!

Economics. Parkin, Powell, Matthews

8th Edition.

Chapter 12- pages 276-283

 Efficiency Comparison
⬥ From the last chapter we have 

learned that PC is efficient. In PC

MSB equals MSC and so the total

surplus is maximum

⬥ But in Monopoly there is Inefficiency


Because it produces smaller quantity

and charges a higher Price than a PC

⬥ This causes a constraint in the MSB


and MSC and creates dead-weight loss
 Monopoly Regulation
⬥ Regulation- Rules made a by the government
to influence prices, quantities, entry etc
⬥ Why regulation? Because

To protect social interest and reduce dead-
weight loss
Efficient Regulation of a Monopoly-
Marginal Cost Pricing Rule
⬥ As we know, a Monopolist produces inefficient (less)
quantity. The government can solve this problem by
regulating the Price equal to MC- known as the
Marginal Cost Pricing Rule— here MSB=MSC
⬥ However, there is a problem here for the Monopoly. As
in Monopoly, Average Total Cost is greater than MC
and hence if P=MC, then Monopoly will incur loss and
will eventually go out of business.
⬥ In such a case, government has to

subsidise the Monopolist
 Monopoly Regulation- Average
Cost Pricing Rule
⬥ This Rule sets the Price

equal to average

total cost. 


⬥ And So the Monopolist 


will now make Zero 

Economic Profit, 

as P=ATC or P=LRAC
⬥ However, it creates 

dead-weight loss in 

comparison to Marginal

cost pricing Rule
 So which one’s better….

Marginal Cost Pricing Rule

Or

Average Cost Pricing Rule

 Average Cost Pricing (ACP) is a
Challenge!

⬥ To implement the ACP Regulation, the government

first needs to know the true costs of the firm. So
regulators use the following practices :



1) Rate of Return regulation: A firm must justify its
price by showing that its return on capital does not
exceed a specific target. 

However, this type of regulation ends up supporting
self-interest (of Monopoly) than the social interest (of
community), since Managers of Monopoly now have
incentive to inflate costs or simply record higher
costs
ACP Regulation- Price Cap Regulation

⬥ Price Cap regulation is


simply a Price ceiling— a 

rule that specifies that firms

cannot exceed a set price
⬥ If a price cap is set at 15tk

then the Monopoly will only

sell 3MW of electricity at 

15tk per MW.
⬥ Interestingly this regulation

is sometimes combined with

Earning Share Regulation— where

a Monopolist requires to refund back

their customers when profit too high
Essential Readings For Today!
Economics. Parkin, Powell, Matthews
8th Edition.

Chapter 12- pages 289-291