C h a p t e r

12 MONOPOLY

Key Concepts ♦ when demand is unit elastic, MR is zero and total

revenue is at its maximum.
♦ when demand is inelastic, MR is negative and total
Market Power revenue falls with output.
Monopolies have market power, the ability to affect A monopoly’s cost curves are similar to those of a com-
the market price by changing the total quantity offered petitive firm. A profit-maximizing monopoly produces
for sale. A monopoly is a firm that produces a good or the output at which MR = MC. (This rule is the same
service for which no close substitute exists and which is used by a competitive firm.) The monopoly uses the
protected by a barrier that prevents other firms from demand curve to determine the maximum price that
selling that good or service. Barriers to entry include: consumers are willing to pay for this quantity of out-
♦ Control over a key resource. put. Figure 12.1 shows a profit maximizing level of
output, 2, and price, $3.
♦ Legal barriers to entry (public franchise, govern-
ment license, or patent) create legal monopolies.
♦ Natural barriers to entry can lead to natural mo-
nopoly, which occurs when economies of scale
(which create a downward sloping LRAC curve) are
so large that one firm can supply the entire market
at lower price than two or more firms.
Monopolists can sell a larger quantity only by charging
a lower price. Monopolies can price discriminate or
charge a single price.
♦ Price-discrimination —selling different units of a
good for different prices, so some customers pay a
lower price than others for the good, or an individ-
ual consumer pays a lower price for larger pur-
chases.
♦ Single-price monopoly — charges the same price
to all its customers for every unit of output.

Single-Price Monopoly’s Output and Price

Decision ♦ As Figure 12.1 demonstrates, P exceeds MC for a
♦ The monopoly firm’s demand curve is the market monopoly.
demand curve. ♦ Because P > ATC, the single-price monopoly in
♦ At each level of output, marginal revenue for a mo- Figure 12.1 earns an economic profit equal to the
nopoly is less than its price (MR < P). area of the shaded rectangle.
In moving down the monopoly’s demand curve: ♦ Barriers to entry prevent new companies from en-
♦ when demand is elastic, MR is positive and total tering the market, so a monopoly’s economic profit
revenue rises with output. can last indefinitely.

203
204 CHAPTER 12

Single-Price Monopoly and Competition Price Discrimination

Compared Price discrimination occurs when a firm charges differ-
Compared to a perfectly competitive industry, a single- ent prices for a good. Price discrimination transfers
price monopoly with the same costs: consumer surplus — the value a consumer receives
♦ charges a higher price. from a good minus the price paid — away from buyers
and to the firm, thereby increasing the monopoly’s
♦ produces less output.
profit. Price discrimination can occur among units of a
good, so that larger orders get a discount, or among
groups of buyers, so that some buyers pay a lower price.
Price discrimination among groups requires that:
♦ groups of consumers with different average willing-
ness to pay exist;
♦ the members of each group are easily identified;
♦ and, no resales of the good are made from one
group to another.
With price discrimination, the group with the high
average willingness to pay pays a high price and the
group with the low average willingness to pay pays a
low price.
♦ Perfect price discrimination occurs if a firm is able
to sell each unit of output for the highest price any-
one is willing to pay for it. Perfect price discrimina-
tion extracts all the consumer surplus.
The more perfectly a monopoly can price discriminate,
the closer its output is to the competitive level. A per-
Figure 12.2 illustrates these results. If the industry is fectly price-discriminating monopoly eliminates all the
perfectly competitive, 7,000 units are produced and the consumer surplus, but does not result in a deadweight
price is $40. (The price and quantity are determined by loss, so it is efficient.
where the demand and supply curves cross.) In com-
parison, as a single-price monopoly with the same
Monopoly Policy Issues
costs, 6,000 units are produced and the price is $50.
With no external costs and benefits, perfect competi- A monopoly might have some advantages for society:
tion is efficient. By restricting its output to be less than ♦ It might increase the incentive to innovate, but the
that of a competitive industry, a single-price monopoly empirical evidence on this possible gain is mixed.
creates a deadweight loss. The deadweight loss is com- ♦ It might be able to capture economies of scale, when
prised of lost consumer surplus and producer surplus. an increase in output lowers average total cost, or
Figure 12.2 illustrates the deadweight loss from a sin- economies of scope, when an increase in the range of
gle-price monopoly. products produced lowers average total cost.
Rent seeking is any attempt to capture consumer sur- When economies of scale are large enough, a natural
plus, producer surplus, or economic profit. Rent seek- monopoly results. Natural monopolies, illustrated in
ers try to buy or can create a monopoly. Figure 12.3 (on the next page) are usually regulated by
Resources used in rent seeking are a cost to society. In the government.
equilibrium, rent seeking continues until the economic ♦ Left unregulated, the firm in Figure 12.3 maxi-
profit from the monopoly is eliminated. mizes its profit by charging Pm and producing
Qm .
MONOPOLY 205

2. UNDERSTANDING MARGINAL REVENUE FOR A

MONOPOLY : In a monopoly, there is only one
firm, so the downward sloping market demand
curve is also the firm’s demand curve. If a single-
price monopoly wants to sell one more unit of out-
put, it must lower its price. Selling another unit
thus has two effects on revenue:
♦ First, the sale of an additional unit raises reve-
nue by the amount of the (new, lower) price. If
this effect was the sole effect, the marginal reve-
nue would equal the price. (This effect is the
only one for a perfectly competitive firm, so for
these firms marginal revenue equals the price.)
♦ Second, because the firm also lowers the price
on all the units it had previously sold, revenue
from these units falls. (This effect is absent from
a perfectly competitive firm because it does not
need to lower its price in order to sell an addi-
tional unit of output.)
♦ A marginal cost pricing rule requires the firm to
By itself, the first effect yields marginal revenue
set its price equal to its marginal cost. In Figure
equal to the price, but the second effect subtracts
12.3, the firm charges Pmc and produces Q mc . The
from the first. Hence marginal revenue is less than
firm produces the efficient amount of output but the price. Therefore, for a monopoly, the marginal
incurs an economic loss. revenue curve lies below the demand curve.
♦ An average cost pricing rule requires the firm to 3. THE “MR = MC ” RULE TO MAXIMIZE PROFITS :
set its price equal to its average cost. In Figure To maximize its profit, a monopoly produces the
12.3, the firm charges Patc and produces Q atc . The level of output such that MC = MR. This rule is
firm produces inefficient amount of output but the same one followed by a perfectly competitive
earns a normal profit. firm. Any profit-maximizing firm will produce a
unit of output if MR > MC because the added
revenue from the unit, the marginal revenue, ex-
Helpful Hints ceeds the added cost, the marginal cost. As a result,
producing this unit adds to the firm’s total profit.
Similarly, any profit-maximizing firm will not pro-
1. WHY STUDY PERFECT COMPETITION AND MO-
duce a unit of output if MR < MC because produc-
NOPOLY ? The opposite extreme from perfect com-
ing the unit reduces the firm’s total profit. Hence
petition is monopoly. In perfect competition there
regardless of whether the firm is a monopoly or
are many firms that can decide only the quantity
perfectly competitive, it produces at the level of
they produce but not the price to be charged. In
output that sets MR = MC.
contrast, a monopoly is a single firm that sets both
its quantity and price. Understanding the differ-
ences between perfect competition and monopoly Questions
is valuable because these two industry structures are
the ends of the competition spectrum. If competi-
tion within an industry heats up, the industry True/False and Explain
moves closer to behaving like a perfectly competi-
tive industry; if competition dries up, the industry’s Market Power
output and price approach those of a monopoly. 11. Barriers to entry are essential to a monopoly.
12. Patents grant the patent owner a legal monopoly.
206 CHAPTER 12

13. A single-price monopoly charges each consumer Multiple Choice

the highest single price the consumer will pay.
Market Power
Single-Price Monopoly’s Output and Price 11. Suppose that one taxi company in your city is
Decisions granted a license by the city so that it is the only cab
14. A difference between a perfectly competitive firm company that may operate within the city limits.
and a monopoly is that the monopolist’s decisions Granting this license is an example of a
about how much to produce affect the good’s price. a. natural barrier to entry.
15. For a single-price monopoly, marginal revenue, b. case in which a single firm controls a resource
MR, equals price, P. necessary to produce the good.
c. price-discriminating monopoly.
16. To maximize their profits, both monopolies and d. legal barrier to entry.
perfectly competitive firms produce the level of
output that sets MR = MC. 12. Which of the following is a natural barrier to the
entry of new firms in an industry?
17. When a single-price monopoly is maximizing its
profit, P > MC. a. Licensing
b. Economies of scale
18. A monopoly can earn an economic profit indefi- c. Issuing a patent
nitely. d. Granting a public franchise
Single-Price Monopoly and Competition
13. In order to sell more output, a single-price monop-
Compared
oly must ____ its price and a price-discriminating
19. Monopolies decrease the deadweight loss from per- monopoly must ____ its price.
fectly competitive industries.
a. raise; raise
10. In moving from perfect competition to single-price b. raise; lower
monopoly, all the surplus lost by consumers is cap- c. lower; raise
tured by the monopoly. d. lower; lower
11. Rent seeking is a cost to society of monopoly.
Single-Price Monopoly’s Output and Price
Price Discrimination Decisions
12. Price discrimination is an attempt by a monopolist 14. Max’s Christmas tree lot has a monopoly on sales of
to capture the producer surplus. Christmas trees. To increase his sales from 100 trees
to 101 trees, he must drop the price of all his trees
13. If a monopoly can successfully price discriminate, it from $28 to $27. What is Max’s marginal revenue
can increase its profit. when he lowers his price and increases his sales from
14. Compared to a single-price monopoly, a price- 100 to 101 trees?
discriminating monopoly reduces the amount of a. $2,800
consumer surplus. b. $28
c. $27
15. Price discrimination works only for goods that can
d. –$73
be resold.
Monopoly Policy Issues 15. A monopolist finds that when it produces 20 units
16. There are no possible benefits to society from a of output, its demand is elastic. At this level of out-
monopoly. put,
a. its marginal revenue necessarily is positive.
17. A natural monopoly is a firm that controls a vital b. its marginal revenue necessarily is zero.
natural resource. c. its marginal revenue necessarily is negative.
18. A marginal cost pricing rule imposed on a natural d. none of the above is correct because the marginal
monopoly creates an efficient use of resources. revenue does not depend upon the elasticity of
demand.
MONOPOLY 207

16. A monopolist finds that the marginal revenue from

producing another unit of output exceeds the mar-
ginal cost of the unit. Then, to increase its profit,
the monopolist will
a. produce the unit.
b. not produce the unit, but not cut back its pro-
duction at all.
c. not produce the unit and cut back its production
by at least one unit.
d. do none of the above.

17. If a monopoly is producing a level of output such

that marginal cost exceeds marginal revenue, to in-
crease its profits the firm
a. should raise its price and decrease its output.
b. should lower its price and increase its output.
c. should lower its price and decrease its output.
d. none of the above because the firm is incurring
an economic loss and it cannot alter this fact.
11. In Figure 12.4, a profit-maximizing single-price
18. Which of the following is true for a single-price monopoly will produce
monopoly? a. Q1 .
a. Price always equals marginal cost, that is, b. Q2.
P = MC at all levels of output. c. Q 3.
b. For all levels of output, price equals marginal d. None of the above.
revenue, that is, P = MR.
c. In the short run, the monopoly might earn a 12. In Figure 12.4, a profit-maximizing single-price
normal profit or incur an economic loss. monopoly will set a price of
d. None of the above because all the statements are a. P1 .
false. b. P 2 .
19. A single-price monopolist will maximize its profits if c. P3 .
it produces the amount of output such that d. P4 .
a. price equals marginal cost, that is, P = MC. 13. In the short run a monopoly can
b. price equals marginal revenue, that is, P = MR. a. earn only an economic profit.
c. marginal revenue equals marginal cost, that is, b. earn only an economic profit or a normal profit.
MR = MC. c. earn only a normal profit.
d. price equals average total cost, that is, P = ATC. d. earn an economic profit, or a normal profit, or
incur an economic loss.
10. Because of an increase in labor costs, a monopoly
14. A monopoly might be able to earn an economic
finds that its MC and ATC have risen. Presuming
profit
that the monopoly does not shut down, it will ____
its price and ____ the quantity it produces. a. only in the short run.
b. only in the long run.
a. raise; increase
c. indefinitely, that is, in both the short run and
b. raise; decrease
the long run.
c. lower; increase
d. The premise of the question is wrong because a
d. lower; decrease
monopoly can never earn an economic profit.
208 CHAPTER 12

Single-Price Monopoly and Competition Compared 19. The economic profit in Figure 12.5 is the area
15. Compared to a perfectly competitive industry with a. abc.
the same cost, the amount of output produced by a b. bcde.
single-price monopoly is c. bcfg.
a. more than the competitive industry. d. beh.
b. the same as the competitive industry.
c. less than the competitive industry. 20. If a perfectly competitive industry becomes a single-
d. not comparable to the competitive industry. price monopoly and costs do not change, which of
the following allocations of costs and benefits is
16. Compared to a perfectly competitive industry, the correct?
price charged by a single-price monopoly with the a. The producer benefits; demanders and society
same costs is are harmed.
a. more than the competitive industry. b. The producer and society are harmed; deman-
b. the same as the competitive industry. ders benefit.
c. less than the competitive industry. c. The producer, demanders, and society are
d. not comparable to the competitive industry. harmed.
d. The producer is harmed but demanders and
Figure 12.5 illustrates a single-price monopoly. Use it for society benefit.
the next three questions
21. If a single-price monopoly is broken up so that it
becomes a perfectly competitive industry and costs
do not change, which of the following statements
describing the costs and benefits is correct?
a. The producer benefits; demanders and society
are harmed.
b. The producer and society are harmed; deman-
ders benefit.
c. The producer, demanders, and society benefit.
d. The producer is harmed; demanders and society
benefit.

22. Activity for the purpose of creating a monopoly is

a. not legal in the United States.
b. called rent seeking.
c. called price discrimination.
d. called legal monopoly.

Price Discrimination
23. In order to successfully price discriminate, a firm
17. The deadweight loss in Figure 12.5 is the area must be able to
a. abc. a. reduce its MC.
b. bcde. b. distinguish between customers who have differ-
c. bcfg. ent willingness to pay.
d. beh. c. encourage many resales of its good among its
customers.
18. The consumer surplus in Figure 12.5 is the area
d. exert a non-price control over the number of
a. abc. demanders who will buy its good.
b. bcde.
c. bcfg.
d. beh.
MONOPOLY 209

24. Price discrimination allows a monopoly to 29. A monopoly has economies of scope if
a. lower its marginal cost. a. average total cost declines as output decreases.
b. reduce its producer surplus. b. average total cost declines as output increases.
c. increase its total revenue. c. total profit declines as output increases.
d. charge all customers a higher price. d. average total cost declines as the number of dif-
ferent goods produced increases.
25. A monopoly that is able to perfectly price
discriminate 30. A natural monopoly
a. charges everyone the lowest price that they want a. is usually regulated by the government.
to pay for each unit purchased. b. earns an economic profit if it must use a mar-
b. produces less output than it would were it a sin- ginal cost pricing rule.
gle-price monopoly. c. has an average total cost curve that is positively
c. eliminates consumer surplus. sloped until it crosses the demand curve.
d. creates a larger deadweight loss than it would if it d. has a demand curve that is positively sloped.
were a single-price monopoly.
Short Answer
26. A monopoly movie theater discovers that the average
willingness to pay for watching movies is higher at 8 1. Why is marginal revenue less than price for a sin-
P.M. than at 5 P.M. As a result, if a monopoly movie
gle-price monopoly?
theater wants to price discriminate and earn a larger 2. In a small college town, Laura’s Bookstore has a
profit, it charges monopoly in selling textbooks. Laura’s fixed costs
a. a higher price at 8 P.M. are $100, and her total costs are shown in Table
b. the same price at 5 P.M. as at 8 P.M. 12.1.
c. a lower price at 8 P.M. a. Complete Table 12.1 by computing average to-
d. There is not enough information given to answer tal cost and marginal cost.
the question.
TABLE 12.1
27. Business travelers usually pay higher airline fares Short Answer Problem 2 (a)
than families on a vacation. So,
Quantity Total cost Average total Marginal
a. business travelers aren’t maximizing their utility. (books per hour) (dollars) cost (ATC ) cost (MC )
b. business travelers have a higher willingness to
9 247.00 27.44
pay than do vacation travelers. 9.00
c. the MC of serving vacation travelers is lower 10 256.00 ____
____
than that of serving business travelers. 11 267.00 ____
d. vacation travelers have a greater demand for air ____
12 280.00 ____
travel than do business travelers. ____
13 295.00 ____
Monopoly Policy Issues ____
14 312.00 ____
28. Which of the following situations might be a gain to ____
society from monopoly? 15 331.00 ____
____
a. Monopolies do not waste resources trying to
16 352.00 ____
innovate. ____
b. Monopolies might be able to capture economies 17 375.00 ____
____
of scale.
18 400.00 ____
c. Monopolies might be able to price discriminate, ____
thereby boosting consumer surplus. 19 427.00 ____
____
d. Monopolies might earn an economic profit in
20 456.00 ____
the long run. ____
21 487.00 ____
210 CHAPTER 12

b. Table 12.2 lists points on the demand curve

facing Laura’s Bookstore. Copy the marginal
costs from Table 12.1 and complete the table.
c. What is Laura’s profit-maximizing quantity of
output? At what price will she sell her books?
What is her total economic profit?
d. In Figure 12.6, plot the demand curve and the
MR, ATC, and MC curves corresponding to the
data in parts (a) and (b). Show the equilibrium
output and price. On your diagram, illustrate
the area that equals Laura’s economic profit.

TABLE 12.2
Short Answer Problem 2 (b)
Quantity
demanded Price Total Marginal Marginal
(books per (dollars revenue revenue cost
hour) per book) (dollars) (MR ) (MC )
9 57.00 513.00
47.00 9.00
10 56.00 ____ TABLE 12.3
____ ____ Short Answer Problem 3 (a)
11 55.00 ____
____ ____ Quantity
12 54.00 ____ demanded Price Total Marginal Marginal
____ ____
(books per (dollars revenue revenue cost
13 53.00 ____
____ ____ hour) per book) (dollars) (MR ) (MC )
14 52.00 ____ 9 24.50 220.50
____ ____ 19.50 9.00
15 51.00 ____ 10 24.00 ____
____ ____ ____ ____
16 50.00 ____ 11 23.50 ____
____ ____ ____ ____
17 49.00 ____ 12 23.00 ____
____ ____
____ ____
18 48.00 ____
____ ____ 13 22.50 ____
19 47.00 ____ ____ ____
____ ____ 14 22.00 ____
20 46.00 ____ ____ ____
____ ____ 15 21.50 ____
21 45.00 ____ ____ ____
16 21.00 ____
3. a. Laura’s cost curves are unchanged from problem ____ ____
17 20.50 ____
2, but now consumers decrease their demand. ____ ____
Table 12.3 lists some points on the new demand 18 20.00 ____
curve. Complete the table by copying the mar- ____ ____
ginal costs from Table 12.1, and by computing 19 19.50 ____
the new total revenue and marginal revenue. ____ ____
20 19.00 ____
b. What is Laura’s new profit-maximizing quantity ____ ____
of output? At what price does she now sell her 21 18.50 ____
books? What is her total profit? Explain your
answers.
MONOPOLY 211

b. What will happen to the profit of the owner

who has been granted the monopoly?
c. Suppose that the owner offers to sell the pizza
delivery company to you. Would you be able to
earn an economic profit? Be careful when you
answer this question; think about the price the
previous owner will charge you for the business.
19. Three industries have the same market demand and
identical cost curves. Industry A is perfectly com-
petitive, industry B is a single-price monopoly, and
industry C is a monopoly able to perfectly price
discriminate.
a. Draw a figure showing the (downward sloping)
market demand curve (label it D); the marginal
revenue curve (label it MR); the marginal cost
curve (label it MC ); and the average total cost
curve (label it ATC).
b. In the figure, identify how much each industry
4. In Figure 12.7 label the curves. Show the amount produces by labeling the outputs as Q A , Q B,
this single-price monopolist will produce and the and Q C for industry A, B, and C, respectively.
price it will charge. Indicate the firm’s economic c. In which industry or industries is consumer sur-
profit and show the deadweight loss created. plus the largest? The smallest?
5. Why can a monopoly — but not a perfectly com- d. In the long run, in which industry or industries
petitive firm — earn an economic profit in the is the total economic profit the largest? The
long run? smallest?
6. Explain why the output of a perfectly competitive e. Which industry structure(s) are efficient?
industry is greater than the output of the same in- 10. What is rent seeking? Why does rent seeking occur
dustry if it is a single-price monopoly. in a monopoly industry, but not in a perfectly
7. Derek is the owner of the only movie theater in competitive industry?
town. By hiring several well-trained economists,
Derek learns that the people watching movies after You’re the Teacher
8 P.M. have a much higher average willingness to
pay than people watching at 5 P.M. The costs of 1. “I don’t really understand how monopoly firms
showing a movie are identical at 5 P.M. and 8 P.M. decide how much to produce and what price to
To maximize his profit, what should Derek do? charge. Can you give me some help? I’d really like
Give him some specific advice, including drawing just a rule or two to remember.” Because you have
him a diagram or two. (Derek can get his econo- studied this material, you are in a position to help
mists to interpret your diagrams as long as you la- this student. Offer a couple of rules that this stu-
bel all the axes and all the curves.) dent can use to determine, first, how much is pro-
8. Suppose that your city grants one pizza delivery duced, and second, what price is charged.
service a legal monopoly on delivering pizzas; all 2. “How does price discrimination reduce the amount
other pizza delivery services must close. of consumer surplus? I mean, by price discriminat-
a. What will happen to the price and quantity of ing the company charges some people a lower
delivered pizzas? price, so how can this reduce consumer surplus?”
These questions are short and to the point, so give
a similar answer to them!
212 CHAPTER 12

Answers Monopoly Policy Issues

16. F Monopolies might be able to capture more
economies of scale or scope than competitive
True/False Answers firms. And, monopolies might have a greater in-
centive to innovate than competitive firms.
Market Power
17. F A natural monopoly is a firm that enjoys such
11. T Without barriers to entry, other firms will enter economies of scale that it can supply the entire
the industry so that it no longer is a monopoly. market at lower cost than could two (or more)
12. T Patents legally prohibit anyone else from pro- firms.
ducing the same good. 18. T However, a marginal cost pricing rule might
13. F A single-price monopoly charges each consumer mean that the firm incurs an economic loss.
the same price.

Single-Price Monopoly’s Output and Price Multiple Choice Answers

Decisions
Market Power
14. T The monopolist is the only producer in the mar- 11. d The taxi company has been granted a legal
ket, so the monopolist’s decisions about how monopoly.
much to produce determine the market price.
12. b The other possibilities are legal barriers to entry.
15. F For a single-price monopoly, P > MR.
13. d All monopolies must lower their price in order
16. T No matter its industry type, a firm producing so to sell more output.
that MR = MC earns the maximum profit.
17. T A single-price monopoly produces at MR = MC. Single-Price Monopoly’s Output and Price
Because P > MR, the equality between MR and Decisions
MC means that P > MC. 14. d Total revenue when 100 trees are sold is $2,800;
18. T Barriers to entry limit the competition faced by when 101 trees are sold, it is $2,727. Hence the
the monopoly, so it is able to earn an economic marginal revenue from the 101st tree is –$73.
profit indefinitely. 15. a When demand is elastic, MR is positive; when
Single-Price Monopoly and Competition demand is inelastic, MR is negative.
Compared 16. a As long as MR exceeds MC, producing the unit
19. F A monopoly creates deadweight loss; it does not adds to the firm’s total profit because it adds
reduce it. more to revenue than to cost.
10. F Single-price monopolists capture only part of 17. a Output should be decreased because the last
the consumer surplus. They create deadweight units produced lower the firm’s profit and, by
loss, part of which is the consumer surplus lost reducing output, the firm can raise its price.
to everyone in society. 18. c Like any firm, if demand for its good declines or
11. T Rent seeking refers to the use of resources to its costs rise, in the short run a monopoly might
establish a monopoly. earn a normal profit or incur an economic loss.
19. c All firms maximize their profit by producing the
Price Discrimination
amount of output so that MR = MC.
12. F Price discrimination captures consumer surplus,
10. b The rise in marginal costs shifts the MC curve
not producer surplus.
leftward. The firm thus decreases the quantity it
13. T This motivation lies behind price discrimina- produces and raises the price it charges.
tion.
11. b The firm produces the level of output that sets
14. T Effectively, the price-discriminating monopolist MR = MC.
converts consumer surplus into additional eco-
12. c The firm produces Q 2 of output. The highest
nomic profit for itself.
price the firm can charge and sell this amount of
15. F Price discrimination requires goods that cannot output is P 3 .
be resold.
MONOPOLY 213

13. d In the short run, depending on demand and Monopoly Policy Issues
cost, any firm can earn an economic profit, a 28. b If economies of scale are large enough, a mo-
normal profit, or incur an economic loss. nopoly might produce more than a competitive
14. c A monopoly might be able to earn an economic industry.
profit and, because of the barriers to entry, the 29. d The answer defines economies of scope.
economic profit can last indefinitely. 30. a Natural monopolies, such as electric power dis-
tributors and local telephone companies, are
Single-Price Monopoly and Competition
usually regulated by the government.
Compared
15. c A single-price monopoly creates a deadweight
loss because it produces less than a competitive Answers to Short Answer Problems
industry. 1. To sell an additional unit of output, a monopoly
16. a Because it produces less output, the monopoly is must lower its price. The additional unit sold at the
able to boost the price it charges. lower price adds to the firm’s revenue an amount
17. d The deadweight loss is created because a single- equal to the price. But a single-price monopoly also
price monopoly produces less than a perfectly lowers the price to previous customers who had
competitive industry. been paying more. Marginal revenue equals the new
18. a The consumer surplus is the area between the revenue, the new price, minus the loss of revenue
demand curve and the price. from lowering the price to previous customers, so
19. c The economic profit is the area of the rectangle marginal revenue is less than the price.
with its height the difference between P and
ATC and with its length the quantity produced. TABLE 12.4

20. a The producer benefits because the monopoly Short Answer Problem 2 (a)
can earn an economic profit; consumers lose be- Quantity (books Total cost Average total Marginal
cause of the reduction in consumer surplus; and per hour) (dollars) cost (ATC ) cost (MC )
society loses due to the deadweight loss. 9 247.00 27.44
9.00
21. d This answer is the reverse of the previous answer 10 256.00 25.60
and shows that society benefits from breaking up 11.00
a monopoly. 11 267.00 24.27
13.00
22. b The question defines rent seeking.
12 280.00 23.33
15.00
Price Discrimination 13 295.00 22.69
23. b The firm must be able to distinguish between 17.00
high and low willingness to pay customers in or- 14 312.00 22.29
19.00
der to determine who should be charged a high
15 331.00 22.07
price and who a low price. 21.00
24. c The monopoly raises its total revenue by captur- 16 352.00 22.00
ing some consumer surplus. 23.00
17 375.00 22.06
25. c Any price discrimination eliminates some con- 25.00
sumer surplus and perfect price discrimination 18 400.00 22.22
eliminates it all. 27.00
19 427.00 22.47
26. a Customers with a high average willingness to
29.00
pay are charged a higher price. 20 456.00 22.80
27. b Airlines price discriminate and charge business 31.00
travelers, who have a high average willingness to 21 487.00 23.19
pay, more than vacation travelers, who have a
low average willingness to pay. 2. a. Table 12.4 shows the average total costs and
marginal costs. The average total costs are calcu-
214 CHAPTER 12

lated by dividing the total costs by the total out- $45. The rest of the marginal revenues are com-
puts. For instance, the average total cost when puted the same way.
10 books are sold is $256 ÷ 10, or $25.60. The c. To maximize her profit, Laura produces at MR =
rest of the ATCs are calculated similarly. Mar- MC. Between 18 and 19 books the marginal
ginal cost equals the change in the total cost di- revenue is $29 and between 19 and 20, it is $27.
vided by the change in output. For example, the So, at 19 books the marginal revenue is $28.
marginal cost going from 10 to 11 units of out- Similarly, the marginal cost is $27 between 18
put is ($267 − $256) ÷ (11 − 10), which equals and 19 books and $29 between 19 and 20
$11.00. The remainder of the MCs are calcu- books, which indicates that at 19 books the mar-
lated in the same way. ginal cost is $28. Marginal revenue equals mar-
ginal cost at an output of 19 books, so this
quantity is the profit-maximizing level of out-
TABLE 12.5
put.
Short Answer Problem 2 (b)
The data for the demand curve show that Laura
Quantity can sell 19 books at a price per book of $47, so
demanded Price Total Marginal Marginal the monopoly price is $47 per book. (Note that
(books per (dollars revenue revenue cost the price, $47, is greater than the marginal cost,
hour) per book) (dollars) (MR ) (MC ) $28.) Laura’s economic profit equals her total
9 57.00 513.00 revenue minus her total cost. From Table 12.5,
47.00 9.00
10 56.00 560.00 the total revenue when selling 19 books is $893,
45.00 11.00 and, from Table 12.4, the total cost of selling 19
11 55.00 605.00 books is $427. Laura’s total economic profit is
43.00 13.00 $893 – $427 = $466.
12 54.00 648.00
41.00 15.00 d. Figure 12.8 shows the demand, MR, and cost
13 53.00 689.00 curves. The area of the darkened rectangle equals
39.00 17.00 Laura’s economic profit.
14 52.00 728.00
37.00 19.00
15 51.00 765.00
35.00 21.00
16 50.00 800.00
33.00 23.00
17 49.00 833.00
31.00 25.00
18 48.00 864.00
29.00 27.00
19 47.00 893.00
27.00 29.00
20 46.00 920.00
25.00 31.00
21 45.00 945.00

b. Table 12.5 gives the total revenue and marginal

revenue. Total revenue is (Quantity) × (Price).
By way of example, the total revenue at the
quantity of 10 books is (10) × ($56) = $560. Af-
ter finishing with the total revenue, the marginal
revenue can be calculated as the change in total
revenue divided by the change in output. Take 3. a. Table 12.6 (on the next page) shows the total
the marginal revenue going from 10 to 11 books revenue, marginal revenue, and marginal cost af-
sold per hour as an example. This marginal ter the decrease in demand. The total and
revenue equals ($605 − $560) ÷ (11 − 10), or
MONOPOLY 215

TABLE 12.6
Short Answer Problem 3 (a)
Quantity Price Total Marginal Marginal
(books per (dollars Revenue Revenue Cost
hour) per book) (dollars) (MR ) (MC )
9 24.50 220.50
19.50 9.00
10 24.00 240.00
18.50 11.00
11 23.50 258.50
17.50 13.00
12 23.00 276.00
16.50 15.00
13 22.50 292.50
15.50 17.00
14 22.00 308.00
14.50 19.00
15 21.50 322.50
13.50 21.00
16 21.00 336.00
12.50 23.00
17 20.50 348.50
11.50 25.00
18 20.00 360.00 4. All the curves are labeled in Figure 12.9. Also illus-
10.50 27.00 trated in the figure is the economic profit (the
19 19.50 370.50
9.50 29.00 darker rectangle) the monopoly earns and the
20 19.00 380.00 deadweight loss (the lighter triangular area) the mo-
8.50 31.00 nopoly creates.
21 18.50 388.50
5. The fundamental reason that monopolies are able to
marginal revenue schedules are calculated simi- earn an economic profit in the long run is that they
larly to those in Table 12.5. are protected from competition by barriers to entry.
Essentially when the monopolist is earning an eco-
b. After the decrease in demand, Laura finds that
nomic profit, other firms would like to enter that
MR = MC when she sells 13 books per hour.
market. However, they are precluded from doing so
(The MR equals $16, the same as the MC.) So, by the existence of barriers to entry — some feature
13 books is the profit-maximizing level of sales. of the market, be it economies of scale or perhaps a
When Laura sells 13 books per hour, the (new) patent, that prevents new firms from entering the
demand schedule shows that she can charge industry. Perfectly competitive firms are not pro-
$22.50 per book and sell all 13. Hence the new tected by barriers to entry. If they are earning an
profit-maximizing price is $22.50 per book. economic profit, new competitors will enter the
Laura’s economic profit equals her total revenue market and, by so doing, compete away the eco-
of $292.50 minus her total cost of $295.00. nomic profit. Hence it is the barriers to entry that
Hence her “profit” is –$2.50; that is, with the allow a monopoly to indefinitely earn an economic
decrease in demand, Laura actually incurs an profit.
economic loss of $2.50. Table 12.6 indicates 6. A perfectly competitive industry produces the level
that this loss is the minimum possible loss. of output at which the industry’s marginal cost
Laura will continue to operate in the short run curve (which is the same as the industry’s supply
because this loss is less than her shut-down loss, curve) intersects the industry’s demand curve. A
which would be $100, the amount of the busi- single-price monopoly produces the level of output
ness’s fixed cost. In the long run, however, if at which the industry’s (the firm’s) marginal cost
matters do not improve, Laura will close down curve intersects the monopoly’s marginal revenue
as soon as at least $97.51 of her (current) fixed curve. Because the marginal revenue curve lies be-
cost becomes a variable cost. low the demand curve, the monopoly industry pro-
216 CHAPTER 12

duces less. More intuitively, compared to a perfectly

competitive industry, a single-price monopoly re-
stricts its output in order to raise its price and gen-
erate an economic profit.
7. In order to maximize his profits, Derek should
charge a lower price for his 5 o’clock movies and a
higher price for his 8 o’clock movies. In other
words, Derek should price discriminate because by
so doing, Derek increases his profit.
Price discrimination is possible because this situa-
tion easily fulfills its requirements. First, Derek can
readily distinguish between customers with a high
average willingness to pay and those with a low av-
erage willingness to pay by noting when they want
to see the movie: those who want to view at 8 P.M.
have a higher average willingness to pay than those
who want to view at 5 P.M. Second, to resell the
good is impossible; that is, people attending at 5
P.M. are not going to be able to resell viewing the
movie to those who want to attend at 8 P.M. Thus
Derek can “separate” his market into two groups
and charge the 5 P.M. group a low price and the 8
P.M. group a higher price.
Why does price discrimination increase Derek’s
profit? Figures 12.10 and 12.11 shed light on this
question. The marginal cost of showing a movie at
5 P.M. or at 8 P.M. is assumed to be constant. In or-
der to maximize his profit in the 5 o’clock market,
Derek equates MR to MC and sells QL (“L” for “low
willingness to pay”) tickets by charging PL. In the
high willingness to pay, 8 P.M. market, Derek sells
QH (“H” for “high willingness to pay”) tickets by
charging PH per ticket. By charging a lower price at
5 P.M. and a higher price at 8 P.M., Derek is able to
convert into economic profit some of the consumer
surplus that would result if he charged both classes
of customers the same price. Price discrimination c. Perhaps surprisingly, though you might be rent
raises Derek’s economic profit. seeking by offering to buy the delivery service,
8. a. When the one firm is granted a monopoly on you will not be able to earn an economic profit.
pizza delivery, it boosts its price and thereby re- Why not? Think of the selling price the pizza
duces its output. The price of a pizza will rise, owner will charge to buy the pizza delivery com-
the quantity of pizzas delivered will decrease, pany and its monopoly. The selling price must
and so the quantity of pizzas consumed de- compensate the owner for all the economic
creases as fewer pizzas are delivered. profit that he or she will lose in the future by not
owning the business. Hence the price of the
b. The owner of the (new) monopoly pizza delivery
business will rise with the economic profit that it
service will earn an economic profit.
is earning, both now and in the future. The fact
MONOPOLY 217

that the price of the business rises means that

you will be able to earn only a normal profit on
the funds that you use to buy the business. So, if
you want to earn an economic profit, you must
be in on the ground floor: Buying into a busi-
ness after it is already earning an economic profit
will not work because the higher price of buy-
ing-in eliminates the economic profit.
9. a. Figure 12.12 shows the demand, marginal reve-
nue, average total cost, and marginal cost curves
for the three industries.
b. Figure 12.13 shows the level of output for each
industry structure. The single-price monopoly
produces the least. Both the perfectly competi-
tive industry and the monopoly able to perfectly
price discriminate produce the same amount,
which is more than that produced by the single-
price monopolist.
c. The consumer surplus is largest in the perfectly
competitive industry; it is smallest (zero) with
the perfectly price-discriminating monopoly.
d. The total economic profit is largest for the mo-
nopoly able to perfectly price discriminate be-
cause this monopoly converts all the potential
consumer surplus to economic profit. It is small-
est for the perfectly competitive industry because
in the long run firms in this industry cannot
earn economic profits.
e. Both the perfectly competitive industry and the
perfectly price-discriminating monopoly pro-
duce the efficient amount.
10. Rent seeking refers to the attempt to create a mo-
nopoly. People rent seek because, if they can create
a monopoly, they stand to earn an economic profit
for an indefinite period of time. Rent seeking occurs
in a monopoly industry precisely because monopo-
lies can earn economic profits. It does not occur in
perfectly competitive industries because firms in
“To find the profit-maximizing quantity, use the
these industries cannot earn a long-lasting economic
MR and MC curves. The equilibrium quantity is
profit. Hence the incentive to rent seek is much less
where these curves cross: Draw a vertical line down
in a perfectly competitive industry.
to the horizontal axis and read the quantity. Then,
to find the profit-maximizing price, continue this
You’re the Teacher vertical line up to the demand curve. From the in-
tersection of the demand curve and your vertical
1. “A couple of mechanical rules might be helpful
quantity line, draw a horizontal line over to the
when we’re studying how a monopoly selects its
price axis. Where this line meets the price axis is the
output and determines its price. First, decide how
profit-maximizing price. Use these rules and you’ll
much the firm produces. Second, determine the
be okay.”
price charged.
218 CHAPTER 12

2. “Look, the whole idea of price discrimination is that you value a good and how much you have to pay
a monopoly wants to charge you a price for the for it. By price discriminating, the monopoly can
good that more closely reflects how much you value reduce this difference: Customers who value it a lot,
it. If you value it a lot, the monopoly wants to stick pay a lot, and customers who don’t value it as much
you with a really high price; if you don’t value it too don’t pay as much. So, a price-discriminating mo-
much, the monopoly will let you buy it for a lower nopoly moves the price closer to how much the
price. Now, the idea behind consumer surplus is good is valued, and so the monopoly reduces con-
that it measures the difference between how much sumer surplus.”
MONOPOLY 219

Chapter Quiz 16. Which of the following occurs with both a perfectly
competitive industry and a perfectly price discrimi-
nating monopoly?
11. Which of the following is a feature of a monopoly?
a. The amount of output is inefficient.
a. Monopoly has no barriers to entry. b. The amount of output is efficient.
b. Monopolies produce a product with a very close c. Deadweight loss is created.
substitute. d. All consumer surplus is lost to the firm(s).
c. A monopoly is the only supplier of the product.
d. A monopoly faces a perfectly elastic demand for 17. A single-price monopolist will shut down if price is
its product. a. less than average fixed cost.
b. less than the minimum average variable cost.
12. A patent is a ____ barrier to entry and a public
c. greater than the minimum average total cost.
franchise is a ____ barrier to entry.
d. greater than minimum average variable cost but
a. natural; natural less than minimum average total cost.
b. natural; legal
c. legal; natural 18. The reason that a perfectly competitive industry is
d. legal; legal more efficient than a single-price monopoly is
because the perfectly competitive industry
13. In a monopoly, the marginal revenue curve lies
a. has higher total costs.
a. above the demand curve. b. produces more output.
b. on top of the demand curve. c. has a market demand that is more elastic.
c. below the demand curve. d. None of the above.
d. sometimes above, sometimes on top of, and
sometimes below the demand curve depending 19. Compared to a perfectly competitive industry, a
on the marginal cost curve. monopoly transfers
a. deadweight loss to consumers.
14. The more perfectly a monopoly can price discrimi-
b. deadweight loss to producers.
nate, the ____ its output and the ____ its profit.
c. producer surplus to consumers.
a. higher; higher d. consumer surplus to the producer.
b. higher; lower
c. lower; higher 10. Economies of scope arise when
d. lower; lower a. an increase in output leads to a fall in average
total cost.
15. A price discriminating monopoly charges higher
b. an increase in the range of goods produced
prices to customers with
causes average total cost to fall.
a. lower quantities demanded. c. doubling the monopoly firm’s inputs more than
b. higher quantities demanded. doubles its output.
c. higher average willingness to pay. d. high profit allows the company to undertake
d. lower average willingness to pay. more research and development.

The answers for this Chapter Quiz are on page 368

220