DYNAMIC P OWERP OINT LIDES BY S OLINA LINDAHL

13
CHAPTER

Monopoly
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 Diamond is Forever
Diamonds are a Girls Best Friend
 De Beers Diamonds
Up until the mid-1800s, diamonds The story of De Beers starts
were a rarity and could be seen with English-born
only on the hand of a monarch. businessman Cecil Rhodes,
But the diamond rush that began who broke into the diamond
in South Africa in the second half business in South Africa by
of the 19th century flooded the renting water pumps to
market with diamonds, which, as
miners before buying
any good businessman knows,
kills demand.
diamond fields of his own.
It would take some ingenious
plotting and advertising to keep In 1880, he bought the claims
the diamond's reputation as of fellow entrepreneur and rival
intrinsically valuable and desirable, Barney Barnato to create the
which is where De Beers comes De Beers Mining Company.
in.
 The significance of monopoly, where a single monopolist is
the only producer of a good
How a monopolist determines its profit-maximizing output
and price
The difference between monopoly and perfect
competition
welfare
How policy makers address the problems posed by
monopoly
What price discrimination is, and why it is so prevalent
when producers have market power

To First To
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Types of Market Structure
In order to develop models and make predictions
about how producers will behave, we have
developed four principal models of market
structure:

perfect competition
monopoly
oligopoly
monopolistic competition

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Types of Market Structure
Are products differentiated?

No Yes

One Monopoly Not applicable

How many
producers Few Oligopoly
are there?

Perfect Monopolistic
Many
competition competition

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The Meaning of Monopoly

Monopolist: a firm that is the only producer of a good with

no close substitutes.
(An industry controlled by a monopolist is known as a monopoly)
Market power: the ability of a firm to raise prices.
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What a Monopolist Does
A monopolist reduces the quantity supplied to QM and moves up
the demand curve from C to M, raising the price to PM.

Market demand = demand of the monopolist

Price

S
PM M

price. C
PC

QM QC Quantity

1. Compared to perfect competition, a

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Why Do Monopolies Exist?
How do they get away with this and protect their
profit from new firms?

Profits will not persist in the long run unless

there is a barrier to entry.

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Barriers to Entry
Barriers to entry are essential for monopolies.
They generate profit for the monopolist in the
short run and long run.
This can take the form of:
control of natural resources or inputs.
increasing returns to scale.
technological superiority.
network externalities
government-made barriers, including patents
and copyrights.
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1. Control of a Scarce Resource or Input
If De Beers owned nearly all of the diamond
mines in the world, it would have a monopoly in
diamond production.

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 When its too expensive for a single firm , so like only the governemnt produces it like trains

2. Increasing Returns to Scale

A natural monopoly exists

when increasing returns to
scale (economies of scale)
provide a large cost
advantage to a single firm.

Hoover Dam, a natural

monopoly Back to
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2. Increasing Returns to Scale
A given quantity of output is produced more cheaply by one large firm than by two
or more smaller firms.

Price,
cost

Natural monopoly.
Average total cost is
falling over the relevant
output range

ATC
break-even price

D
Quantity
Relevant output range
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3. Technological Superiority

A firm that maintains a consistent technological

advantage over potential competitors can
establish itself as a monopolist.

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4. Network Externality
Network externality: the value of a good or
service to an individual increasing as more others
use the same good or service.

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5. Government-Made Barrier
A patent gives an inventor a
temporary monopoly in the
use or sale of an invention.

A copyright gives the

creator of a literary or
artistic work sole rights
to profit from that work.
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How a Monopolist Maximizes Profit
Competitive firms cannot choose price. Monopolists can.

(a) Demand curve of an individual (b) Demand curve of a monopolist

perfectly competitive producer
Price Price

Market DC
price

DM

Quantity Quantity

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How a Monopolist Maximizes Profit
All firms face the same rule: Profit is
maximized at the Q where MR = MC.

So what does MR look like?

MR TR/ Q.

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How a Monopolist Maximizes Profit
MR
An increase in production by a monopolist
has two opposing effects on revenue:
A quantity effect: One more unit is sold,
increasing total revenue by the price at which
the unit is sold.
A price effect: To sell the last unit, the
monopolist must cut the market price on all
units sold. This decreases total revenue.
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Demand, Total Revenue, and Marginal Revenue

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Your Turn: Fill in the Missing MR

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Active Learning: Practice

Suppose that a monopolist can sell 5 units

of output at a price of $5 or 6 units of
output at a price of $4. What is the
marginal revenue of the sixth unit?

a) $24
b) $49
c) $1
d) $10

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Marginal Revenue Curves
(a) Demand and marginal revenue
Price, cost, marginal
revenue of demand
$1,000

Quantity effect
550 A
B = +$500
500
Price effect
= $450
50 C
D
0 9 10 20
200 Marginal revenue
400 = $50 MR
Quantity of diamonds
(b)Total Revenue

Total Quantity effect Price effect dominates

Revenue dominates price effect. quantity effect.

$5,000
4,000
3,000
2,000
1,000
TR Back to
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0 10 20 contents
Quantity of diamonds
Profit Maximization for a Monopoly
Profit maximization consists of two steps:
1.Choosing a quantity
Rule: Choose Q where MR = MC.
2.Choosing a price
Choose the highest price you can get away with, which is
the highest price consumers will pay for that quantity.
Rule: picked your quantity, follow the
graph to the demand curve, which shows you how
much consumers will pay.

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 -Maximizing Output and Price
Price, cost,
marginal revenue
of demand
$1,000
optimal point

B
PM 600
Perfectly competitive
Monopoly
profit
PC 200 MC ATC
A C
D
0
8 10 16 20
Quantity of diamonds
200 QM QC
MR
400

The price De Beers can charge per diamond is found by going to the point on the
demand curve directly above point A, (point B here) $600 per diamond. It makes a
profit of $400 × 8 = $3,200. Back to
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Monopoly Versus Perfect Competition

P = MR= MC -
maximizing quantity of output

P > MR = MC -maximizing quantity

of output

Compared with a competitive industry, a monopolist does the

following:
Produces a smaller quantity: QM < QC
Charges a higher price: PM > PC
Earns a profit

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FINDING THE MONOPOLY PRICE
In order to find the profit-maximizing quantity of
output for a monopolist, you look for the point
where the MR curve crosses the MC curve.
monopolist will
choose. The firm will want to charge as much as
it can. Why stop at MR if it can charge up to
what the demand curve says people will pay?

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As long as the monopoly has strong barriers to entry,
profit will stay.

Price, cost,
marginal
revenue
MC
ATC
B
PM

Monopoly
profit
A
D
ATCM
C

MR

QM Quantity Back to
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Active Learning: Practice

What are the monopolist's profit-maximizing price and

output level here?
a) P = $3.00; Q = 40
b) P = $16.50; Q = 40
c) P = $6.00; Q = 40 Back to
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Active Learning: Practice

The monopolist earns a profit of:

a) $600.
b) $420.
c) $240.
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IS THERE A MONOPOLY SUPPLY
CURVE?
You might be tempted to ask about the
supply curve of a monopolist. But this is a
meaningless question:
have supply curves.

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Active Learning: Practice

If the market for some good were converted from

a competitive industry to a monopoly, which of
the following would occur as a result?

a) Prices would fall on the output produced by

the monopolist.
b) Some consumer surplus would be reallocated
to the monopolist as profit.
c) The overall level of profit earned in the
industry would decrease.
d) More output would be produced by the
monopolist.
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Monopoly Causes Inefficiency

(a) Total surplus with perfect competition (b)Total surplus with monopoly
Price, Price, cost,
cost Consumer surplus with marginal Consumer surplus
perfect competition revenue with monopoly

PM Profit

Deadweight
loss

PC MC = ATC MC = ATC
D D
MR
QC Quantity QM Quantity

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Monopoly and Public Policy

When a monopoly raises prices and lowers Q,

consumer surplus falls and deadweight loss is created.

To avoid deadweight loss, government policy

attempts to prevent monopoly behavior.

The government policies used to prevent or

eliminate monopolies are known as antitrust
policy.
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Dealing with Natural Monopoly
Natural monopolies are a different story:

voluntarily pass along its cost savings to

consumers.

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Dealing with Natural Monopoly
What can public policy do about this? Two
common answers:
Public (government) ownership: But
publicly owned companies are often
poorly run.
Price regulation: A price ceiling imposed
on a monopolist does not create
shortages if it is not set too low.

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Unregulated and Regulated Natural Monopoly
(a) Total surplus with an (b) Total surplus with a
unregulated natural regulated natural
monopolist monopolist
Price, cost, Price, cost,
marginal Consumer marginal Consumer
revenue surplus revenue surplus

Profit
PM

ATC PR* ATC

MC MC
D D
MR MR
QM QR Quantity QR* Quantity

PR, consumer surplus

rises (and profits fall).

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Price Discrimination

¿Qué pasa?

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Price Discrimination

single-
price monopolist: It offers its product to all
consumers at the same price.

Some firms practice price discrimination: They

charge different prices to different consumers
for the same good.

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Price Discrimination and Profit Maximization

Recall the profit-maximizing rule for firms with

monopoly power:
Produce the Q at which MR = MC.
Based on that Q, charge as much as the market will
bear (found by the position of the demand curve).
But what if you sell to more than one market, each
with its own demand curve?
E.g., senior citizens and young people, business
travelers and leisure travelers.

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Price Discrimination

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Price Discrimination

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Two Types of Airline Customers
Price, cost of
ticket Profit from sales to If your consumers have
business travelers low price elasticity,
$550 charge them more!

B Profit from sales to student

travelers

150
125 MC
S
D
0 2,000 4,000
Quantity of tickets
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Active Learning: Practice

Who probably has more elastic demand for a Hertz rental

car? Person A reserves a car online weeks before a trip;
person B walks up to a Hertz counter after he walks off
an airplane after a four-hour flight? Who probably gets
charged more?
a) Person B a more elastic demand and will be charged
less.
b) Person B has a more elastic demand and will be
charged more.
c) Person A has a more elastic demand and will be
charged more.
d) Person A has a more elastic demand and will be
charged less. Back to
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Price Discrimination Increases Sales and Profits
(a) Discrimination with two prices (b) Discrimination with three prices
Price, Price,
cost cost
Profit with Profit with
two prices Phigh
three prices
Phigh
Pmedium
Plow
Plow

MC MC

D D

Quantity Quantity
Sales to Sales to Sales to Sales to Sales to
consumers consumers consumers consumers consumers
with a high with a low with a high with a with a low
willingness willingness willingness medium willingness
to pay to pay to pay willingness to pay
to pay
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Price Discrimination
There is no deadweight loss, because all mutually beneficial
transactions are exploited.
There is zero consumer surplus: The entire surplus is captured by the
monopolist in the form of profit.
Price, cost
(c) Perfect price discrimination

Profit with perfect price

discrimination

MC

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Perfect Price Discrimination
Common techniques for price discrimination:
Advance purchase restrictions
Volume discounts
Two-part tariffs

Your Costco card: a two-part tariff Back to

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