Introduction to Microeconomics ECO1104

14. Monopoly

Cristina Blanco-Perez

Faculté des sciences sociales | Faculty of Social Sciences

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 Outline

• Monopoly:

– Barriers of Entry

– Monopoly Characteristics

– Problems with Monopoly

– Market power and Price Discrimination

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 14.1 Monopoly

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 Monopoly

• A monopoly refers to a firm that is the only producer of a

good or service with no close substitutes.

– A firm is a perfect monopoly if it controls the entire

market.

– A firm has monopoly power if it can manipulate the

price.

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 Monopoly
• Why do monopolies exist?

• Monopolies exist because of barriers to entry that prevent

other firms from entering the market:
– Scarce Resources
– Economies of Scale
– Governmental intervention
– Aggressive business tactics

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 14.1.1 Barriers of Entry

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 Monopoly: scarce resources

• Not possible to enter the market because there is

scarcity resources or input of the production process

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 Monopoly: economies of scale

• High fixed costs, better to produce at larger scale to

take advantage of economies of scale

• New firms are prevented to enter the market because of

this

• E.g.: railway, water-supply, fix phone lines, electricity

• A natural monopoly refers to a market where a single

firm can produce the entire market quantity demanded
at a lower cost than multiple firms.

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 Monopoly: government intervention

• Monopoly created or sustained by governments where

they would not otherwise exist:

– To protect consumers

– For state-owned firms

– To protect intellectual property rights (patents,

copyrights, trademarks, …)

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 Monopoly: Aggressive business tactics

• Incumbent firm prevent new entries:

– Acquiring competitors

– Predatory Pricing

– Threating them

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Active Learning: Identify the barrier to entry

• For each of the following, identify which barrier to

entry permits monopoly power.

– H2O Company owns all of the water rights to a

town’s drinking water supply.

– XYZ Pharmaceuticals is awarded a patent for

their new asthma drug.

– National Brewing Company buys a successful,

local microbrewery.

– ABC Motor Company produces cars at a lower

cost than smaller firms could.

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 14.1.2 Monopoly characteristics

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 Monopoly characteristics

• Monopolies are also rational economic agents: maximize

their profits

• But they have different characteristics than perfect

competition firms:

– Monopoly is not price taker!!!

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 Monopolists and the demand curve
• Monopoly markets differ from perfectly competitive markets with
regard to their demand curves.
Perfectly competitive firm’s demand curve Monopolist’s demand curve
Price ($) Price ($)
Competitive Monopolists face
firms face a a downward-
horizontal sloping demand
demand curve. 5,00 0 curve.

2,500 D 2,50 0

D
0
0 3 8
Quantity of diamonds
Quantity of diamonds
Firms cannot affect the market Monopolists can affect the market price,
price through their production
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but are constrained by the market
decisions. demand curve.
 Monopoly revenue
• When a monopolist produces more of a good, the market
price is driven down.

• Therefore, producing an additional unit of output has two

effects on total revenue:
1. Quantity effect: Total revenue increases.
2. Price effect: Total revenue decreases.

• Total revenue might increase or decrease, depending on

which effect is larger.

• In perfectly competitive markets, a firm can sell as much as it wants

at the market price.
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 Monopoly revenue
• Total revenue is maximized when marginal revenue equals $0.

• Average revenue equals price and is greater than or equal to marginal

revenue.
Ma rg i na l Avera g e
Pri ce Qua nti ty s ol d Tota l revenue
revenue Revenue
( $/di a m ond) ( V i ol et di a m onds ) ( $) ( $) ( $/di a m ond)
6,500 0 0 0
6,000
6,000 1 6,000 6,000
5,000
5,500 2 11,000 5,500
4,000
5,000 3 15,000 5,000
3,000
4,500 4 18,000 4,500
2,000
4,000 5 20,000 4,000
1,000
3,500 6 21,000 3,500
0
3,000 7 21,000 3,000
- 1,000
2,500 8 20,000 2,500
- 2,000
2,000 9 18,000 2,000
- 3,000
1,500 10 15,000 1,500
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 Monopoly revenue
• The total revenue maximizing point is identified where MR = $0.
TR, AR, MR ($)
25,000 1. A monopolist's
total revenue first
increases. 2. then decreases.
20,000

15,000
The MR curve intersects the x-
axis at the revenue-maximizing
TR quantity.
10,000

5,000
The average revenue equals the
AR price at any quantity sold.
0 1 2 3 4 5 6 7 8 9 1 0 11 12

MR
25,000 Quantity of violet diamonds
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Active Learning: Determine revenue-maximizing quantity
• Fill in the following table and identify the monopolist’s revenue-
maximizing level of production.

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Active Learning: Determine revenue-maximizing quantity
• Fill in the following table and identify the monopolist’s revenue-
maximizing level of production.

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 Monopoly profit-maximizing quantity

• While revenue is important, firms maximize profits.

• The profit-maximizing quantity of output for a monopoly is

found where marginal revenue equals marginal cost.

– This is the same marginal decision-making analysis used

in perfectly competitive markets.

MR= MC

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 Monopoly profit maximization
• A monopolist’s profit maximizing price and quantity can be found graphically:

MC, MR, ATC ($)

8,000 • The profit-maximizing
7,000 MC quantity is identified
where MR = MC, point B.
6,000
ATC • The price is determined
5,000
A by the point on the
4,500
4,000 demand curve that
3,000 B corresponds to the

2,000 profit-maximizing
D
quantity, point A.
1,000
MR • Price is set higher than
0
1 2 3 4 5 6 7 8 9 10 the marginal revenue.
Quantity of violet diamonds
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 Monopoly profit maximization
• A monopolist’s profits can be found graphically:

MC, MR, ATC ($)

Monopolist’s • Profit per unit =
8,000
profit P – ATC.
7,000 MC
Profit per unit • Vertical distance
6,000 between A and B.
ATC
5,000 • Profit = (P – ATC)
A
4,500 × Q.
4,000
• Since P > MC and
3,000 B barriers to entry
exist, monopolists
2,000
D earn positive
1,000 economic profits in
0
MR the long-run.
1 2 3 4 5 6 7 8 9 10
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Quantity of violet diamonds
Active Learning: Determine
profit-maximizing price and quantity and profit
• Use the following graph to determine a coffee-producing monopolist’s
profit-maximizing price and quantity.

P
12
MC =
11
10
9
8
7
6
5
4
3
2
1 MR D
0
0 1 2 3 4 5 6 7 8 9 10 Q
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Active Learning: Determine
profit-maximizing price and quantity and profit

• Use the following graph to determine a coffee-producing monopolist’s

profit-maximizing price and quantity.

P
12
MC =
11
10
9
8
7
6
5
4
3
2
1 MR D
0
Q
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 14.1.3 Problems with Monopoly

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 Problems with monopoly
• Monopoly power benefits monopolists but causes social
welfare losses.

• In a competitive market, the equilibrium price and quantity

maximize total surplus.

• Monopolists produce at a lower quantity than the efficient

level.
– Total surplus is not maximized.
– Producer surplus (monopolist profit) increases.
– Consumer surplus decreases.
– The loss of total surplus is a deadweight loss equal to the
total surplus under perfect competition minus the total
surplus under a monopoly.
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 The welfare costs of monopoly
Efficient market Inefficient monopoly
MC, MR ($)equilibrium MC, MR ($)market
Consumer surplus Consumer surplus

Producer surplus Producer surplus

Deadweight loss
MC A MC
4,500
C
3,500
B
2,250

D D
MR MR
0 6 0 4
Quantity of violet diamonds Quantity of violet diamonds
• Consumer surplus decreases because of
• Total surplus is maximized and there is the lower quantity and higher price.
no deadweight loss. • Monopolists earn positive economic
profits.
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• Society suffers a deadweight loss.
 The welfare costs of monopoly
• The welfare costs associated with monopolies is a positive
statement.

• Many voters and policy-makers make normative

statements concerning monopolies:

– Extra profits to monopolies.

– Benefits of maintaining a particular monopoly outweigh

the social welfare costs.

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 Public policy responses

• Pressure from both the government and consumers can lead

to a decrease in monopoly power.

• Policy responses are often imperfect and controversial.

• The goals of policy responses are typically:

– Break up existing monopolies.

– Prevent new monopolies from forming.

– Ease the effect of monopoly power on consumers.

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 Public policy responses

• How?
– Antitrust laws
– Public Ownership
– Regulation
– Vertical Splits
– No response

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 Public policy responses: Antitrust laws

• One public policy response is to enact antitrust laws that

investigate and prosecute corporations that engage in
anti-competitive practices.
– Competition Act.
– Administered by the Competition Bureau.

• Critics of antitrust laws argue that they:

– Are typically politically motivated.
– Cause more inefficiency than they create.

– E.g.: https://www.wsj.com/articles/the-antitrust-case-
against-facebook-google-amazon-and-apple-
1516121561
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 Public policy responses: Public ownership

• Natural monopolies occur when one firm can achieve lower

costs of production than multiple firms.

• A public policy response to natural monopolies is to allow the

government to run them.

Benefits Costs

• Provide broader services. • Political pressure.

• Set prices lower than
• Loss of profit incentive
unregulated monopolies.
potentially leading to

inefficiencies.

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 Public policy responses: Public ownership
• Below provide the effect of price regulation of a natural
monopolist.
Price (cents per kilowatt hour) Price (cents per kilowatt hour)
Monopoly profit Monopoly loss
Deadweight loss

Efficient price:
(P = MC)

20 Ceiling
ATC ATC
MC 14 MC
D D
MR MR
0 5,600 0 6,350
Millions of kilowatt hours of electricity Millions of kilowatt hours of electricity

• Price ceiling set above the • Price regulated to marginal

monopolist’s ATC. cost.
• Monopolist produces where price • Monopoly is producing at a
intersects average revenue loss because P < ATC.
(identical to demand).
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competitive market price.
 Public policy responses: Regulation
• If policymakers do not want public ownership, one common
intermediate step is to regulate the behavior of natural
monopolies.

– Takes the form of price controls.

• Firms have an incentive to avoid releasing information

about their true production costs.

– This makes it difficult for regulators to determine the

appropriate price.

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 Public policy responses: Vertical splits

• Another policy response is to vertically split an

industry to introduce competition.
– Different firms now operate at different points in the
production process.

• In a horizontal split, a monopolist is separated into

several firms that compete with each other to sell the
same product.

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 Public policy responses: No response

• Cost-benefit analysis might suggest that the best response

is to do nothing.

• This might be preferable if regulation is difficult and/or

ineffective to establish and manage.

• Common when government interventions are subject to

corruption or political mishandling.

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 14.1.4 Market power and Price
discrimination

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 Market power and price discrimination

• Some consumers are willing to pay more for a good than the
prevailing market price.

• Price discrimination is the practice of charging customers

different prices for the same good (to increase monopoly
profits)

– Firms with monopoly power can charge higher prices to

consumers with a higher willingness to pay.

– The more monopoly power a firm has, the more it is able to

price discriminate.

– E.g.: by age (students, elderly, children), be the first of

doing something (choosing a plane sit, or ticket), different
quality (the first edition or the pocket format)…Assuming
different willingness to pay among these different groups

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 Market power and price discrimination

Suppose Microsoft has the following potential customers for MS Office:

• 1 million ‘business owner’ customers willing to pay $225.
• 1 million ‘standard user’ customers willing to pay $150.
• 1 million ‘student’ customers willing to pay $75.

Microsoft also has fixed costs of $50 million.

• The demand curve for
Only business Microsoft Office is a step
Price ($) owners buy function.
Business owners • At $225 per copy, only
225 and standard
business owners will buy
users buy
Office.
150 All customers • At $150 per copy, both
buy business owners and standard
users will buy Office.
75 • At $75 per copy, all
customers, including
Demand students, will buy Office.
0 1 2 3
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 Market power and price discrimination

• What price should Microsoft charge for Office to maximize

profits without price discrimination?

Price ($) Number of copies Total Revenue ($) Fixed Costs ($) Profits ($)

75 3,000,000 225,000,000 50,000,000 175,000,000

150 2,000,000 300,000,000 50,000,000 250,000,000
225 1,000,000 225,000,000 50,000,000 175,000,000

‒ A price of $150 maximizes profits.

‒ Note that by charging $150, Microsoft loses the business of
students.
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 Price discrimination
• What are Microsoft’s profits with price discrimination?
No price discrimination Imperfect price Perfect price
Price ($) Price ($) discrimination Price ($) discrimination
Consumer surplus
300 Producer surplus 30 0 30 0
Deadweight loss Business price = $225
22 5
Standard price = $150
150 15 0
Student price = $75
75
D D D
0 2 4 0 1 2 3 4 0
Millions of copies of Office
Millions of copies of Office Millions of copies of Office
• Sets price equal to each
• One price of $150 to • Sets price per each
customer’s willingness to
all customers. group of customers.
pay.
• Loses student • Earns profits from
• Earns profits from all
customers. all customers.
customers.
• Results in a
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• Zero deadweight loss and
deadweight loss deadweight loss.
consumer surplus.
 Price discrimination

• Price discrimination requires firms to accurately know

how much each customer (or group of customers) are
willing to pay.

– Requires some sort of verification.

• The ability to resell products creates problems for firms

trying to price discriminate.

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 Summary
• Monopoly markets have barriers that prevent firms other
than the monopolist from entering the market.

• Monopolists are constrained by the market demand curve.

• Monopolists choose their profit-maximizing quantity the

same way that firms in competitive markets do.

– Produce where MR = MC.

• However, monopolists earn positive economic profits.

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 Summary

• Monopolists produce less than the competitive market

quantity, causing a deadweight loss.

• Public policy exists to break up, prevent entry, and

mitigate the effect of monopolies.

• Monopolies can use price discrimination strategies to

maximize profits.

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 References

• Karlan, D., Morduch, J., Startz. M.L., Wong, A., (2017).

Microeconomics. Chapter 14. McGraw-Hill.

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