Monopoly

H.M.S. Amanda N. Herath, PhD

Senior Lecturer,
Department of Business Economics,
PowerPoint Slides prepared by:
Faculty of Management & Finance,
Andreea CHIRITESCU
University of Colombo Eastern Illinois University

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 Why Monopolies Arise
• Monopoly
– Firm that is the sole seller of a product without close
substitutes
– Price maker
• Barriers to entry
– Monopoly resources
– Government regulation
– The production process

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 Why Monopolies Arise
• Government regulation
– Government gives a single firm the exclusive right to
produce some good or service
– Government-created monopolies
• Patent and copyright laws
• Higher prices
• Higher profits

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 Why Monopolies Arise
• Monopoly resources
– A key resource required for production is owned by a
single firm
– Higher price
• The production process
– A single firm can produce output at a lower cost than can
a larger number of producers

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 Why Monopolies Arise
• Natural monopoly
– A single firm can supply a good or service to an entire
market
• At a smaller cost than could two or more firms
– Economies of scale over the relevant range of output

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Figure 1
Economies of Scale as a Cause of Monopoly

Costs

Average total cost

0 Quantity of output

When a firm’s average-total-cost curve continually declines, the firm has what is
called a natural monopoly. In this case, when production is divided among more
firms, each firm produces less, and average total cost rises. As a result, a single firm
can produce any given amount at the smallest cost
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 Production and Pricing Decisions
• Monopoly
– Price maker
– Sole producer
– Downward sloping demand
• Market demand curve
• Competitive firm
– Price taker
– One producer of many
– Demand – horizontal line (Price)
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Figure 2
Demand Curves for Competitive and Monopoly Firms
(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve
Price Price

Demand

Demand

0 Quantity of output 0 Quantity of output

Because competitive firms are price takers, they in effect face horizontal demand
curves, as in panel (a). Because a monopoly firm is the sole producer in its market, it
faces the downward-sloping market demand curve, as in panel (b). As a result, the
monopoly has to accept a lower price if it wants to sell more output.
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 Production and Pricing Decisions
• A monopoly’s revenue
– Total revenue = price times quantity
– Average revenue
• Revenue per unit sold
• Total revenue divided by quantity
– Marginal revenue, MR < P
• Revenue per each additional unit of output
• Change in total revenue when output increases by 1 unit
• Can be negative

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Table 1
A Monopoly’s Total, Average, and Marginal Revenue

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 Production and Pricing Decisions
• Increase in quantity sold
– Output effect
• Q is higher
• Increase total revenue
– Price effect
• P is lower
• Decrease total revenue
• Because MR < P
– MR curve – is below the demand curve
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MR in Competitive Firm and Monopoly

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Figure 3
Demand and Marginal-Revenue Curves for a Monopoly
Price
$11
10
9
8
7
6
5
4
3 Demand
2
1 (average revenue)
0
-1 1 2 3 4 5 6 7 8 Quantity
-2 of water
-3
-4 Marginal revenue

The demand curve shows how the quantity affects the price of the good. The marginal-revenue
curve shows how the firm’s revenue changes when the quantity increases by 1 unit. Because
the price on all units sold must fall if the monopoly increases production, marginal revenue is
always less than the price.
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 Production and Pricing Decisions
• Profit maximization
– If MR > MC – increase production
– If MC > MR – produce less
– Maximize profit
• Produce quantity where MR=MC
• Intersection of the marginal-revenue curve and the marginal-
cost curve
• Price – on the demand curve

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Figure 4
Profit Maximization for a Monopoly
Costs 2. . . . and then the demand
and curve shows the price consistent
with this quantity.
Revenue Marginal cost

Monopoly B
price
Average total cost
A

Demand
1. The intersection of the marginal-revenue
curve and the marginal-cost curve
determines the profit-maximizing quantity . . .

Marginal revenue
0 Q1 QMAX Q2 Quantity
A monopoly maximizes profit by choosing the quantity at which marginal revenue equals
marginal cost (point A). It then uses the demand curve to find the price that will induce
consumers to buy that quantity (point B).
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 Production and Pricing Decisions
• Profit maximization
– Perfect competition: P=MR=MC
• Price equals marginal cost
– Monopoly: P>MR=MC
• Price exceeds marginal cost
• A monopoly’s profit
– Profit = TR – TC = (P – ATC) ˣ Q

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Figure 5
The Monopolist’s Profit
Costs
and
Marginal cost
Revenue

Monopoly E B
Average total cost
price
Monopoly
profit
Average Demand
total
cost D C

Marginal revenue

0 QMAX Quantity

The area of the box BCDE equals the profit of the monopoly firm. The height of the box (BC) is
price minus average total cost, which equals profit per unit sold. The width of the box (DC) is the
number of units sold.
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 The Welfare Cost of Monopolies
• Monopoly
– Produce quantity where MC = MR
– Produces less than the socially efficient quantity of output
– Charge P>MC
– Deadweight loss
• Triangle between the demand curve and MC curve

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The Inefficiency of Monopoly

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 The Welfare Cost of Monopolies
• The monopoly’s profit: a social cost?
– Monopoly - higher profit
• Not a reduction of economic welfare
– Bigger producer surplus
– Smaller consumer surplus
• Not a social problem
– Social loss = Deadweight loss
• From the inefficiently low quantity of output

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 Price Discrimination
• Price discrimination
– Business practice
– Sell the same good at different prices to different
customers
– Rational strategy to increase profit
– Requires the ability to separate customers according to
their willingness to pay

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Price Discrimination

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Price Discrimination

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 Price Discrimination
• Examples of price discrimination
– Movie tickets
– Airline prices
– Financial aid
– Railway tickets

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Table 2
Competition versus Monopoly: A Summary Comparison

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