What is Monopoly?

Can you give

some examples of monopoly
market?
Imperfect Competition
Imperfect competition: firms differentiate their product in
some way and so can have some influence over price.

Monopoly is a market structure with only one firm and no

close substitutes.

Eg: Google, Amazon, Microsoft, Facebook

Can you name 5 monopoly firms?

Price Maker
A competitive firm is a price taker, a monopoly firm is a
price maker
◦ Market share is the proportion of total sales in a market
accounted for by a particular firm.
◦ Market power is where a firm is able to raise the price of
its product and not lose all its sales to rivals. (Apple
product)
Why do you think monopolies
arise?
Why do monopolies arise?
The presence of barriers to entry
◦ Ownership of a key resource.
◦ The government gives a single firm the exclusive right
to produce some good.
◦ Costs of production make a single producer more
efficient than a large number of producers.
◦ A firm is able to gain control of other firms in the
market and thus grow in size.
◦ Patent and copyright laws are two important examples
of how government creates a monopoly
Natural Monopolies: Economies of scale
Cost

When a single firm can supply a good or

service to an entire market at a smaller cost
than could two or more firms.
Eg: IRCTC

Average
total
cost

0 Quantity of Output
Can you give some examples of companies
that have expanded by external growth?
o By acquisition, merger or takeover of other
firms?
o Develop monopoly power over its rivals and
erect barriers to entry to make it harder for new
firms to enter?
Monopoly Versus Competition
The key difference between a
competitive firm and a
monopoly is the monopoly's
ability to control price.
◦ A monopoly faces a
downward sloping demand
curve
◦ A monopoly can increase
price and not lose all its
sales.
A Monopoly’s Revenue
Total Revenue

P  Q = TR

Average Revenue

TR/Q = AR = P

Marginal Revenue

TR/Q = MR
A Monopoly’s Revenue
A Monopoly’s Total, Average, and Marginal Revenue
A Monopoly’s Revenue

◦A monopolist’s marginal revenue is

always less than the price of its good.
◦ The demand curve is downward sloping.
◦ When a monopoly drops the price to sell one more unit, the revenue
received from previously sold units also decreases.
◦ When a monopoly increases the amount it sells, it has two effects on total
revenue (P  Q).
◦ The output effect—more output is sold, so Q is higher.
◦ The price effect—price falls, so P is lower.
A Monopoly’s Revenue
Demand and Marginal Revenue Curves for a Monopoly
Price
€11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average
1 revenue revenue)
0
–1 1 2 3 4 5 6 7 8 Quantity of Water
–2
–3
–4
Profit Maximization
o A monopoly maximizes profit by producing the
quantity at which marginal revenue equals
marginal cost. (MR=MC)
o It then uses the demand curve to find the price
that will induce consumers to buy that quantity.
Profit Maximization
Profit Maximization for a Monopoly
Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity
Profit Maximization
Comparing Monopoly and Competition
◦ For a competitive firm, price equals marginal cost.
P = MR = MC
◦ For a monopoly firm, price exceeds marginal cost.
P > MR = MC
A Monopoly’s Profit
Monopolist’s Profit The monopoly will receive
Costs and economic profits as long as
Revenue price is greater than average
total cost.
Marginal cost

Monopoly E B
price

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue

0 QMAX Quantity
Exercise
Inverse demand function for a monopolist’s
product is given by P = 100 – 2Q and cost
function is given by C(Q) = 10 + 2Q.
Determine profit maximizing price and
quantity (hint: MC(Q) = MR(Q) at QM) and
maximum Profits.
Answer

QM = 24.5; PM = 51 Profit = $1190.50

TR = PxQ = (100 – 2Q) x Q Profit = Revenue – Cost
MR = dR/dQ = 100 – 4Q = QM PM - C(QM)
MC = dC/dQ = 2 = (51)(24.5) – [10+2(24.5)]
Set MR = MC: 100 – 4Q = 2 = $1190.5
QM = 24.5; PM = 51
Exercise
Johnny Rockabilly has just finished recording his latest CD.
His record company’s marketing department determines
that the demand for the CD is in the table.

The company can produce the CD with no fixed cost and a

variable cost of $5 per CD.

a. Find total revenue for quantity equal to 10,000, 20,000,

and so on. What is the marginal revenue for each 10,000
increase in the quantity sold?

b. What quantity of CDs would maximize profit? What

would the price be? What would the profit be?

c. If you were Johnny’s agent, what recording fee would

you advise Johnny to demand from the record company?
Why?
Answer
A publisher faces the following demand
schedule for the next novel of one of its
popular authors:

The author is paid $2 million to write the

book, and the marginal cost of publishing the
book is a constant $10 per book.
a. Compute total revenue, total cost, and
profit at each quantity. What quantity would a
profit-maximizing publisher choose? What
price would it charge?
b. Compute marginal revenue. How does
marginal revenue compare to the price?
Explain.
c. Graph the marginal-revenue, marginal-cost,
and demand curves. At what quantity do the
marginal-revenue and marginal-cost curves
cross? What does this signify?
a. A profit-maximizing publisher would choose a quantity of 400,000
at a price of $60 or a quantity of 500,000 at a price of $50; both
combinations would lead to profits of $18 million.
b. Marginal revenue is always less than price. Price falls when
quantity rises because the demand curve slopes downward, but
marginal revenue falls even more than price because the firm loses
revenue on all the units of the good sold when it lowers the price.
c. The marginal revenue and marginal-cost curves cross between
quantities of 400,000 and 500,000. This signifies that the firm
maximizes profits in that region.
Answer
 Absence of Supply Curve
• No well-defined supply curve for a monopoly firm
• Supply curve: shows unique relationship between
price and quantity
• Supply determined at P=MC under perfect
competition
• Supply determined at MR=MC under monopoly
• Takes into account shape of demand
curve/elasticity of demand
• No unique relationship b/w price and quantity
supplied by monopolist
Multi-plant Decisions

• Situation: identical product, sold at P(Q), produced at multiple plant

• Profit maximization for two-plant monopolist:

MR(Q) = MC1(Q1)
MR(Q) = MC2(Q2)
Where MR: Marginal revenue of total product Q;
MC1(Q1): Marginal cost of producing in Q1 plant 1
MC2(Q2): Marginal cost of producing in Q2 plant 2
• Example
Suppose a monopolist’s analytics team estimated inverse
demand as P(Q) = 70 − .5Q The monopolist can produce
output in two plants. The marginal cost of producing in plant 1
is MC1 = 3Q1, and the marginal cost of producing in plant 2 is
MC2 = Q2. How much output should be produced in each
plant to maximize profits, and what price should be charged
for the product?
(Hint: Substitute Q with (Q1+Q2) in MR(Q))

• Answer:
Q1 = 10, Q2 = 30, P = $50
The Efficient Level of Output
Price
Marginal cost

Value Cost
to to
buyers monopolist

Demand
Cost Value (value to buyers)
to to
monopolist buyers

0 Quantity

Value to buyers Value to buyers

is greater than is less than
cost to seller. cost to seller.
Efficient
quantity
The Deadweight Loss: Inefficiency of
monopoly
Price
Deadweight Marginal cost
loss

Monopoly • Monopoly sets its price

price above marginal cost

• Wedge between the

consumer’s willingness
to pay and the
producer’s cost.

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
The Deadweight Loss
o The monopolist produces less than the socially efficient quantity of output.
o The deadweight loss caused by a monopoly is similar to the deadweight
loss caused by a tax.
o The difference between the two cases is that the government gets the
revenue from a tax, whereas a private firm gets the monopoly profit.
o Is monopolies profit a loss to the society?
o The transfer of surplus from consumers to producers is not a social
loss.
o The losses are: producing less than the socially efficient level of output,
monopolist incurs cost to maintain monopoly power
Price Discrimination
Price discrimination is selling the same good at different
prices to different customers, even though the costs for
producing for the two customers are the same.

Arbitrage will limit a monopolist's ability to price

discriminate.
Arbitrage is the process of buying a good in one market at a
low price and then selling it in another market at a higher
price. (Eg Rs 100 per kg mangoes in Kolkata and Rs 80 in
Dhanbad, effect: price will increase in Dhanbad and
decrease in Kolkata)
Provide examples of price discrimination?
Examples of price Discrimination
① Cinema tickets
② Airline prices
③ Discount coupons
④ Quantity discounts
Policy Makers Response to
Monopolies
◦ Making monopolized industries more competitive
(prevent mergers, break up companies,
◦ Regulating the pricing behavior of monopolies.
◦ Turning some private monopolies into public
enterprises.
◦ Doing nothing at all.
You live in a town with 300 adults and
200 children, and you are thinking about
putting on a play to entertain your
neighbors and make some money. A play
has a fixed cost of $2,000, but selling an
extra ticket has zero marginal cost. Here
are the demand schedules for your two
types of customer:
a. To maximize profit, what price would
you charge for an adult ticket? For a
child’s ticket? How much profit do you
make?
b. The city council passes a law
prohibiting you from charging different
prices to different customers. What price
do you set for a ticket now? How much
profit do you make?
Answers

•A. To maximize profit, you should charge

adults $7 and sell 300 tickets. You should
charge children $4 and sell 200 tickets. Total
revenue will be $2,100 + $400 = $2,500.
Because total cost is $2,000, profit will be
$900.
•B. If price discrimination were not allowed,
you would want to set a price of $7 for the
tickets. You would sell 300 tickets and profit
would be $100.
Exercise
Larry, Curly, and Moe run the only saloon in town.
Larry wants to sell as many drinks as possible
without losing money. Curly wants the saloon to
bring in as much revenue as possible. Moe wants to
make the largest possible profits. Using a single
diagram of the saloon’s demand curve and its cost
curves, show the price and quantity combinations
favored by each of the three partners. Explain.
Larry wants to sell as many drinks as possible without losing money, so he wants to set
quantity where price (demand) equals average total cost, which occurs at quantity QL and
price PL. Curly wants to bring in as much revenue as possible, which occurs where marginal
revenue equals zero, at quantity QC and price PC. Moe wants to maximize profits, which
occurs where marginal cost equals marginal revenue, at quantity QM and price PM.