Monopoly

 A monopoly is the sole seller of its

product.
its product does not have close
substitutes.
 While a competitive firm is a price
taker, a monopoly is a price maker.

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 The fundamental cause of
monopoly is barriers to entry
Why barriers to entry?
Ownership of key resource.
Government franchise: exclusive right to produce
the good.
Costs of production: a single producer is more
efficient than many producers  natural monopoly.
.

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Economies of Scale as a Cause of Monopoly:
HIGH fixed costs  ATC turn up only beyond
the extent of the market “Natural Monopoly”
Cost

Average
total
cost

0 Quantity of Output
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 Demand Curves for Competitive and
Monopoly Firms...

(a) A Competitive Firm’s (b) A Monopolist’s

Demand Curve Demand Curve is the
Price The competitive firm Price downward sloping
takes the market price industry demand curve

Demand

Demand

0 Quantity of 0 Quantity of
Output Output

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 Monopoly Revenue
 Total Revenue
P x Q = TR
… just like competitive firm.
 Average Revenue
TR/Q = AR = P
… just like competitive firm.
BUT
 Marginal Revenue

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

Average
Quantity Price Total Revenue Revenue Marginal Revenue
(Q) (P) (TR=PxQ) (AR=TR/Q) (MR=TR / Q )
0 $11.00 $0.00
1 $10.00 $10.00 $10.00 $10.00
2 $9.00 $18.00 $9.00 $8.00
3 $8.00 $24.00 $8.00 $6.00
4 $7.00 $28.00 $7.00 $4.00
5 $6.00 $30.00 $6.00 $2.00
6 $5.00 $30.00 $5.00 $0.00
7 $4.00 $28.00 $4.00 -$2.00
8 $3.00 $24.00 $3.00 -$4.00

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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Demand and Marginal Revenue Curves

for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
 A Monopoly’s Marginal Revenue
TR/Q = MR < P

When a monopoly increases the

amount it sells, it has two effects on
total revenue (TR = P x Q).
 The output effect—more output is
sold, so Q is higher  + P x ΔQ.
 The price effect—price falls, so P is
lower  - Q x ΔP.

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 Profit Maximization of a Monopoly

 Produce quantity where

MR = MC
 Sell at the price where consumers buy
that profit maximizing quantity.
P = AR > MR = MC

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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Profit-Maximization for a Monopoly...

2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
 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
P > MC
Inefficiency
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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Monopolist’s Profit...

Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro
on f

Average total cost

op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Inefficiency of Monopoly...

Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
 The Inefficiency of Monopoly
The monopolist produces less
than socially efficient output.
The monopolist earns more by
doing less.

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 Public Policy Toward Monopolies

 Antitrust Laws: Make monopolized

industries more competitive.
 Regulate monopoly prices.
 Run monopolies as public enterprises.
 Do nothing.

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 Price Discrimination
Price discrimination -- selling the
same good at different prices to
different customers.
In order to price discriminate, the
firm must have some market power.

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 Welfare Without Price
Discrimination...
Price (a) Monopolist with Single
Price

Consumer
surplus

Monopoly Deadweight
loss
price
Profit
Marginal cost

Marginal Demand
revenue

0 Quantity sold Quantity

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 Welfare With Price
Discrimination...
Price (b) Monopolist with Perfect Price Discrimination

Profit
Marginal cost

Demand

0 Quantity sold Quantity

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 Examples of Price Discrimination

 Movie tickets
 Airline prices
 Discount coupons
 Financial aid
 Quantity discounts

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 The Prevalence of Monopoly
 Most firms have some control over
their prices because of differentiated
products.
 Firms with substantial monopoly
power are rare: few goods are truly
unique.
 Monopolists face competition from
other industries.

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 Summary

 A monopoly is a firm that is the sole

seller in its market.
 It faces a downward-sloping demand
curve for its product.
 A monopoly’s marginal revenue is
always below the price of its good.

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 Summary

 Like a competitive firm, a monopoly

maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.
 Unlike a competitive firm, its price
exceeds its marginal revenue, so its
price exceeds marginal cost
 INEFFICIENCY
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 Summary

 A monopolist’s profit-maximizing level

of output is below the level that
maximizes the sum of consumer and
producer surplus
 INEFFICIENCY

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 Summary

 Monopolists can raise their profits by

charging different prices to different
buyers based on their willingness to
pay.
 Price discrimination can raise
economic welfare and lessen
deadweight losses.

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 Graphical
Review

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 Economies of Scale as a Cause of
Monopoly...
Cost

Average
total
cost

0 Quantity of Output
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 Demand Curves for Competitive and
Monopoly Firms...
(a) A Competitive Firm’s (b) A Monopolist’s
Demand Curve Demand Curve
Price Price

Demand

Demand

0 Quantity of 0 Quantity of
Output Output

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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Demand and Marginal Revenue Curves

for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Profit-Maximization for a Monopoly...

2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Monopolist’s Profit...

Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro
on f

Average total cost

op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 The Market for Drugs...
Costs and
Revenue

Price
during
patent life

Price after Marginal

patent cost
expires Marginal
revenue Demand

0 Monopoly Competitive Quantity

quantity quantity
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 The Efficient Level of Output...
Price
Marginal cost

Value Cost to
to monopolist
buyers

Value
Cost to to Demand
monopolist buyers (value to buyers)
0 Efficient Quantity
quantity

Value to buyers is greater Value to buyers is less

than cost to seller. than cost to seller.
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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

The Inefficiency of Monopoly...

Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
 Marginal-Cost Pricing for a Natural
Monopoly...
Price

Average
total cost Average total cost
Loss
Regulated
price Marginal cost

Demand

0 Quantity
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 Welfare Without Price
Discrimination...
Price (a) Monopolist with Single
Price

Consumer
surplus

Monopoly Deadweight
loss
price
Profit
Marginal cost

Marginal Demand
revenue

0 Quantity sold Quantity

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 Welfare With Price
Discrimination...
Price (b) Monopolist with Perfect Price Discrimination

Profit
Marginal cost

Demand

0 Quantity sold Quantity

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