Monopoly
CHAPTER
9
© 2003 South-Western/Thomson Learning
1
Barriers to Entry
A monopoly is the sole supplier of a
product with no close substitutes
The most important characteristic of a
monopolized market is barriers to entry
 new firms cannot profitably enter the
market
Barriers to entry are restrictions on the
entry of new firms into an industry
Legal restrictions
Economies of scale
Control of an essential resource
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Legal Restrictions
One way to prevent new firms from
entering a market is to make entry
illegal
Patents, licenses, and other legal
restrictions imposed by the government
provide some producers with legal
protection against competition
3
Patent and Invention Incentives
A patent awards an inventor the
exclusive right to produce a good or
service for 20 years
Patent laws
Encourage inventors to invest the time and
money required to discover and develop
new products and processes
Also provide the stimulus to turn an
invention into a marketable product, a
process called innovation
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Licenses and other Entry Restrictions
Governments often confer monopoly
status by awarding a single firm the
exclusive right to supply a particular
good or service
Broadcast TV and radio rights
State licensing of hospitals
Cable TV and electricity on local level
5
Economies of Scale
A monopoly sometimes emerges
naturally when a firm experiences
economies of scale as reflected by the
downward-sloping, long-run average
cost curve
In these situations, a single firm can
sometimes supply market demand at a
lower average cost per unit than could
two or more firms at smaller rates of
output
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Natural Monopoly
Because such a monopoly emerges from
the nature of costs, it is called a natural
monopoly
A new entrant cannot sell enough
output to experience the economies of
scale enjoyed by an established natural
monopolist  entry into the market is
naturally blocked
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Control of Essential Resources
Another source of monopoly power is a
firm’s control over some
nonreproducible resource critical to
production
Professional sports teams try to block the
formation of competing leagues by signing
the best athletes to long-term contracts
Alcoa was the sole U.S. maker of aluminum
for a long period of time because it
controlled the supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade
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Local Monopolies
Local monopolies are more common
that national or international
monopolies
Numerous natural monopolies for
products sold in local markets
However, as a rule long-lasting
monopolies are rare because, as we will
see, a profitable monopoly attracts
competitors
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Revenue for the Monopolist
Because a monopoly, by definition,
supplies the entire market, the demand
for goods or services produced by a
monopolist is also the market demand
The demand curve for the monopolist’s
output therefore slopes downward,
reflecting the law of demand
As seen in the following discussion this
has important implications for revenues
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Demand, Average and Marginal Revenue
Suppose De Beers controls the entire
diamond market and suppose they can
sell three diamonds a day at $7,000
each  total revenue of $21,000
Total revenue divided by quantity is the
average revenue per diamond which is
also $7,000
Thus, the monopolist’s price equals the
average revenue per diamond
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Demand, Average and Marginal Revenue
To sell a fourth diamond, De Beers must
lower the price to $6,750  total
revenue for 4 diamonds is $27,000 and
average revenue is again $6,750
The marginal revenue from selling the
fourth diamond is $6,000  marginal
revenue is less than the price or average
revenue
Recall that these were equal for the
perfectly competitive firm
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Firm’s Costs and Profit Maximization
The monopolist can choose either the
price or the quantity, but choosing one
determines the other
Because the monopolist can select the
price that maximizes profit, we say the
monopolist is a price maker
More generally, any firm that has some
control over what price to charge is a
price maker
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Profit Maximization
Exhibits 5 and 6 repeat the revenue
data from the previous exhibits and also
include short-run cost data
The cost data are similar to those
already introduced in the preceding
chapters
The key issue is which price-quantity
combination should De Beers select to
maximize profits
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Short-Run Losses and the Shutdown Decision
A monopolist is not assured of profit
The demand for the monopolists good or
service may not be great enough to
generate economic profit in either the short
run or the long run
In the short run, the loss-minimizing
monopolist must decide whether to
produce or to shut down
If the price covers average variable cost, the
firm will produce
If not, the firm will shut down, at least in
the short run
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Monopolist’s Supply Curve
The intersection of a monopolist’s
marginal revenue and marginal cost
curve identifies the profit maximizing
quantity, but the price is found on the
demand curve
Thus, there is no curve that shows both
price and quantity supplied  there is
no monopolist supply curve
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Long-Run Profit Maximization
For a monopoly, the distinction between
the long and short run is not as
important
If a monopoly is insulated from
competition by high barriers that block
new entry, economic profit can persist
in the long run
However, short-run profit is no
guarantee of long-run profit
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Long-Run Profit Maximization
A monopolist that earns economic profit
in the short-run may find that profit can
be increased in the long run by
adjusting the scale of the firm
Conversely, a monopoly that suffers a
loss in the short run may be able to
eliminate that loss in the long run by
adjusting to a more efficient size
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Price and Output Comparison
Purpose here is to compare monopoly
using the benchmark established in our
discussion of perfect competition
When there is only one firm in the
industry, the industry demand curve
becomes the monopolist’s demand
curve  the price the monopolist
charges determines how much gets sold
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Why the Welfare Loss Might Be Lower
If economies of scale are extensive
enough, a monopolist may be able to
produce output at a lower cost per unit
than could competitive firms
If this is true, the price or at least the
cost of production could be lower under
monopoly than under competition
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Why the Welfare Loss Might Be Lower
The welfare loss shown in Exhibit 8 may
also overstate the true cost of monopoly
because monopolists may, in response
to public scrutiny and political pressure,
keep prices below what the market
could bear
Finally, a monopolist may keep the price
below the profit maximizing level to
avoid attracting new competitors
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Why the Welfare Loss Might Be Higher
Another line of thought suggests that
the welfare loss of monopoly may, in
fact, be greater than shown in our
example
If resources must be devoted to
securing and maintaining a monopoly
position, monopolies may involve more
of a welfare loss that simple models
suggest
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Why the Welfare Loss Might Be Higher
Consider, for example, radio and TV
broadcasting rights confer on the
recipient the exclusive right to use a
particular band of the scarce broadcast
spectrum
In the past, these rights have been
given away by government agencies to
the applicants deemed most deserving
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Why the Welfare Loss Might Be Higher
Because these rights are so valuable,
numerous applicants spend millions on
lawyers’ fees, lobbying expenses, and
other costs associated with making
themselves appear the most deserving
The efforts devoted to securing and
maintaining a monopoly position are
largely a social waste because they use
up scarce resources but add not unit to
output
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Why the Welfare Loss Might Be Higher
Activities undertaken by individuals or
firms to influence public policy in a way
that will directly or indirectly
redistribute income to them are referred
to as rent seeking
Second, monopolists insulated from the
rigors of competition in the
marketplace, may also become efficient
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Why the Welfare Loss Might Be Higher
Finally, monopolists have also been
criticized for being slow to adopt the
latest production techniques, to develop
new products, and generally lacking
innovativeness
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Price Discrimination
A monopolist can sometimes increase
economic profit by charging higher
prices to customers who value the
product more
The practice of charging difference
prices to different customers when the
price differences are not justified by
differences in cost is called price
discrimination
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Conditions for Price Discrimination
Conditions
The demand curve for the firm’s product
must slope downward  the firm has some
market power and control over price
There are at least two groups of consumers
for the product, each with a different price
elasticity of demand
The producer must be able, at little cost, to
charge each group a different price for
essentially the same product
The producer must be able to prevent those
who pay the lower price from reselling the
product to those who pay the higher price
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Model of Price Discrimination
Consumers are divided into two groups
with different demands
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Examples of Price Discrimination
Because businesspeople face
unpredictable yet urgent demands for
travel and communication, and because
employers pay such expenses,
businesspeople are less sensitive to
price than householders
Telephone companies are able to sort
out their customers by charging
different rates based on the time of day
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Perfect Price Discrimination
If a monopolist could charge a different
price for each unit sold, the firm’s
marginal revenue curve from selling one
more unit would equal the price of that
unit  the demand curve would become
the marginal revenue curve
A perfectly discriminating monopolist
charges a different price for each unit of
the good
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Perfect Price Discrimination
Perfect price discrimination gets high
marks based on allocative efficiency
Because such a monopolist does not
have to lower price to all customers
when output expands, there is no
reason to restrict output
In fact, because this is a constant-cost
industry, Q is the same quantity
produced in perfect competition
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Perfect Price Discrimination
As in perfect competition, the marginal
benefit of the final unit of output
produced just equals its marginal cost
And although perfect price
discrimination yields no consumer
surplus, the total benefits consumers
derive just equal the total amount they
pay for the good
Since the monopolist does not restrict
output, there is no deadweight loss
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