Monopoly
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Outline:
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Characteristics of a monopoly
Why monopolies arise?
Production and pricing decision of monopolies
Monopoly and societal well- being
Government policy and monopolies
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Price discrimination
What is a monopoly?
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Monopoly is a firm that is the sole seller of
a product without close substitutes
Monopoly has market power and this
alters relationship between a monopoly
firm’s price and its costs.
A monopoly is a price maker
Characteristics of a monopoly:
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Product has no close substitutes
There are barriers to entry
Barriers to entry
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Barriers to entry arise from three sources
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Monopoly over key resources
Government gives a firm exclusive right to
produce
Natural monopoly due to costs of production
Natural monopoly arises because a single
firm can supply a good or service to an
entire market at a smaller cost than could
two firms (when a firm’s ATC continually
declines)
Production and Pricing Decisions
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Monopoly versus Competition:
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Monopoly has market power and perfect
competition has no market power
Monopoly is a price maker and competitive
firm is a price taker
Demand curve faced by the competitive firm
is perfectly elastic
Demand curve faced by the monopoly is
downward sloping
Market demand curve is a constraint on the
monopolist’s profit
Production and Pricing Decisions: Monopoly’s Revenue
Q
P
TR
AR
MR
0
1
11
10
0
10
10
10
2
3
4
9
8
7
18
24
28
9
8
7
8
6
4
5
6
30
6
2
6
7
8
5
4
3
30
28
24
5
4
3
0
-2
-4
Monopoly's Revenue
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TR=PQ
AR=P
MR<P (demand curve is down-ward
sloping)
There are two effects when a monopoly
increases the amount it sells
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Output effect: Q is higher
Price effect: P is lower
MR=0, positive, negative (depending on
the price effect on TR)
Monopoly's Profit Maximization
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A monopoly maximizes profit by producing
output at the point where MR=MC
The price for the profit maximizing output
is determined using the demand curve
For a monopoly firm:
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P>MR=MC
For a competitive firm:
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P=MR=MC
Monopoly's Supply Curve
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Since a monopoly is a price maker, the
monopolist’s decision to supply a particular
quantity is linked to its demand curve
The demand curve determines MR, which
in turn determines the profit maximizing
quantity to be sold
Welfare Cost of Monopoly
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P>MC and therefore this affects the wellbeing of the society by imposing a social
cost on them
Socially efficient quantity maximizing total
surplus occurs at the intersection of the
demand and MC curves
Monopoly’s chosen level of output occurs
at the intersection of the MC and MR
curves
Welfare Cost of Monopoly
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Monopolist produces less than the socially
efficient quantity of output thus
minimizing total surplus
P>MC implies that some potential
consumers do not buy the good due to the
deadweight loss imposed by the monopoly
price (similar to a tax)
The welfare cost= cost of rent seeking
activities+ deadweight loss
Public Policy Toward Monopolies
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Policy makers respond to the problem of
monopoly in 4 ways:
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Competition law : problem of synergies
Regulation: problems with MC and ATC pricing
Public ownership: problem with bureaucratic
methods
Leaving it to market forces
Price Discrimination
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The practice of selling the same good at
different prices to different consumers is
known as price discrimination
Firms must have market power in order to
price discriminate
Price discrimination is a rational strategy
for a profit-maximizing monopolist
Price discrimination requires ability to
distinguish consumers according to their
willingness to pay
Price Discrimination
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Certain market forces (arbitrage) can
prevent firms from price discriminating
Price discrimination can eliminate the
inefficiency inherent in monopoly pricing
Increase in welfare is reflected as an
increase in producer surplus (profit)
and there is no dead weight loss
Conclusion: monopoly power is a matter
of degree and is usually limited