MICROECONOMICS: Theory & Applications
Chapter 11: Monopoly
By
Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College
Learning Objectives

Define monopoly and show what a
monopolist’s demand and marginal revenue
curves look like.
 Explain why a monopolist’s profit-maximizing
output is where marginal revenue equals
marginal cost.
 Describe why the extent to which a
monopolist’s price exceeds marginal cost is
larger the more inelastic the demand faced by
the monopolist.
(continued)
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Learning Objectives
(continued)

Understand why the shutdown condition
applies to monopolies as well as to firms
operating in a perfectly competitive market.
 Outline the potential sources of monopoly
power: absolute cost advantages, economies
of scale, product differentiation, and regulatory
barriers.
 Explore the efficiency effects of monopoly from
a static as well as a dynamic perspective.
 Overview public policy toward monopoly.
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Terminology
Monopoly – a market with a single seller
 Monopoly power – some ability to set price
above marginal cost
 Price maker – a monopoly that supplies the
total market and can choose any price
along the market demand curve that it
wants

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The Monopolist’s Demand and
Marginal Revenue Curves

Demand curve
market demand
 average revenue


Marginal revenue:
effect on total revenue due to change in
output
 decreases as output increases
 less than price when demand curve slopes
downward

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Figure 11.1 - The Monopolist’s (Desperate
Housewives co-stars) Demand Curve
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Table 11.1
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Profit-Maximizing Output of a Monopoly

Marginal revenue is always less than price when
the demand curve slopes downward.

Profit is maximized where MR=MC:

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If MR>MC, then profits will increase if output is
increased.
If MR<MC, then profits will increase if output is
decreased.
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Table 11.2
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Figure 11.2 - Profit-Maximization:
Total and per-Unit Curves
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Figure 11.3 - Profit Maximization
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The Monopoly Price and Its
Relationship to Elasticity of Demand
The smaller the demand elasticity, the
greater the profit-maximizing price,
relative to marginal cost.
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Derivation of Price Formula
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Figure 11.4 - The Inverse Elasticity
Pricing Rule
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Further Implications of Monopoly
Analysis

A monopoly has no supply curve.
 A monopoly does not necessarily make
positive economic profit.
 A monopoly’s demand curve is elastic
where marginal revenue is positive.
 A profit-maximizing monopolist will always
sell at a price where demand is elastic.
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Figure 11.5 - Monopoly and the
Shutdown Condition
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Figure 11.6 - Monopoly Demand, Marginal
Revenue, and Total Revenue
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Figure 11.7 - Monopoly Power When
There are Several Suppliers
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Measuring Monopoly Power
Lerner Index – a means of measuring a
firm’s monopoly power that takes the
markup of price over marginal cost
expressed as a percentage of a product’s
price:
Lerner Index = (P – MC)/P
(3)
 The Lerner index varies between zero and
one.
 The larger the Lerner index value, the
greater a firm’s monopoly power.

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Sources of Monopoly Power

What factors determine the extent to
which a firm has monopoly power?

The elasticity of the market demand curve


If the market demand curve is perfectly elastic,
any individual supplier has no monopoly
power.
The elasticity of supply by other firms
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The monopoly power of any one firm is more
limited when there is a greater number of rival
firms.
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Barriers to Entry

Barrier to entry – any factor that limits the number of firms
operating in a market and thereby serves to promote monopoly
power

Categories:


Absolute cost advantage
 A situation in which an incumbent firm’s production cost
(long-run average total cost) is lower than potential
rivals’ production costs at all relevant output levels
Economies of scale
 A situation in which the long-run average total cost
curve for all firms slopes downward over the entire
range of market output
 Natural monopoly – an industry in which production cost
is minimized if one firm supplies the entire output.
(continued)
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Barriers to Entry

(continued)
Categories (continued):

Product differentiation


Regulatory barriers


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A means by which consumers may perceive the product
sold by an incumbent firm to be superior to that offered by
prospective rivals.
Barriers to entry created by the government through
vehicles such as patents, copyrights, franchises, and
licenses
Government purchases from particular firms
Limits on nonprice competition, e.g., advertising
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Strategic Behavior by Firms:
Incumbents and Potential Entrants

Factors affecting market power:
Elasticity of demand
 Number of other firms in industry
 Elasticity of market demand
 Elasticity of supply of other firms
 Product homogeneity
 Nature of the competition between firms
 Possibility of entry by new firms

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Figure 11.8 - Potential Entry and Monopoly
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The Efficiency Effects of Monopoly

Comparison between perfectly competitive
industry and monopoly:



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Perfectly competitive firm - horizontal MR
Monopoly – downward-sloping MR
Marginal cost curve is horizontal for both industry
structures
For the same demand and cost conditions,
price will be higher and output lower under
monopoly than under competition.
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Figure 11.9 - The Deadweight Loss of Monopoly
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A Dynamic View of Monopoly and
Its Efficiency Implications

Static analysis – a form of economic analysis that
looks at the efficiency of a market at any one point in
time


Dynamic analysis – a form of economic analysis that
looks, over time, at the efficiency of a market


Monopoly: less efficient than a perfectly competitive industry
Monopoly: enhances social welfare in the creation of better
products
Which approach is more appropriate? It depends:



Pricing power provides incentive to innovate
Competition increases total surplus
Pricing power forestalls benefits of competition
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Figure 11.10 - A Dynamic View of Monopoly
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Public Policy Toward Monopoly
Antitrust laws – a series of codes and
amendments intended to promote a
competitive market environment
 3 major statutes:

Sherman Act (1890)
 Clayton Act (1914)
 Federal Trade Commission Act (1914)

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Regulation of Price

Price ceiling:

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government-imposed maximum limit on price
=> restriction on output cannot result n higher price
eliminates the monopolist’s reason for restraining output
reduces monopoly profit
benefits consumers by lowering price
increases output to the efficient level, eliminating the
deadweight loss from monopoly
Limitations:

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outcome depend upon where price ceiling is set
Price should be high enough for profit>=0
Monopoly firm may decrease quality as a result
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Figure 11.11 - Regulation of Price
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The Math Behind Monopoly

(Slide 1)
The Monopolist’s Demand and Marginal
Revenue Curves
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The Math Behind Monopoly

(Slide 1)
The Monopolist’s Profit-Maximizing Output
Choice
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