Prepared by:
Kevin Richter, Douglas College
Charlene Richter,
British Columbia Institute of Technology
© 2006 McGraw-Hill Ryerson Limited. All rights reserved.
1

Introduction
 Monopoly is a market structure in which a single firm makes up the entire market.
 Monopolies exist because of barriers to entry into a market that prevent competition.
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2

Introduction
 Legal barriers , such as patents, prevent others from entering the market.
 Sociological barriers – entry is prevented by custom or tradition.
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3

Introduction
 Natural barriers – the firm has a unique ability to produce what other firms can’t duplicate.
 Technological barriers – the size of the market can support only one firm.
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4

Differences Between a Monopolist and a Perfect Competitor
 A competitive firm is too small to affect the price.
 The monopolist takes into account the fact that its production decision can affect price.
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5

Differences Between a Monopolist and a Perfect Competitor
 A competitive firm's marginal revenue is the market price.

A monopolistic firm’s marginal revenue is not its price – it takes into account that in order to sell more it has to decrease the price of its product.
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6

Differences Between a Monopolist and a Perfect Competitor
 Monopolist as the only supplier faces the entire market demand curve.
 Therefore, monopoly demand is downward sloping, and to increase output the firm must decrease its price.
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7

Model of Monopoly
 How much should the monopolistic firm choose to produce if it wants to maximize profit?
 The monopolist employs a two-step profit maximizing process; it chooses quantity and price.
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8

Monopolist’s Price and Output
Numerically
 The first thing to remember is that marginal revenue is the change in total revenue that occurs as a firm changes its output.
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9

Monopolist’s Price and Output
Numerically
 When a monopolist increases output, it lowers the price on all previous units.

As a result, a monopolist’s marginal revenue is always below its price.
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10

Monopolist’s Price and Output
Numerically
 In order to maximize profit, a monopolist produces the output level at which marginal cost equals marginal revenue.
 Producing at an output level where MR >
MC or where MR < MC will yield lower profits.
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11

Profit Maximization for a Monopolist
Output Price TR
2
3
0
1
4
5
8
9
6
7
36
33
30
27
24
21
18
15
12
9
0
33
60
81
96
105
108
105
96
81
MR
—
33
27
21
15
9
3
–3
–9
–15
TC
47
48
50
54
62
78
102
142
196
278
MC
—
1
2
4
8
16
24
40
56
80
ATC Profit
48.00 –15
25.00
18.00
15.50
15.60
17.00
–47
10
27
34
27
6
20.29 –37
24.75 –102
30.89 –197
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12

Monopolist’s Price and Output
Graphically
 The marginal revenue curve is a graphical measure of the change in revenue that occurs in response to a change in price.
 It tells us the additional revenue the firm will get from an additional unit of output.
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13

Maximizing Output
 If MR > MC , the monopolist gains profit by increasing output.
 If MR < MC , the monopolist gains profit by decreasing output.
 If MC = MR , the monopolist is maximizing profit.
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14

Price a Monopolist Charges
 The MR = MC condition determines the quantity a monopolist produces.
 The monopolist will charge the maximum price consumers are willing to pay for that quantity.
 That price is found on the demand curve.
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15

Price a Monopolist Charges
 To determine the profit-maximizing price
(where MC = MR), first find the profit maximizing output.
 That quantity determines the price the monopolist will charge.
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16

Determine Monopoly Price and Output
Price
$36
30
24
18
12
6
0
6
12
Monopolist price
MC
1 2 3 4 5 6 7 8 9 10
MR
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D
17

Comparing Monopoly and Perfect
Competition
 Equilibrium output for both the monopolist and the competitor is determined by the MC
= MR condition.
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18

Comparing Monopoly and Perfect
Competition

Because the monopolist’s marginal revenue is below its price, price and quantity will not be the same as it is under perfect competition.

The monopolist’s equilibrium output is less than, and its price is higher than, for a firm in a competitive market.
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19

Comparing Monopoly and Perfect
Competition
MC
Price
$36
30
24
18
12
6
0
6
12
Monopolist price
Competitive price
1 2 3 4 5 6 7 8 9 10
MR
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D
20

Profits and Monopoly
 Draw the firm's marginal revenue curve.
 Determine the output the monopolist will produce by the intersection of the MC and
MR curves.
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21

Find Monopoly Price and Output
Price
MC
D
MR
Quantity
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22

Profits and Monopoly
 Determine the price the monopolist will charge for that output.
 Determine the average cost at that level of output.
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23

Find Monopoly Price and Output
Price
MC
P
M
MR
Q
M
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D
Quantity
24

Profits and Monopoly
 Determine the monopolist's profit (loss) by subtracting average total cost from average revenue ( P ) at that level of output and multiply by the chosen output.
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25

Profits and Monopoly
 The monopolist will make a profit if price exceeds average total cost.
 The monopolist will make a normal return if price equal average total cost.
 The monopolist will incur a loss if price is less than average total cost.
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26

Monopolist Making a Profit
 A monopolist can make a profit.
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27

Monopolist Making a Profit
Price
MC
0
ATC
P
M
C
M
Profit
A
B
MR
Q
M
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D
Quantity
28

Monopolist Breaking Even
 A monopolist can break even.
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29

Monopolist Breaking Even
Price
P
M
MC
ATC
0
MR
Q
M
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D
Quantity
30

Monopolist Making a Loss
 A monopolist can make a loss.
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31

Monopolist Making a Loss
Price
C
M
P
M
Loss
B
A
MC
ATC
0
MR
Q
M
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D
Quantity
32

Welfare Loss from Monopoly

People’s purchase decisions don’t reflect the true cost to society because monopolies charge a price higher than marginal cost.
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33

Welfare Loss from Monopoly
 The marginal cost of increasing output is lower than the marginal benefit of increasing output.
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34

Welfare Loss from Monopoly
 A single price monopoly creates welfare losses.
 Welfare losses can be illustrated by the area of consumer and producer surplus that is lost due to smaller output produced, compared to output produced in perfect competition.
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35

Welfare Loss from Monopoly
 Compare the normal monopolist's equilibrium to the equilibrium of a perfect competitor.
 Equilibrium in both market structures is determined by the MC = MR condition.
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36

Welfare Loss from Monopoly
 But the monopolist's MR is below its price, thus its equilibrium output is different from a competitive market.
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37

Welfare Loss from Monopoly
 The welfare loss of a monopolist is represented by the triangles B and D .
 The welfare loss is often called the deadweight loss or welfare loss triangle .
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38

Welfare Loss from Monopoly
Price
MC
P
M
P
C
0
C
D
B
A
MR
Q
M
Q
C
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D
Quantity
39

Price-Discriminating Monopolist
 Price discrimination is the ability to charge different prices to different individuals or groups of individuals.
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40

Price-Discriminating Monopolist
 In order to price discriminate, a monopolist must be able to:

Identify groups of customers who have different elasticities of demand;

Separate them in some way; and

Limit their ability to resell its product between groups.
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41

Price-Discriminating Monopolist
 A price-discriminating monopolist can increase both output and profit.
 It can charge customers with more inelastic demands a higher price.
 It can charge customers with more elastic demands a lower price.
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42


Price Discrimination Occurs in the
Real World
Movie theaters give senior citizens and child discounts.
 Airline seat sales usually require Saturday night stopovers.
 Automobiles are seldom sold at their sticker price.
 Theaters have midweek special rates.
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43

Price-Discriminating Monopolist
 A perfect price discriminating monopoly will stop expanding its output when MR = MC, which corresponds to the perfectly competitive output.
 The deadweight loss is therefore eliminated under perfect price discrimination.
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44

Perfect Price Discrimination
Price
4
3
6
5
10
9
8
7
2
1
MC
D=MR
1 2 3 4 5 6 7 8 9 10 11
MR
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Quantity (number of consumers) rights reserved.
45

Barriers to Entry and Monopoly
 What prevents other firms from entering the monopolist’s market in response to profits the monopolist earns?
 Monopolies exist because of barriers to entry .
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46

Barriers to Entry and Monopoly
 Barrier to entry – a social, political, or economic impediment that prevents firms from entering the market.
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47

Barriers to Entry and Monopoly
 In the absence of barriers to entry, the monopoly would face competition from other firms, which would erode its monopoly position .
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48

Barriers to Entry and Monopoly
 Economies of scale:

When production is characterized by increasing returns to scale, the larger the firm becomes, the lower its per unit costs become.
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49

Economies of Scale
 If significant economies of scale are possible, it is inefficient to have two producers.
 If each produced half of the output, neither could take advantage of economies of scale.
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50

Economies of Scale
 A natural monopoly is an industry in which one firm can produce at a lower cost than can two or more firms.
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51

Barriers to Entry and Monopoly
 Economies of scale:

In cases of natural monopoly, technology is such that minimum efficient scale is so large that average total costs decrease over the range of potential output.
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52

Natural Monopoly
C
3
C
2
C
1
0
ATC
Q
⅓
Q
½
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Q
1
Quantity
53

Economies of Scale
 There is no welfare loss in the natural monopoly situation.
 There can actually be a welfare gain because a single firm is so much more efficient than several firms producing the good.
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54

Natural Monopoly
P
M
C
M
Profit
C
C
P
C
0
Loss
MR
Q
M
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Q
C
ATC
MC
D
Quantity
55

Barriers to Entry and Monopoly
 Set-up costs:

In many industries high set-up costs characterize production.

The industry may be highly capital-intensive, requiring a large investment in expensive but highly specialized capital.

Examples are an oil refinery or a diamond mine.
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56

Barriers to Entry and Monopoly
 Set-up costs:

In some industries a lot of money may be spent on advertising.

Heavy advertising creates a barrier to entry in those cases, such as in the perfume industry or the automobile industry.
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57

Barriers to Entry and Monopoly
 Legislation:

Monopolies can also exist as a result of government charter.

Patents are another way in which government can grant a company a monopoly.
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58

Barriers to Entry and Monopoly
 Legislation:

A patent is a legal protection of technical innovation that gives the inventor a monopoly on using the invention.

To encourage research and development of new products, government gives out patents for a wide variety of innovations.
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59

Barriers to Entry and Monopoly
 Other barriers to entry:

Sometimes one company can gain ownership of some essential aspect of the production process, a unique input, or control over a resource.

An example is DeBeers. By controlling the worldwide distribution network for diamonds, the company enjoys a monopoly in the diamond industry.
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60

Normative Views of Monopoly
 The public generally views monopolies the way the Classical economists did – they consider them unfair and wrong.
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61

Normative Views of Monopoly
 Some normative arguments against monopoly include:

Income distributional effects associated with monopoly.

Rent-seeking activities in which people spend resources to lobby government for the monopoly power.
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62

Normative Views of Monopoly
 The public does not like the distributional effects of monopoly.
 They believe that it transfers income from
“deserving” consumers to “undeserving” monopolists.
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63

Normative Views of Monopoly
 It is possible for the well-financed and the well-connected to garner government favours.
 The public prefers that firms do productive things rather than lobby for government favours.
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64

Government Policy and Monopoly:
AIDS Drugs
 The patents for AIDS drugs are owned by a small group of pharmaceutical companies.
 They can charge a very high price for a drug whose marginal cost is very low.
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65

Government Policy and Monopoly:
AIDS Drugs
 What, if anything, should the government do?

Government could force the producer to charge a price equal to its marginal cost.

Society would be better off but this would create a significant disincentive for drug companies to do further research on other life-threatening diseases.
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66

Government Policy and Monopoly:
AIDS Drugs
 Another alternative is for the government to buy the patents and allow anyone to produce the drugs.

Payment would come from increased taxes and would be quite expensive.

The cost of regulation would decrease, but it would raise the question as to which patents the government should buy.
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67

End of Chapter 11
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68