Monopoly Chapter 12

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Monopoly
Chapter 12
© 2003 McGraw-Hill Ryerson Limited.
12 - 2
Introduction
Monopoly is a market structure in
which a single firm makes up the entire
supply side of the market.
 Monopoly is the polar opposite of
perfect competition.

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12 - 3
Introduction
Monopolies exist because of barriers to
entry into a market that prevent entry by
new firms.
 Barriers to entry include legal barriers
such as a patent, and natural barriers
such as the size of the market that can
support only one firm.

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The Key Difference Between
a Monopolist and a Perfect
Competitor
A competitive firm is too small to affect
the price.
 It does not have to take into account the
effect of its output decision on the price
it receives.

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The Key Difference 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 equal to 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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The Key Difference 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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12 - 7
A Model of Monopoly

How much should a monopoly produce
to maximize its profit?
 The
monopolist employs a two-step profit
maximizing process; it chooses quantity
and price.
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The Monopolist’s Price and
Output
As in perfect competition, profit for the
monopolist is maximized at a point
where MC = MR.
 What is different for a monopolist –
marginal revenue does not equal price;
marginal revenue is below price.

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The Monopolist’s Price and
Output

If a monopolist deviates from the output
level at which marginal cost equals
marginal revenue, profits will fall.
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Profit Maximization for a Monopolist,
Output Price
0
1
2
3
4
5
6
7
8
9
36
33
30
27
24
21
18
15
12
9
Table 12-1, p 257
TR
MR
TC
MC
0
33
60
81
96
105
108
105
96
81
—
1
2
4
8
16
24
40
56
80
—
33
27
21
15
9
3
–3
–9
–15
47
48
50
54
62
78
102
142
196
278
ATC
Profit
48.00
25.00
18.00
15.50
15.60
17.00
20.29
24.75
30.89
–47
–15
10
27
34
27
6
–37
–102
–197
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The Monopolist’s Price and
Output Graphically
The marginal revenue curve tells us the
additional revenue the firm will get from
an additional unit of output.
 The marginal cost curve is a graph of
the change in firm’s total cost as it
changes output.

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The Monopolist’s Price and
Output Graphically

To determine the profit-maximizing price
and quantity:
 one
first finds output (where MC = MR),
and then
 extends a vertical line for that output, up to
the demand curve to find the price.
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The Monopolist’s Price and
Output Graphically
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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The Monopolist’s Price and
Output Graphically
The MR = MC condition determines the
quantity a monopolist produces.
 That quantity determines the price the
monopolist will charge.

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Comparing Monopoly and
Perfect Competition

Profit-maximizing output for the
monopolist, like profit maximizing
output for the competitor in a perfectly
competitive market is where MC = MR.
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Comparing Monopoly and
Perfect Competition

Because the monopolist’s marginal
revenue is below its price, its
equilibrium output is less than, and price
is higher than that of a perfectly
competitive market.
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The Monopolist’s Price and
Output Graphically, Fig.12-1, p 259
MC
Price
$36
30
24
20.5018
12
6
0
6
12
Monopolist
price and
output
Perfectly competitive
price and output
D
1
2
3
4
5 6
5.17
7
8 9 10
MR
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Finding the monopolist’s
price and output
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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Finding the monopolist’s
price and output

Determine the price the monopolist will
charge for that output by finding where
the quantity line intersects the demand
curve.
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Finding the monopolist’s
price and output, Fig. 12-2a and b, p 260
Price
MC
D
MR
Quantity
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Finding the monopolist’s
price and output, Fig. 12-2 c and d, p 260
Price
MC
PM
MR
QM
D
Quantity
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Finding the Monopolist’s
Profit
Determine the average cost at the
profit-maximizing level of output.
 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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Monopoly

A monopolist can make a profit, it can
break even, or it can incur a loss.
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A Monopolist Making a
Profit, Fig. 12-3, p 261
MC
Price
A
PM
Profit
CM
ATC
B
MR
0
QM
D
Quantity
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A Monopolist Breaking Even,
Fig. 12-4a, p 262
MC
Price
ATC
PM
MR
0
QM
D
Quantity
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A Monopolist Making a Loss
Fig. 12-4b, p 262
MC
Price
CM
PM
B
Loss
A
MR
0
ATC
QM
D
Quantity
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The 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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The 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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The Welfare Loss from
Monopoly
But the monopolist's MR is below its
price, thus its equilibrium output is
different from a competitive market.
 The welfare loss of a monopolist is
represented by the triangles B and D.

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12 - 30
The Welfare Loss from
Monopoly, Fig. 12-5, p 262
Price
MC
PM
C
PC
D
B
A
0
QM
MR
QC
D
Quantity
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12 - 31
The Welfare Loss from
Monopoly
Welfare loss is often called the
deadweight loss or welfare loss triangle.
 It is the geometric representation of the
welfare cost in terms of misallocated
resources that are caused by monopoly.

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The Price-Discriminating
Monopolist

Price discrimination is the ability to
charge different prices to different
customers.
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The 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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The Price-Discriminating
Monopolist

A price-discriminating monopolist 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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The Price-Discriminating
Monopolist

A perfect price discriminating monopoly
can extract the most consumers are
willing to pay for each unit of the product
it sells.

All consumer surplus is transferred to the
monopolist.
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The 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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Perfect Price Discrimination,
Fig. 12-6, p 265
Price
10
9
8
7
6
5
4
3
2
1
MC
D=MR
1 2 3 4 5 6 7 8 9 10 11
MR
Quantity (number of
consumers)
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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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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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Barriers to Entry and
Monopoly

Some important barriers to entry are:
 Economies
of scale,
 Set-up costs,
 Legislation.
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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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Barriers to Entry and
Monopoly

Economies of scale:
 If
significant economies of scale are
possible, it is inefficient to have two
producers because if each produced half of
the output, neither could take advantage of
economies of scale.
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Barriers to Entry and
Monopoly

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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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 fall within the
range of potential output.
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A Natural Monopoly, Fig. 12-7b, p 267
Price, Cost
PM
CM
CC
PC
ATC
MC
QM MR
QC D
Quantity
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12 - 46
Barriers to Entry and
Monopoly

Set-up costs:
 In
many industries high set-up costs
characterize production.
 The industry may be highly capitalintensive, requiring a large investment in
expensive but highly specialized capital.
 Examples are an oil refinery or a diamond
mine.
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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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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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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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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
world-wide distribution network for
diamonds, the company enjoys monopoly
in the diamond industry.
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Monopoly
End of Chapter 12
© 2003 McGraw-Hill Ryerson Limited.
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