Monopoly
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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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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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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
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 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
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 If a monopolist deviates from the output level at which marginal cost equals marginal revenue, profits will fall.
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Table 12-1, p 257
Output Price TR MR TC MC ATC Profit
0 36 0 — 47 — –47
1 33 33 33 48 1 48.00 –15
2 30 60 27 50 2 25.00 10
3 27 81 21 54 4 18.00 27
4 24 96 15 62 8 15.50 34
5 21 105 9 78 16 15.60 27
6 18 108 3 102 24 17.00 6
7 15 105 –3 142 40 20.29 –37
8 12 96 –9 196 56 24.75 –102
9 9 81 –15 278 80 30.89 –197
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The Monopolist’s Price and
Output Graphically
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 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
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 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
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 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
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 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
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Price
$36
30
20.50
24
18
12
6
0
6
12
MC
Monopolist price and output
Perfectly competitive price and output
1 2 3 4 5 6 7 8 9 10
5.17
MR
D
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Finding the monopolist’s price and output
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 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
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D
MR
Quantity
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Finding the monopolist’s price and output,
Fig. 12-2 c and d, p 260
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Price
MC
P
M
Q
M
D
MR
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
ATC
P
M
C
M
Profit
A
B
0 Q
M
MR
D
Quantity
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12 - 25
A Monopolist Breaking Even,
Fig. 12-4a, p 262
MC
Price
ATC
P
M
0 Q
M
MR
D
Quantity
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A Monopolist Making a Loss
Fig. 12-4b, p 262
MC
Price
C
M
P
M
Loss
B
A
ATC
0 Q
M
MR
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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The Welfare Loss from
Monopoly,
Fig. 12-5, p 262
Price
MC
P
M
C
P
C
0
D
B
Q
M
A
MR
Q
C
D
Quantity
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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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12 - 37
Perfect Price Discrimination,
Fig. 12-6, p 265
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
Quantity (number of consumers)
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12 - 38
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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12 - 45
A Natural Monopoly,
Fig. 12-7b, p 267
Price, Cost
P
M
C
M
C
C
P
C
Q
M
MR
ATC
MC
Q
C
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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12 - 47
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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12 - 49
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
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