Monopoly
• Monopoly
– Firm is the only seller of a good with no close
substitutes
– The firm sets the price (price maker)
– This must mean there are barriers to free entry
into the market
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Examples:
Monopoly on resources
Government regulation
Production process
Natural Monopoly (economies of scale)
• Monopoly on resources
– Maybe own the sole input required for production
• Government Regulation
– Government might give out patents/copyrights
• Production Process
– Maybe a firm is just so much better no other firm
can compete
• Natural Monopoly
– Because of economies of scale a sole producer can
supply entire market for cheaper than two
separate firms
Costs
If a firms ATC curve continues to drop over the relevant
range of the market, than it can produce all goods for
cheaper than two separate firms working
independently. This is a case for a natural monopoly
ATC
Quantity
Monopoly Vs Competition
• Competitive firm
– Price taker
– One producer among many
– Faces a horizontal demand curve
• Monopoly
– Price Maker
– Sole producer
– Faces a downward sloping demand curve
• (The market demand curve)
Demand Curve Faced By
Competitive Firm
Demand Curve Faced By
Monopoly
P
P
Demand
Demand
Q
Q
Since competitive firms are price takers they in effect face a horizontal demand
curve at the market price. Since monopolies are the sole producer they face the
actual market demand curve. If a monopoly wants to sell more they have to
lower the price, competitive firms can sell as much as they want at the market
price. But monopolies can raise the price (and sell less) whereas competitive
firms cannot raise the price.
• Total Revenue
– Price time quantity sold
• Average Revenue
– Revenue divided by quantity sold
• Marginal Revenue
– Change in revenue by selling one more unit
(remember to sell more units the monopolist must
lower the price)
– MR can be negative for the monopolist
• MR < P
Total, Average and Marginal
Revenue of a Monopolist
Quantity
Price
Total
Revenue
Average
Revenue
Marginal
Revenue
0
20
0
--
--
1
18
18
18
18
2
16
32
16
14
3
14
42
14
10
4
12
48
12
6
5
10
50
10
2
6
8
48
8
-2
7
6
42
6
-6
• Monopolist faces a trade-off when deciding
whether to produce/sell more or not
• Quantity goes up
– By selling more the quantity effect increases
revenue
• Price must go down
– Since to sell more he must lower the price, the
price effect is to decrease revenue
• So MR < P
– That is the MR curve is below the demand curve
P
Mathematic reason for MR < Demand:
P = A + B*Q (equation of demand curve)
Revenue = P*Q
Revenue = (A + B*Q)*Q = A*Q + B*Q2
MR = Derivative of Revenue
MR = A + 2*B*Q
So MR curve is twice as steep as the demand
curve so falls twice as fast
MR
Demand
Q
Intuition behind MR < Demand:
Because the price on all units sold must
be lowered to sell more the MR curve
falls faster than the demand curve on
which only the last units price must be
lower.
Profit Maximization
• Still as before always produce at quantity
where MR = MC
• If MR < MC
– Not worth producing that unit, make less
• If MR > MC
– Will be gaining more than it costs you, make more
P
Then that Q up to the
demand curve shows
the price consistent with
that quantity
MC
PM
Monopolist (as all producers)
choose quantity where MR = MC
ATC
Demand
MR
Q*
Q
• Perfect Competition
– P = MR = MC
– Price equals marginal cost
• Monopoly
– P > MR = MC
– Price is greater than marginal cost
• Profit
– TR – TC
– (P – ATC)*Q
P
Monopolist Profit
MC
PM
ATC
ATC
Demand
MR
Q*
Q
Welfare and Monopolies
• Remember to maximize welfare we maximize
the total surplus
• Consumer Surplus
– Value to consumer minus price paid
• Producer Surplus
– Price received minus cost to make
• So to maximized we said we should produce
where MC curve crosses marginal benefit
curve (demand curve)
MC
Demand
(marginal benefit)
Here MC is less than
benefit, so should
produce
Q
efficient
Here MC is greater than
benefit, so should not produce
• Efficient
– Produce where MC = Demand
• Monopolist
– Produces where MC = MR
– MR curve below Demand curve
• So
– Produces less than efficient level
– Charges P > MC
– Leads to deadweight loss (area where production
would increase welfare, but it is not produced)
P
Deadweight
Loss
MC
MR
PM
Note: It is not the fact that the
monopolist charges a higher
price that leads to the
inefficiency, it is that they
produce less than the efficient
quantity.
Demand
QM
QE
Q
Since the monopolist produces less than the efficient level, it
leads to a deadweight loss, because some consumers who
value the good more than the MC don’t get to consume it.
Price Discrimination as a Fix to DWL
from Monopoly
• Charging different people different prices
• Perfect price discrimination
– Charge each person exactly what they value the good
at
– Thus the monopolist MR curve is the demand curve
– Monopolist gets all the surplus, but no DWL
• Under normal circumstances
– Everybody pays same price
– Thus monopolists MR curve is below the demand
curve
– Monopolist profit max decision leads to DWL
Monopolist with Single
Price
Monopolist with Price
Discrimination
Consumer Surplus
Producer Surplus
MC
MC
DWL
PM
Producer Surplus
Demand
Demand
MR
QM
Q sold