MONOPOLY
ECO 2023
Principles of Microeconomics
Dr. McCaleb
Monopoly
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TOPIC OUTLINE
I.
Sources of Monopoly
II. Monopoly Equilibrium
III. Monopoly and Competition
IV. Price Discrimination
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Sources of Monopoly
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SOURCES OF MONOPOLY
 Characteristics of a Monopoly Market
Definition
A market with a single supplier of a good or service that has no close
substitutes and in which there are economic or legal barriers to the
entry of new competition.
Two key features
• No close substitutes
• Barriers to entry
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SOURCES OF MONOPOLY
 Characteristics of a Monopoly Market
Absence of close substitutes
Even a single seller in a market faces competition from substitute
goods outside its market. The closer the available substitutes, the
greater the competition and the less market power the monopolist can
exercise.
If a good has a close substitute, even though there is only one seller,
the market is effectively competitive. The single seller is unable to
exercise any significant degree of market power.
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SOURCES OF MONOPOLY
 Characteristics of a Monopoly Market
Barriers to entry
Anything that protects a seller from new competition, for example
• Exclusive ownership of an essential resource
• Economies of scale
• Government grant of an exclusive franchise.
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SOURCES OF MONOPOLY
 Barriers to Entry
Exclusive ownership of an essential resource
A seller can create its own barrier to entry if it owns a significant
portion of a key resource required for the production of the good or
service.
In practice, monopolies rarely arise for this reason. The market for
most resources is national or even international, and ownership of
most resources is dispersed among a large number of people and
nations.
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SOURCES OF MONOPOLY
 Barriers to Entry
Economies of scale
Economies of scale arise when a single seller can supply the entire
market at lower average total cost than two or more sellers.
A monopoly that arises because of economies of scale is called a
natural monopoly. Natural monopoly provides an economic
argument for regulated public utilities.
Markets characterized by economies of scale often become
competitive over time because of technological advances or because
of natural growth in the size of the market.
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SOURCES OF MONOPOLY
Economies of Scale
The cost to distribute 4 million
kilowatt hours of electric power is
5 cents a kilowatt-hour with one
seller in the market, or . . .
10 cents a kilowatt-hour with two
sellers, or . . .
15 cents a kilowatt-hour with four
sellers.
Because of economies of scale, one
seller can meet the market demand
at a lower average cost than two or
more sellers.
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SOURCES OF MONOPOLY
 Barriers to Entry
Government grant of an exclusive franchise
Legal barriers to entry are the source of most present-day monopolies.
Entry into the market or competition within the market are restricted
by the granting of a public franchise, government license, patent, or
copyright.
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Monopoly Equilibrium
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MONOPOLY EQUILIBRIUM
 Demand and Marginal Revenue
Demand and marginal revenue are negatively-sloped
Demand
Market demand is negatively-sloped. The monopolist faces a
tradeoff between price and quantity sold.
To obtain a higher price, the monopolist must lower quantity. Or, if it
wants to sell a larger quantity, it must lower price.
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MONOPOLY EQUILIBRIUM
 Demand and Marginal Revenue
Marginal revenue is less than price
An increase in quantity has two opposing effects on total revenue:
Output effect: An increase in TR equal to the price of the additional
quantity sold, which is partly offset by the
Price effect: A decrease in total revenue equal to the decrease in price
required to sell the additional quantity, multiplied by the quantity
sold before the price decrease.
The marginal revenue curve is negatively-sloped but lies below the
demand curve at each quantity: MR<P at all Q.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
Calculate the marginal revenue generated along the demand curve.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
If the price is $16, quantity demanded is 2 haircuts per hour.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
If the price is $14, quantity demanded is 3 haircuts per hour.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
Total revenue from two haircuts per hour decreases by $4.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
Total revenue from the additional haircut is $14.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
Marginal revenue from the additional haircut is $10.
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MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
The marginal revenue curve is negatively-sloped and lies below the
demand curve. Marginal revenue is less than price at each quantity.
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MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist
The diagram shows the
monopolist’s
• average total cost (ATC),
• marginal cost (MC),
• demand (D),
• and marginal revenue (MR).
The monopolist maximizes profits
or minimizes losses by producing
the quantity at which marginal
revenue equals marginal cost.
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MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist
The equilibrium quantity is 3
haircuts per hour where MR=MC,
and
the equilibrium price is $14, shown
by the demand at the quantity 3.
The ATC of 3 haircuts is $10.
Because P>ATC at the equilibrium
quantity, the monopolist earns a
profit of $4 per haircut or $12 per
hour.
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MONOPOLY EQUILIBRIUM
Profit Maximization by a Monopolist: Numerical Example
The data in the table below verify that 3 haircuts per hour maximizes the
monopolist’s profit.
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MONOPOLY EQUILIBRIUM
 Short-Run and Long-Run Equilibria
When a monopolist earns short-run profits
Because new competitors are barred from entering the market, a
monopolist’s short-run profits are not competed away. They persist
into the long-run.
Without new competition to increase quantity and lower price, the
monopolist’s long-run equilibrium quantity and price are the same as
the short-run equilibrium quantity and price.
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MONOPOLY EQUILIBRIUM
 Short-Run and Long-Run Equilibria
When a monopolist incurs short-run losses
However, if a monopolist incurs economic losses in the short-run, it
exits the market in the long-run. The long-run equilibrium quantity is
zero.
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Monopoly and Competition
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MONOPOLY AND COMPETITION
Competitive Equilibrium
The market demand curve is D.
The market supply curve is S.
The competitive market equilibrium
is where quantity demanded equals
quantity supplied.
The competitive equilibrium
quantity is QC and the equilibrium
price is PC.
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MONOPOLY AND COMPETITION
Monopoly Equilibrium
The competitive market supply
curve, S, is the monopolist’s
marginal cost curve, MC.
The monopolist’s marginal revenue
curve is MR.
The monopolist’s equilibrium
quantity is QM where marginal
revenue equals marginal cost. The
equilibrium price is PM , shown by
the demand at QM.
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MONOPOLY AND COMPETITION
 Competitive and Monopolistic Equilibria
Monopoly quantity is lower and price is higher
A monopolist supplies a smaller quantity than a competitive market
would supply at a higher price.
The higher price allows a monopolist to earn positive long-run
economic profits.
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MONOPOLY AND COMPETITION
 Economic Consequences of Monopoly
The absence of competition results in
• Inefficiency and deadweight loss
• Redistribution of wealth
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MONOPOLY AND COMPETITION
Efficiency of Competitive
Equilibrium
The competitive equilibrium price,
PC, brings consumers’ marginal
benefit into equality with producers’
marginal cost.
Therefore, the competitive
equilibrium quantity, QC, is
efficient. The sum of consumer
surplus and producer surplus is
maximized.
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MONOPOLY AND COMPETITION
Inefficiency of Monopoly
Marginal benefit in the monopoly
equilibrium (equals to the
monopoly equilibrium price, PM)
exceeds marginal cost.
Therefore, the monopoly
equilibrium quantity, QM, is
inefficient because of
underproduction. Monopoly results
in a deadweight loss.
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MONOPOLY AND COMPETITION
 Economic Consequences of Monopoly
Redistribution of wealth
Because of barriers to entry, a monopolist may earn positive long-run
economic profits--more than a normal accounting profit.
Unlike short-run profits (or losses) in a competitive market, a
monopolist’s positive long-run economic profits perform no useful
economic function. They provide no incentive for increasing the
supply of the good because new sellers cannot enter the market.
Positive long-run profits in a monopoly market only redistribute
wealth from consumers to the monopoly’s workers, managers, or
investors.
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MONOPOLY AND COMPETITION
Monopoly Redistributes
Wealth
The deadweight loss of monopoly
arises from a net loss in both
consumer and producer surplus
compared with the competitive
equilibrium.
In addition to the net loss in the
total surplus, monopoly also
redistributes some of the remaining
surplus from consumers to the
monopolist.
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Price Discrimination
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PRICE DISCRIMINATION
 Characteristics of Price Discrimination
Definition
Selling a good or service at a number of different prices where the
price differences do not reflect differences in cost but instead reflect
differences in consumers’ price elasticities of demand.
Successful price discrimination requires
• Market segmentation—the seller is able to identify different
types of buyers based on differences in their demand
elasticities.
• Costly arbitrage—it is costly for one consumer to buy the
good at a lower price and resell to another consumer at a
higher price
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PRICE DISCRIMINATION
 Characteristics of Price Discrimination
Two types of price discrimination
Discriminating among groups of consumers
Different prices for consumers with different elasticities. The market is
segmented based on some easily distinguished characteristic of
consumers—age, for example.
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PRICE DISCRIMINATION
 Characteristics of Price Discrimination
Discriminating among units of a good
The seller charges the same prices to all consumers but offers each
consumer a lower price for a larger number of units bought—volume
discounts, for example.
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PRICE DISCRIMINATION
 Characteristics of Price Discrimination
Comments
There is nothing evil or illegal about economic price discrimination.
It simply means charging different prices for the same good or
service unrelated to differences in cost.
Price discrimination is common in all markets other than perfectly
competitive markets.
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PRICE DISCRIMINATION
 Effects of Price Discrimination
Price discrimination may
•
Increase seller’s profit, at least in the short run
•
Enhance economic efficiency
•
Conserve on scarce resources.
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PRICE DISCRIMINATION
 Effects of Price Discrimination
Increases seller’s profits
Reducing price to buyers with elastic demands increases revenues.
Raising price to buyers with inelastic demands also increases
revenues.
If total quantity is unchanged, then costs are unchanged but revenues
and profits are higher.
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PRICE DISCRIMINATION
 Effects of Price Discrimination
Enhances economic efficiency
Monopoly is inefficient because of underproduction. Too little of the
good—less than the efficient quantity—is supplied by the
monopolist.
A price-discriminating monopolist is able to sell a larger quantity
than a single-price monopolist by reducing price only on the
additional units sold, not on all units sold.
Because the problem with monopoly is underproduction, increasing
quantity enhances efficiency. The sum of producer and consumer
surplus is higher in a monopoly market with price discrimination than
in a market with a single-price monopolist.
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PRICE DISCRIMINATION
Enhances Economic
Efficiency
20
18
A non-discriminating monopolist
sets a price of $12 and sells 3,000
units.
Consumer surplus is shown by the
green area. Producer surplus is
shown by the blue area.
The deadweight loss of monopoly is
shown by the purple area. The
deadweight loss is a measure of the
inefficiency because of
underproduction by the monopolist.
Consumer
Surplus
Producer
Surplus
16
14
12
Deadweight
Loss
MC
10
8
6
4
D
2
0
Monopoly
MR
0
1
2
3
4
5
6
7
8
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PRICE DISCRIMINATION
Enhances Economic
Efficiency
20
Consumer
Surp
lus
Surplus
18
If the monopolist discriminates by
charging $12 for the first 3,000
units and $9 for any additional
units, consumers buy 4,500 units.
Producer
Surp
lus
Surplus
16
14
Deadweight
Loss
12
MC
10
The deadweight loss disappears.
8
A portion of the deadweight loss is
added to producer surplus, and . . .
the rest of the deadweight loss is
added to consumer surplus.
6
4
D
2
MR
0
Price discrimination in this example
benefits both sellers and buyers.
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1
2
3
4
5
6
7
8
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PRICE DISCRIMINATION
 Effects of Price Discrimination
Conserves on scarce resources
In many markets, demand fluctuates systematically, often by time of
day or day of the week or seasonally.
Demand fluctuations result in crowding of facilities during peak
periods and excess capacity during off-peak periods.
Price discrimination reallocates demand from peak times to off-peak
times. With lower demand during peak times, the capacity of a
facility needed to serve the market is smaller and fewer resources are
required to satisfy consumer demand.
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