Chapter 10
Pure Monopoly
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Characteristics of pure
monopoly
• Profit-maximizing output and
price
• Economic effects of monopoly
• Charging different prices in
different markets
10-2
Characteristics of Monopoly
• A “pure monopoly” exists when a
single firm is the sole producer of
a product for which there is no
close substitutes
• There are a number of products
where the producers have
significant, but not total monopoly
power – there are called “near”
monopolies
• Pure monopolies are “Price
makers” because they control the
price of the product that they sell
10-3
Characteristics of Monopoly
• Blocked entry of other firms into
the monopoly industry is probably
the most important factor in the
creation and maintenance of
monopolies
• Monopolies may or may not
advertise to increase demand for
their product
Examples of Monopoly
• Regulated or natural monopolies include
public utilities such as gas, electric,
water, cable TV
• Near monopolies include Western Union
and the De Beers diamond company.
• Geographic monopolies would include
professional sport teams who are
located in large cities
– Small towns may have only one bank and
one barber shop
• There are almost no manufacturing
monopolies because of the availability of
substitutes for the manufacture items
(cars, for example)
10-5
Barriers to Entry
• Economies of scale are a major barrier to
other firms entering the monopolized
industry
– In a monopoly, the lowest unit costs and
thus the lowest unit prices for consumers
are achieved only by the monopolist
– Because a very large firm is with a large
market share is most efficient, new firms
cannot afford to start up in industries with
economies of scale
– Public utilities are often natural monopolies
because they have such large economies
of scale that no other firms can compete
10-6
Economies of Scale
Barriers to Entry
• Legal barriers to entry may consist of patents
and licenses
– Patents grant the inventor exclusive rights to
produce a product for 20 years, earning profits for
more inventions
– Licenses restrict the number of people or firms who
can enter an industry, creating a monopoly for a
few who already have a license
• Ownership or control of essential resources
– De Beers controls 55% of the world’s supply of
diamonds; International Nickel for a long time
controlled 90 % of the world’s nickel supply
Barriers to Entry
• Pricing and other strategic barriers to
entry
– Microsoft charged higher prices for its
Windows operating system to computer
manufactures who featured Netscape
Navigator instead of Microsoft’s Internet
Explorer
– U.S. courts ruled this action illegal
Monopoly Demand
• An analysis of the demand curve in
monopoly makes three assumptions:
– The monopoly is secure because of patents,
economies of scale, or resource ownership
– The firm is not regulated by government
– The firm charges the same price for all units
of production
• The firm is the entire industry and so
the firm’s demand curve is the industry’s
demand curve
• The demand curve is downward sloping;
i.e., at each price level, there is a different
quantity produced
10-10
Price and Marginal Revenue
Marginal revenue is less than price
• A monopolist is
selling 3 units at
$142
• To sell 4, price must
be lowered to $132
• All customers
must pay the same
price
• TR increases $132
minus $30 (3x$10)
$142
132
122
112
Loss = $30
D
102
Gain = $132
92
82
0
1
2
3
4
5
6
10-11
Price and Marginal Revenue
Marginal revenue is less than price
• A monopolist is
selling 3 units at
$142
• To sell 4, price must
be lowered to $132
• All customers
must pay the same
price
• TR increases $132
minus $30 (3x$10)
• $102 becomes a
point on the MR
curve
• Try other prices to
determine other
MR points
$142
132
122
112
Loss = $30
D
102
Gain = $132
92
82
MR
0
1
2
3
4
5
6
The Constructed Marginal Revenue Curve
Must Always Be Less Than the Price
10-12
Down-Sloping Demand
• Price will exceed marginal
revenue because the monopolist
will need to lower price to
increase sales
• Firm is a price maker and so, by
selecting the amount the firm
wants to produce, they also
select the price (or vice-versa)
10-13
Down-Sloping Demand
• There is a relationship between the
elastic and inelastic regions of the
demand curve and the amount of total
revenue received
– When demand is elastic, total revenue
will rise when the monopoly lowers price
– When demand is inelastic, total revenue
will fall when the monopoly lowers price
• Therefore, monopolies will want to
operate in the elastic range of its
demand curve
Profit Maximization
• Monopolists want to operate at the profitmaximizing output
– Marginal revenue marginal cost rule is
followed; maximum profit occurs when
MR=MC
– The same result can be found by comparing
total revenue and total costs at each level of
production
• There is no supply curve for a monopolist
because there is no constant relationship
between price and quantity supplies
– The price and quantity supplied always
depend on the location of the demand curve
10-15
Monopoly Revenue and Costs
Cost Data
Revenue Data
(2)
Price
(1)
Quantity (Average
Of Output Revenue)
0
1
2
3
4
5
6
7
8
9
10
$172
162
152
142
132
122
112
102
92
82
72
(3)
Total
Revenue
(1) X (2)
$0 ]
162 ]
304 ]
426 ]
528 ]
610 ]
672 ]
714 ]
736 ]
738 ]
720
(4)
Marginal
Revenue
$162
142
122
102
82
62
42
22
2
-18
(5)
(6)
(7)
(8)
Average Total Cost Marginal Profit (+)
Total Cost (1) X (5)
Cost
or Loss (-)
$190.00
135.00
113.33
100.00
94.00
91.67
91.43
93.75
97.78
103.00
$100 ]
190 ]
270 ]
340 ]
400 ]
470 ]
550 ]
640 ]
750 ]
880 ]
1030
$90
80
70
60
70
80
90
110
130
150
$-100
-28
+34
+86
+128
+140
+122
+74
-14
-142
-310
Can you See Profit Maximization?
10-16
Monopoly Revenue and Costs
$200
Demand and Marginal-Revenue Curves
Elastic
Inelastic
Price
150
100
50
D
MR
0
2
4
Total Revenue
$750
6
8
10
12
Total-Revenue Curve
14
16
18
500
250
0
TR
2
4
6
8
10
12
14
16
18
10-17
Profit Maximization
Price, Costs, and Revenue
$200
175
MC
150
Pm=$122
125
100
75
Economic
Profit
ATC
A=$94
D
MR=MC
50
25
0
MR
1
2
3
4
5
6
7
8
9
10
Quantity
10-18
Misconceptions
• Monopolists cannot charge the highest price it
can get because it will maximize profits where
total revenue minus total cost is greatest
– This depends on quantity sold as well as on
price, and will never be the highest price
possible
• Total profit, not profit per unit, is the goal of
the monopolist
– A check of Table 10.1 in the text shows that
unit profits are $32 at 4 units, while at the profitmaximizing output of 5 units, unit profits are
only $28
10-19
Possibility of losses to a monopolist
• In the long run, a pure monopolist can
continue to received economic profits since
no other firms can enter the industry and
provide competition
• Although losses can occur in a pure
monopoly in the short run, the less-thanprofitable monopolist will shutdown in the
long run
Price, Costs, and Revenue
Loss Minimization
MC
A
Pm
ATC
Loss
AVC
V
D
MR=MC
MR
0
Qm
Quantity
10-21
Economic Effects
Pure
Monopoly
Purely
Competitive
Market
S=MC
MC
Pm
P=MC=
Minimum
ATC
Pc
b
c
Pc
a
D
D
MR
Qc
Qm
Qc
Pure competition is efficient
Monopoly is inefficient
10-22
Policy Options
• The government can use antitrust laws to
break up the firm – standard oil in 1911
– Microsoft was charged by the government
with monopoly, but an earlier court decision
was overturned
– Instead of breaking up the firm, microsoft
was required to cease certain anticompetitive practices
• Natural monopoly
– Regulate price
• Ignore
– Unstable in long run because of new
technology
10-23
Price Discrimination
• Monopolies may practice Price
Discrimination
– They may charge each customer in
a single market the maximum price
he or she is willing to pay
– Charge each customer one price for
the first set of products purchased,
and a lower price for any purchased
later
– They may charge one group of
customers one price and another
group a different price
10-24
Price Discrimination
• Conditions needed for price
discrimination
– Monopoly power with the ability
to control price and output
– The firm must have the ability to
divide buyers into separate
groups that have a different
willingness to pay for the product
(elasticities)
– Buyers must be unable to resell
the original product or service
10-25
Price Discrimination
• Examples
– Airfares charge high fares to business
travels who have inelastic demands
than vacation travelers who have
elastic demand
– Electric utilities can charge a higher
price for electricity because the
demand is inelastic (only one source
of electricity) than for heating which is
elastic (consumer can use oil, gas, or
electric)
Price Discrimination
• Long-distance phone surfaces have
higher rates during the day when
businesses must make their call and lower
rates at night and on week-ends, when
less important calls are made
• International trade has examples of firms
selling at different prices to customers
indifferent countries
• Golf courses vary their charges on the
basis of time
Regulated Monopoly
• The rate (price) natural monopolies charge may
be regulated through government intervention
• The socially optimum price is the price that
where allocative efficiency is achieved
– At that price, the marginal benefits to society
are equal to the marginal costs, and the
resources could not be used elsewhere more
efficiently
o At that point, P = MC
However, if the price is too low, the
monopoly may not make profit and will go out
of business
• In order for a monopoly to operate at the
socially optimum price level, it may need to be
subsidized by the government
10-28
Regulated Monopoly
• A Fair return price allows the monopoly to
make enough profit to pay for its costs
– This is determined at the point output where
P = ATC
– When P=ATC, the firm is realizing a normal
profit, but not an economic profit
– The monopoly still operates at an inefficient
level from a social aspect but more efficiently
than at the socially optimal price level
Regulated Monopoly
Dilemma of Regulation
Price and Costs (Dollars)
Monopoly
Price
Pm
Fair-Return
Price
f
Pf a
Socially
Optimal
Price
ATC
Pr
r
D
MR
0
MC
b
Qm
Qf
Qr
Quantity
10-30
Key Terms
•
•
•
•
•
•
•
•
•
pure monopoly
barriers to entry
simultaneous consumption
network effects
X-inefficiency
rent-seeking behavior
price discrimination
socially optimal price
fair-return price
10-31
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Monopolistic
Competition
and Oligopoly
10-32