Microeconomic Exam #3 Study Guide (Chapter 14-18)
Chapter 15
 Monopoly
o No close competitors
o Can influence the market price of its product
o Price maker
o P > MC
o Charge high prices
o Maximize profit
o Outcome in a market with a monopoly is often not in the best interest of society
 Why monopoly arise
o Monopoly
 Sole seller of a product without close substitutes
 Cause
 Barriers to entry: Other firms can’t enter the market and compete with it
o Monopoly resources
 A key resource is owned by a single firm
 Greater market power
 For necessities, monopolist could command high price
 Not the real reason in real life
o Government-Created Monopolies
 The gov. gives a single firm the exclusive right to produce
some good or service
 Sheer political clout (순전한 정치영향) of the would-be
monopolist
 Patent (특허) & Copyright (저작권)
 Cost: Higher prices
 Benefits: Increased incentive for creative activity
o Natural Monopolies
 Single firm can supply a good or service to an entire
market at a smaller cost than could two or more firms
(Water)
 Economies of scale over the relevant range of output
 ATC curve continually declines
 Less concerned about new entrants
 Knows that they can achieve the same low costs
because each firm would have a smaller piece of
the market
 As the size of the market increase, evolve to competitive
market
 How Monopolies make production and pricing decisions
o Monopoly vs. Competition
 Monopoly’s ability to influence the price of its output
 Demand curve
o Competitive market
 P = horizontal line
 B/C a Competitive firms can sell as much or as little as it
wants at this price, the Competitive Firms faces a
horizontal demand (perfectly elastic)
 Sell with many perfect substitutes
o Monopoly
 Demand curve = Market demand curve (downward)
 P increase, Consumer buy less
 Q decreases, P increases

Market demand curve describes the combinations of P
and Q that are available to a monopoly firm
 By adjusting the Q produced or P changed, the
monopolist can choose any point on the demand
curve, but it can not choose a point off the curve
o Monopoly’s revenue
 Q increase, P decrease (downward curve)
 Monopolistic marginal revenue < Price
 Monopoly faces a downward-sloping demand curve
 When monopoly increases amount it sells
 Two effects on Total Revenue (P * Q)
o The output effect: more output is sold, so Q is higher
o The price effect: the price falls, so P is lower
 Reduces revenue on the units it was already selling
 Monopoly’s marginal revenue < Price
 Average Revenue = Price = Demand curve
 Start at the same point on the vertical axis b/c marginal revenue of the
first unit sold = P
 Monopolist’s marginal revenue on all units after the first < P
 Marginal revenue can be negative
o When price effect on revenue > output effect
o When firm produces an extra unit of output, the P falls by
enough to cause the firm’s total revenue to decline, even though
the firm is selling more units
o Profit Maximization
 By choosing the quantity at which marginal revenue = marginal cost
 Then uses the demand curve to find the P that will induce consumers to buy
that quantity



For competitive firm: P = MR = MC
For a monopoly firm: P > MR = MC
How does the monopoly find the profit-maximizing price?
 Demand curve relates the amount that customers are willing to pay to
the quantity sold
 After finding MR = MC, use demand curve to find the P
o A Monopoly’s profit
 Profit = TR – TC
 Profit = (TR/Q – TC/Q) * Q
 Profit = (AR – ATC) * Q
 Profit = (P – ATC) * Q
 The Welfare Cost of Monopoly
 Total surplus measures the economic well-being of buyers and sellers
 Consumer surplus: consumers’ willingness to pay for a good – the
amount they actually pay for it
 Producer surplus: amount producers receive for a good – their costs of
producing it
 In contrast to a competitive firm, the monopoly charges a price above the
marginal cost.
 From the standpoint of consumers, this high price makes monopoly
undesirable.
 However, from the standpoint of the owners of the firm, the high price makes
monopoly very desirable.
o Monopoly fail to maximize total economic well-being
 Deadweight-Loss
 Socially efficient quantity is found where the demand curve and the
marginal-cost curve intersect
 Because a monopoly sets its price above marginal cost, it places a
wedge between the consumer’s willingness to pay and the producer’s
cost.
o This wedge causes the quantity sold to fall short of the social
optimum.
 The Inefficiency of Monopoly
o DWL triangle
o The monopolist produces less than the socially efficient quantity
of output.
 The deadweight loss caused by a monopoly is similar to the deadweight
loss caused by a tax.
 The difference between the two cases is that the government gets the
revenue from a tax, whereas a private firm gets the monopoly profit.
 Problem arises b/c the firm produces and sells a quantity of output
below the level that maximizes total surplus
 Public policy toward monopolies
o In Monopoly, we fail to allocate resources efficiently
 Produce less than the socially desirable quantity of output
 Charge prices above MC
o Increasing Competition with Antitrust Laws
 Antitrust laws are a collection of statutes aimed at curbing monopoly power.
 Antitrust laws give government various ways to promote competition.
 They allow government to prevent mergers.
 They allow government to break up companies.
 They prevent companies from performing activities that make markets
less competitive.
 Two Important Antitrust Laws
 Sherman Antitrust Act (1890)
o Reduced the market power of the large and powerful “trusts” of
that time period.
 Clayton Act (1914)
o Strengthened the government’s powers and authorized private
lawsuits.
o Regulation
 Government may regulate the prices that the monopoly charges.
 The allocation of resources will be efficient if price is set to equal
marginal cost.
 In practice, regulators will allow monopolists to keep some of the
benefits from lower costs in the form of higher profit, a practice that
requires some departure from marginal-cost pricing.
o Public Ownership
 Rather than regulating a natural monopoly that is run by a private firm, the
government can run the monopoly itself (e.g. in the United States, the
government runs the Postal Service).
o Doing nothing
 Rather than regulating a natural monopoly that is run by a private firm, the
government can run the monopoly itself (e.g. in the United States, the
government runs the Postal Service).
 Price discrimination
o Business practice of selling the same good at different prices to different customers,
even though the costs for producing for the two customers are the same.
o not possible when a good is sold in a competitive market since there are many firms
all selling at the market price. In order to price discriminate, the firm must have
some market power.
o Perfect Price Discrimination
 Perfect price discrimination refers to the situation when the monopolist knows
exactly the willingness to pay of each customer and can charge each
customer a different prices
o Two important effects of price discrimination:
 It can increase the monopolist’s profits.
 It can reduce deadweight loss
o Examples of Price Discrimination
 Movie tickets
 Airline prices
 Discount coupons
 Financial aid
 Quantity discounts