Chapter
Monopoly
CHAPTER OUTLINE
14
I. Explain how monopoly arises and distinguish between single-price
monopoly and price-discriminating monopoly.
A. How Monopoly Arises
1. No Close Substitutes
2. A Barrier to Entry
a. Natural Barrier to Entry
b. Ownership Barrier to Entry
c. Legal Barrier to Entry
B. Monopoly Price-Setting Strategies
1. Single-Price
2. Price Discrimination
2. Explain how a single-price monopoly determines its output and price.
A. Price and Marginal Revenue
B. Marginal Revenue and Elasticity
C. Output and Price Decision
3. Compare the performance of single-price monopoly with that of perfect
competition.
A. Output and Price
B. Is Monopoly Efficient?
C. Is Monopoly Fair?
D. Rent Seeking
1. Buy a Monopoly
2. Create a Monopoly by Rent Seeking
3. Rent-Seeking Equilibrium
4. Explain how price discrimination increases profit.
A. Price Discrimination and Consumer Surplus
1. Discriminating Among Groups of Buyers
2. Discriminating Among Units of a Good
B. Profiting by Price Discriminating
C. Perfect Price Discrimination
D. Price Discrimination and Efficiency
352
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
5. Explain why monopoly can sometimes achieve a better allocation of
resources than competition can.
A. Benefits of Monopoly
1. Capturing Economies of Scale
2. Strengthening the Incentives to Innovate
B. U.S. Patent Law
 What’s New in this Edition?
Checkpoint 14.5 has been rewritten. The material on regulating natural monopolies has been eliminated. In its place is a
longer discussion of how monopoly can benefit society by
capturing economies of scale and strengthening the incentive to innovate. The checkpoint concludes with a brief discussion of U.S. patent law.
 Where We Are
In this chapter, we examine another market structure: monopoly. We discuss how monopoly arises and how a monopoly (single-price or price-discriminating) chooses its
profit-maximizing output and price. Recognizing that monopoly creates a deadweight loss, we discuss whether monopoly is efficient and fair. The concept of rent seeking is examined and reveals that rent seeking is likely to extract all of
the economic profit earned by a monopoly. Finally, benefits
of monopoly is covered.
 Where We’ve Been
The previous chapter studied perfectly competitive firms’
demand and marginal revenue curves. We combined them
with the cost curve analysis in Chapter 12 to determine perfectly competitive firms’ profit-maximizing output and price
decisions.
 Where We’re Going
After this chapter we examine two more market structures:
monopolistic competition, in Chapter 15, and oligopoly, in
Chapter 16. Then, in Chapter 17, we move to a discussion of
antitrust and regulation. All these chapters depend on the
material presented in this chapter.
Chapter 14 . Monopoly
IN THE CLASSROOM
 Class Time Needed
Because the students are familiar with firm behavior in perfect competition, this
chapter is somewhat easier to present. You should spend between two to three
class sessions on this material.
An estimate of the time per checkpoint is:

14.1 Monopoly and How It Arises—15 minutes

14.2 Single-Price Monopoly—25 to 45 minutes

14.3 Monopoly and Competition Compared—30 to 40 minutes

14.4 Price Discrimination—30 to 40 minutes

14.5 Monopoly Policy Issues—10 to 15 minutes
353
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
354
CHAPTER LECTURE
14.1
How Monopoly Arises
A monopoly has two key features:
 No Close Substitutes: There are no close substitutes for the good or service.
 Barriers to Entry: Legal or natural constraints that protect a firm from potential competition are called barriers to entry. Monopolies are protected by barriers to entry.
 Natural barriers to entry create a natural monopoly, which is an industry in which
one firm can supply the entire market at a lower price than two or more firms can.

When one firm owns all (or most) of a natural resource, it creates an ownership barrier to entry. DeBeers owns about 80 percent of the world’s diamonds.

Legal barriers to entry create a legal monopoly, which is a market in which competition and entry are restricted by the granting of a public franchise (an exclusive right is
granted to a firm to supply a good or service—the U.S. Postal Service has a public
franchise to deliver first-class mail), a government license (when the government controls entry into particular occupations, professions and industries—a license is required to practice law), a patent (an exclusive right granted to the inventor of a product or service) or a copyright (exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work).
There are many examples of government licensing. Licensing can protect consumers from fraud
and abuse, but they can also hurt consumers by preventing competition from producing an efficient allocation of resources. Have the students debate the merits of the following licensing arrangements: 1) Doctors can receive a medical license to practice medicine only by graduating
from an AMA approved medical program; 2) Lawyers can practice law only after passing an extensive Bar Exam; 3) Cab drivers in New York City can operate a taxi only if they have purchased
a medallion from the city, of which there are a finite number; 4) Beauticians in many states cannot
operate a beauty parlor without a state certification that requires training in sanitary practices as
well as other courses completely unrelated to their profession (such as civics and history courses).
Monopoly Price-Setting Strategies


Price discrimination is the practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms.
A single-price monopoly is a firm that must sell each unit of its output for the same price
to all its customers.
Chapter 14 . Monopoly
14.2
355
A Single-Price Monopoly’s Output and Price Decisions
Price and Marginal Revenue


The demand curve facing a monopoQuantity
Total revMarginal
ly firm is the market demand curve.
Price
demanded
enue
revenue
Total revenue (TR) is the price (P )
$4
0
$0
multiplied by the quantity sold (Q ).
$3
Marginal revenue (MR ) is the
$3
2
$6
change in total revenue resulting
$1
from a one-unit increase in the quan$2
4
$8
tity sold. The table shows the calcula$1
tion of TR and MR.
$1
6
$6
A key feature of a single-price monopoly is that MR < P at each quantity so, as illustrated in the figure below, the MR curve lies below the demand curve.
MR < P because a single–price monopoly must lower its price on all units sold to sell an
additional unit of output.
Marginal Revenue and Elasticity
If demand is elastic, the MR is positive; if demand is unit elastic, the MR equals zero; and if demand is inelastic, MR is negative. A single-price monopoly never produces in the inelastic part of
its demand because if it did, the firm could increase its total profit by decreasing its output,
which would raise its total revenue and decrease its total cost.
Output and Price Decisions


To maximize its profit, a monopoly
produces the level of output where
MR = MC. The monopoly then uses
its demand curve to set the price at
the maximum possible price for
which it will be able to sell the quantity it produces. In the figure, which
uses the demand and MR schedules
from the table above, the firm produces 200 units of output and sets a
price of $160 per unit.
The firm earns an economic profit if
P> ATC, which is the case for the
firm in the figure. The monopoly can
earn the economic profit even in the
long run because the barriers to entry
protect the firm from competition. However, a monopoly firm is not guaranteed an economic profit. In the short run and/or long run, it might earn a normal profit, (P = ATC ) or
in the short run, it might incur an economic loss (P > ATC ).
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
356
14.3
Single-Price Monopoly and Competition Compared
Output and Price



Perfect Competition: The market demand curve (D) in perfect competition is the same
demand curve that the firm faces in monopoly. The market supply curve (S ) in perfect
competition is the horizontal sum of the individual firm’s marginal cost curves. This
supply curve also is the monopoly’s marginal cost curve, so in the figure above the supply curve is labeled MC. In a competitive market, equilibrium occurs where the quantity
demanded equals the quantity supplied, which in the figure above is 250 units of output
and a price of $140 per unit.
Monopoly: The monopoly produces where MR = MC and sets its price using its demand
curve. In the figure, the monopoly produces 200 units of output and sets a price of $160
per unit.
Compared to a perfectly competitive industry, a single-price monopoly produces less
output and sets a higher price.
Is Monopoly Efficient?


A perfectly competitive industry produces the efficient quantity of output. Because a single-price monopoly produces less output, it creates a deadweight loss.
Though the monopoly creates a deadweight loss, the monopoly benefits its owners because it earns an economic profit. A monopoly benefits the owner because it redistributes
some of the consumer surplus away from the consumer and to the monopoly producer.
It is important for students to recognize that the source of the inefficiency of a monopoly firm’s
output and pricing decision arises from the absence of competition in the market, rather than any
change in the behavioral assumptions about the firm owners. So, “Mom and Pop,” the owners of
a perfectly competitive firm, are maximizing their profit as surely as the owners of a monopoly.
Rent Seeking


The social cost of monopoly might exceed the deadweight loss it creates because of rent
seeking, which is any attempt to capture consumer surplus, producer surplus, or economic profit. Rent seeking can occur when someone uses resources seeking the opportunity to buy a monopoly for a price less than the monopoly’s economic profit. Rent seeking also can occur when someone uses resources lobbying the government to restrict the
competition faced by the lobbyist.
The resources used up in rent seeking are a cost to society that adds to the monopoly’s
deadweight loss. Because there are no barriers to entry in the activity of rent seeking, the
resources used up can equal the monopoly’s potential economic profit.
Chapter 14 . Monopoly
14.4
357
Price Discrimination
Price discrimination is the practice of selling different units of a good or service for different
prices. Price discrimination converts consumer surplus into economic profit. To be able to price
discriminate, a firm must:
 Identify and separate different buyer types.
 Sell a product that cannot be resold
Price Discrimination and Consumer Surplus


Price discrimination occurs because of different willingnesses to pay for the good. A firm
can charge the same buyer different prices for different units of a good or a firm can charge
different prices to different groups of buyers.
 Discriminating Among Groups of Buyers: A firm can charge different customers
different prices for the product. Groups with a higher average willingness to pay are
charged a higher price and groups with a lower average willingness to pay are
charged a lower price. An example is airline travel, where business travelers who
have a high average willingness to pay and often make last-minute reservations are
charged a higher price than leisure travelers, who have a low average willingness to
pay and often make advance reservations.
 Discriminating Among Units of a Good: A firm can charge a higher price for the
first units purchased and a lower price for later units purchased. An example is pizza
delivery, where the second pizza is generally cheaper than the first.
Perfect price discrimination occurs if a firm is able to sell each unit of output for the
highest price anyone is willing to pay for it. In this case, the price of each unit is the same
as the unit’s marginal revenue, so the firm’s (downward sloping) demand curve becomes
the same as its marginal revenue curve. Output increases to the point where the demand
(= marginal revenue) curve intersects the marginal cost and the efficient quantity is produced. The deadweight loss is eliminated. The firm’s economic profit is the greatest possible. But consumer surplus equals zero because the firm captures the entire consumer
surplus.
14.5
Monopoly Policy Issues
Benefits from Monopoly


Economies of Scale: If a monopoly has economies of scale (so its ATC decreases as its
output increases), it might be able to produce at lower cost than could several competing
firms.
Incentives for Innovation: Granting the discoverer a monopoly to an innovation increases
the incentives to innovate.
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
358

Patents give the innovator a monopoly on the invention for 20 years. So patents strengthen the incentive to innovate but at the cost of granting a monopoly with the resulting
deadweight loss.
Consider the struggle for developing countries with populations dealing with world-wide epidemics such as AIDS. In the developed countries in which they operate, pharmaceutical companies are granted legal barriers (patents) on their drugs, granting them a legal monopoly and enabling them to earn a high economic profit once they bring a new and successful medicine to market. The anticipation of this profit provides the incentive for these firms to undertake the expensive (currently estimated at approximately $900 million per approved drug) and risky development of innovative cures for the terrible diseases afflicting mankind, such as AIDS. However,
once the new medicines are made available, the absence of competition means the price is high,
which decreases the use of these new medicines, especially among the population of the poorer,
developing nations that have been hit the hardest by these diseases. So, once the drug is discovered, the monopoly creates a deadweight loss but without the economic profit the monopoly
brings, the drug might not have been discovered. There is a tradeoff between current sufferers,
who want a low price, and sufferers in the future, who want new and better medicines developed.
Chapter 14 . Monopoly
 Lecture Launchers
1.
Students love monopoly! Most of your students are taking an economics
course because they think it will help them either get a better job or run a
better business. Many of your students are aspiring entrepreneurs. You’ve
just had them slog through a heavy chapter on perfect competition the bottom line of which is the bottom line is miserable. Normal profit might be
the best that many people can achieve but it is not very exciting. This chapter teaches the students how to make a serious entrepreneurial income. Innovate, create a monopoly that produces something that people value
much more than the cost of producing it, and price discriminate as much as
possible.
2.
After defining a monopoly, you can ask your students to discuss the economic factors which lead to the development of monopolies. To what extent are those conditions products of the free market? In which case, students can debate the role of government with regard to monopoly. If it is
the result of natural coalescence in a free market, then is it equitable and/or
efficient to intervene? Clearly there is no definitively correct answer to
these questions, which is perhaps why they are so much fun to debate!
3.
Explain that the monopoly model is a benchmark model. Similar to the case
of perfect competition, although no real-world industry satisfies the full
definition of a monopoly market, the behavior of firms in many real world
industries can be predicted by using the monopoly model. Mention that
this chapter examines the least competitive end of the spectrum of markets,
just like Chapter 13 discussed the most competitive end.
4.
Figure 14.5, the classic monopoly diagram, provides a good opportunity to
tell your students about the contribution of one of the most brilliant economists of the 20th century, Joan Robinson. This diagram first appeared in her
book The Economics of Imperfect Competition, published in 1933 when she was
just 30 years old. You and your students can learn more about Joan Robinson at http://cepa.newschool.edu/het/profiles/robinson.htm . Women are
still not attracted to economics on the scale that they’re attracted to most
other disciplines. So the opportunity to talk about an outstanding female
economist shouldn’t be lost. Joan Robinson was a formidable debater and
reveled in verbal battles, a notable one of which was with Paul Samuelson
on one of her visits to MIT. Anxious to make and illustrate a point, Samuelson asked Robinson for the chalk. Monopolizing the chalk and the blackboard, the unyielding Robinson snapped, “Say it in words young man.”
Samuelson meekly obeyed. This story illustrates Joan Robinson’s approach
to economics: work out the answers to economic problems using the ap-
359
360
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
propriate techniques of math and logic, but then “say it in words.” Don’t be
satisfied with formal argument if you don’t understand it. Your students
will benefit from this story if you can work it into your class time.
 Land Mines
1.
Marginal revenue can be a sticking point for many students. Students find
it easier to see the difference between the monopoly’s demand and marginal revenue curves if you take two steps. First develop a total revenue
schedule using price and quantity data. Then add another column showing
marginal revenue. As the text shows, place the marginal revenue values between the quantity values. In the next step, draw the demand and marginal
revenue curves. Again, emphasize that marginal revenue is plotted between
two quantity levels. By explicitly graphing the data, you also have the
framework for showing that the price of the good is always less than marginal revenue of a monopoly.
2.
Students differ in their learning styles. It is always wise to accommodate as
many of these styles as possible. To more clearly show the deadweight loss,
start with a numeric approach. Draw a figure, labeling points on the axes
with prices and quantities. Use these values to make your point and explicitly calculate the deadweight loss. Then, realizing that some students learn
better from a geometric approach, shade the appropriate areas.
Chapter 14 . Monopoly
361
ANSWERS TO CHECKPOINT EXERCISES
 CHECKPOINT 14.1 Monopoly and How It Arises
1a. A large shopping mall in downtown Houston is not a monopoly because
there are many other similar stores and malls nearby.
1b. Tiffany is not a monopoly because there are many other upscale jewelers.
1c. Wal-Mart is not a monopoly because there are many other similar retailers.
1d. The Grand Canyon mule train is a monopoly because there is only one firm
providing mule-ride services in the Grand Canyon.
1e. The only shoe-shine stand licensed to operate in an airport is a monopoly.
1f. The U.S. Postal Service is a monopoly when it comes to first class mail.
2.
The mule train is a natural monopoly because if two or more firms tried to
produce mule train services, the costs would be higher because of congestion on the paths. The shoe-shine stand and U.S. Postal Service are legal
monopolies.
The shoe-shine stand can price discriminate because the service cannot be
resold. The mule train ride and services of the U.S. Postal service can be resold, so they cannot price discriminate.
 CHECKPOINT 14.2 Single-Price Monopoly
1a. The table showing Fossett’s total revenue schedule and marginal revenue schedule is to the
right.
Price
(thousands
of dollars
per ride)
Total
Marginal
revenue
revenue
Quantity (thousands (thousands of
(rides per of dollars
dollars per
month) per month)
ride)
220
0
0
200
1
200
180
2
360
160
3
480
140
4
560
120
5
600
200
160
120
80
40
362
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
1b. Figure 14.1 illustrates Fossett’s demand curve
and marginal revenue curve.
1c. Fossett’s marginal cost equals marginal revenue at 2 1/2 rides a month, where both equal
$120,000. From the demand curve, the price is
$170,000 a ride. The total cost of 2 1/2 rides a
month is $320,000. Fossett’s total revenue
equals the number of rides multiplied by the
price per ride, which is (2 1/2 rides per month)
 ($170,000) = $425,000. So his total economic
profit is total revenue minus total cost, which
is $425,000  $320,000 = $105,000.
1d. As a result of the tax, Fossett’s fixed cost
changes, but his marginal cost does not. His
profit-maximizing level of output is still 2 1/2
rides a month and his price still equals
$170,000. The tax decreases his economic profit
by $60,000 so his new economic profit is $45,000.
1e. A $30,000 per ride tax increases Fossett’s marginal cost by $30,000 at every
level of output. With the increase in his marginal costs, Fossett now sells 2
rides a month because this is the level at which his new marginal cost
equals his marginal revenue (both equal $140,000). From the demand curve,
Fossett sets a price of $180,000 a ride. Total profit equals total revenue minus total cost. His total revenue is 2 rides  $180,000, which is $360,000. His
total cost is $260,000 plus the tax of $60,000, which is $320,000. So his new
economic profit is $360,000  $320,000 = $40,000.
 CHECKPOINT 14.3 Monopoly and Competition Compared
1.
Bobbie’s barbershop is not efficient because she produces fewer haircuts
than a perfectly competitive market would produce. The barbershop generates a deadweight loss of $3. The monopoly captures $6 of the consumer
surplus. A rent seeker would be willing to pay $12, the amount of the economic profit.
 CHECKPOINT 14.4 Price Discrimination
1.
For a firm to price discriminate it must be able to identify specific consumers’ willingness to pay different prices and must be able to prevent the resale of the good or service. So if a firm can identify customers’ willingness
to pay different prices and if the firm can prevent resale of its good or service, then the firm can price discriminate.
2a. The diner is price discriminating.
Chapter 14 . Monopoly
2b. The airline is price discriminating.
2c. The airline is price discriminating.
2d. The supermarket is price discriminating.
2e. Different interest rates reflect borrowers’ different risks, which is a possible
cost. Charging different interest rates is not price discriminating.
2f. The water company is price discriminating.
2g. The cell phone company is price discriminating.
2h. The museum is price discriminating.
2i. If the price difference is based on different costs of generating electricity at
different times of the day, then there is no price discrimination.
 CHECKPOINT 14.5 Monopoly Policy Issues
1a. The distribution of water is a natural monopoly because one firm can distribute water at a lower average total cost than could two or more firms.
There are large economies of scale in water distribution because the cost of
installing the water mains that must go down each street is high while the
(marginal) cost of supplying another customer off of a main is quite low. As
a result, as more customers are served, the average total cost decreases.
1b. Because water distribution is a natural monopoly, it cannot be supplied
more efficiently by having competitive water companies. If there were several competitive water companies, each company’s average total cost would
be higher than if there was only one company and so the total cost of supplying water with many companies would be higher than supplying it with
only one company.
363
364
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
ANSWERS TO CHAPTER CHECKPOINT EXERCISES
1.
The three types of barrier to entry are natural barriers to entry, ownership
barrier to entry, and legal barriers to entry. A natural barrier to entry exists
when one firm can meet the entire market demand at a lower price than
two or more firms could. An ownership barrier to entry exists when one
firm owns a natural resource that is necessary in order to produce the good
or service. A legal barrier to entry exists when the government grants a
public franchise, government license, patent, or copyright to a single firm.
Local telephone service is a market with a natural barrier to entry. DeBeers, which owns more than 80 percent of the world’s raw diamonds, has
an ownership barrier to entry. The pharmaceutical drug market has legal
barriers to entry. Natural barriers to entry cannot be removed because they
are the result of the existing technology. Ownership and legal barriers to
entry are difficult to remove because the holder of the barrier will lobby intensively to protect its barrier.
2a. Technological change has made personal computers more affordable and
has created a monopoly for Microsoft in the production of operating systems for PCs. Technological change has resulted in many new pharmaceutical drugs being developed and so has created a monopoly for the firms
developing specific drugs. Technological change has created the Internet
and has given MCI a virtual monopoly over “backbone” services for the
Internet in many areas.
2b. Technological change has made it possible for many more firms to provide
phone service, both local and long distance. Technological change has allowed home television dish systems to compete with cable television.
Technological change has decreased the efficient size of electrical generating plants and has allowed more firms to enter the market to generate electricity.
3.
The good or service produced by a monopoly has no close substitutes, so its
demand is not perfectly elastic. In this case, when the monopoly raises the
price of its good or service, people continue to buy some of it because they
have nothing else that (perfectly) takes its place. The good or service produced by a perfectly competitive firm is identical to the good or service
produced by its competitors, so its demand is perfectly elastic. If a perfectly
competitive firm raises the price of its good or service, people buy none of it
because there are perfect substitutes available.
4.
Price discrimination occurs when a monopoly is able to sell different units
of a good or service for different prices. In some instances, different consumers pay a different price for the good or service. In other instances, the
same consumer pays a different price for different units of the good or ser-
Chapter 14 . Monopoly
365
vice. Not all monopolies can price discrimination. In order to price discriminate, a monopoly must be able to identify which buyers have a higher
willingness to pay and to be able to prevent resale of the good by the customers who buy for the lower price.
5.
A monopoly’s marginal revenue curve is downward sloping because a
monopoly faces a downward sloping (market) demand curve. As a result
of the demand curve, in order for a monopoly to sell an additional unit of
output the monopoly must lower its price. So when a monopoly sells an
additional unit, there are two effects on its total revenue: First, the firm collects the new, lower price on the additional unit sold. Second, the firm loses the difference between the old, higher price and the new, lower price on
all the units it had previously sold. As more units are sold, the new price
decreases and the amount lost on all the previous units sold increases. On
both counts, the marginal revenue decreases as the quantity produced and
sold increases.
6a. Elixer Spring’s total revenue and
marginal revenue schedules are in
the table to the right. Figure 14.2 illustrates Elixer’s total revenue
curve and Figure 14.3 illustrates
Elixer’s marginal revenue curve and
its demand curve.
Total
Marginal
Price
Quantity revenue
revenue
(dollars per (bottles per (dollars (dollars per
bottle)
day)
per day)
bottle)
10
0
0
9
1,000
9,000
8
2,000
16,000
7
3,000
21,000
6
4,000
24,000
5
5,000
25,000
4
6,000
24,000
3
7,000
21,000
2
8,000
16,000
1
9,000
9,000
0
10,000
0
9
7
5
3
1
1
3
5
7
9
366
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
6b. In Figure 14.4, the marginal cost curve runs
along the horizontal axis because the marginal
cost is zero. Elixir produces where the marginal
cost curve intersects the marginal revenue
curve, so the figure shows that Elixir produces
5,000 bottles a day. Elixir sets a price of $5 a
bottle because that is the price at which 5,000
bottles a day is the quantity demanded. Elixir’s
profit equals its revenue, which is $5 a bottle 
5,000, = $25,000 a day, minus its cost, which is
its fixed cost of $5,000 a day. So Elixir’s economic profit is $25,000  $5,000, which is
$20,000 a day.
6c. The price, $5, is well above the marginal cost,
$0.
6d. As Figure 14.2 shows, Elixir is producing where
its total revenue is at its maximum. So the elasticity of demand for Elixir water equals 1.0.
Chapter 14 . Monopoly
7a. Blue Rose’s total revenue and marginal revenue schedules are in the
table to the right. Figure 14.5 illustrates Blue Rose’s total revenue
curve and Figure 14.6 illustrates
Blue Rose’s marginal revenue curve
and also its demand curve.
367
Total
Marginal
revenue
revenue
(dollars (dollars per
per day)
bunch)
Price
(dollars per
bunch)
Quantity
(bunches
per day)
80
0
0
72
1
72
64
2
128
56
3
168
48
4
192
40
5
200
32
6
192
24
7
168
16
8
128
72
56
40
24
8
8
24
40
368
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
7b. The marginal cost schedule is in the table to the
right. The marginal cost curve is illustrated in Figure 14.6 (on the previous page) as MC.
7c. To maximize profit, Blue Rose produces where the
marginal cost curve intersects the marginal revenue curve. Figure 14.6 shows that Blue Rose produces 3 1/2 bunches a day. The demand schedule
shows that the price is $52 a bunch because that is
the price at which 3 1/2 bunches per day is the
quantity demanded. The total revenue when 3 1/2
bunches a day are produced is 3 1/2 bunches  $52
a bunch, which is $182 a day. Blue Rose’s cost
schedule shows that the total cost of producing 3
1/2 bunches a day is $112. So Blue Rose’s total
economic profit is its total revenue minus its total
cost, which is $182 dollars a day  $112 a day = $70
a day.
Quantity
(bunches
per day)
Total
Marginal
cost
cost
(dollars (dollars per
per day)
bunch)
0
80
1
82
2
88
3
100
4
124
5
160
6
208
7
268
8
340
8a. If there are 1,000 firms, the market is perfectly competitive. The price
equals the marginal cost, so the price is zero. At a price of zero, the quantity demanded is 10,000 bottles a day.
8b. The monopoly price, $5 a bottle, is higher than the perfectly competitive
price of zero. The monopoly quantity, 5,000 bottles a day, is less than the
perfectly competitive quantity of 10,000 bottles a day.
8c. The consumer surplus is the triangular area under the demand curve and
above the price. The area of a triangle equals 1/2  base  height, so the
consumer surplus equals 1/2  10,000 bottles a day  $10 a bottle, which is
$50,000 a day.
8d. Producer surplus equals the area above the supply curve and below the
price. If the water is produced in perfect competition, the price is zero, so
the producer surplus for Elixir water is zero.
8e. If a monopoly produces Elixir water, consumer surplus equals 1/2  5,000
bottles a day  $5 a bottle, which is $12,500 a day. Producer surplus equals
the area above the marginal cost curve and below the price. In the case of a
monopoly producer of Elixir water, this area is a rectangle and equals $5 a
bottle  5,000 bottles a day, which is $25,000 a day.
8f. The deadweight loss equals the total surplus (the sum of consumer surplus
and producer surplus) when the market is perfectly competitive minus the
total surplus when the market is a monopoly. The total surplus when the
market is perfectly competitive is $50,000 a day. The total surplus when the
market is a monopoly is $37,500 a day. The deadweight loss equals $50,000
a day minus $37,500 a day, which is $12,500 a day.
2
6
12
24
36
48
60
72
Chapter 14 . Monopoly
369
9a. The most a firm is willing to pay to obtain a monopoly is the amount of
economic profit. If there are no fixed costs, then the total economic profit
when one firm produces Elixir water is $25,000 a day. So the most a firm is
willing to pay is $25,000 a day.
9b. When Elixir water is produced by a monopoly, the price is $5 a bottle and the quantity is
5,000 bottles a day. Figure 14.7 illustrates the
economic profit when Elixir water is produced by a monopoly. The economic profit is
the shaded rectangular area.
9c. If the firm pays $25,000 a day to secure the
monopoly, the firm has an additional cost of
$25,000 a day. With this cost it is not earning
any economic profit. Rent seeking has eliminated the economic profit.
Total
Marginal
Marginal
10a. Bobbie produces
revenue
revenue
Total
cost
the quantity such
Price
Quantity (dollars (dollars
cost
(dollars
that
marginal
(dollars per (haircuts
per
per hair- (dollars per hairrevenue equals
haircut)
per hour) hour)
cut)
per hour)
cut)
marginal
cost.
20
0
0
20
The table to the
18
1
right has Bob18
1
18
21
14
3
bie’s
marginal
16
2
32
24
revenue
and
10
6
14
3
42
30
marginal
cost
6
10
schedules. The
12
4
48
40
2
15
table shows that
10
5
50
55
Bobbie produces
3 haircuts an
hour at a price of $14 a haircut. Her economic profit is her total revenue,
$42, minus her total cost, $30, which is $12.
10b. If Bobbie price discriminates, she charges the woman $18, the senior citizen
$16, the student $14, and the boy $12.
10c. If Bobbie price discriminates, she sells 4 haircuts an hour.
370
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
10d. Bobbie’s economic profit is her total revenue minus her total cost. Her total
revenue is $18 + $16 +$14 + $12, which is $60. Her total cost to produce 4
haircuts is $40, so her economic profit is $60  $40, which is $20.
10e. Because Bobbie is perfectly price discriminating, Bobbie is producing the
efficient quantity of haircuts.
10f. Because Bobbie is charging each customer the maximum the customer is
willing to pay, there is no consumer surplus. Consumer surplus is zero.
Bobbie’s producer surplus is $33.50. The producer surplus on the first hair
cut is $18 - $2 = 16, where the $2 is the marginal cost. The producer surpluses on the remainder of the haircuts are calculated similarly.
10g. Bobbie benefits because her economic profit is higher. The boy willing to
pay $12 benefits because he now gets a haircut. Society benefits because
the deadweight loss is eliminated.
11. The museum can offer discounts to senior citizens and students. It could
offer free admission to children accompanied by adults to attract more visitors.
Total
Marginal
12a. Big Top’s total revenue and
Price
Quantity
revenue
revenue
marginal revenue schedules
(dollars per (tickets per (dollars (dollars per
ticket)
show)
per show)
show)
are in the table to the right.
12b. Big Top’s marginal cost is con20
0
0
stant and equal to $6 per tick18
18
100
1800
et. So Big Top’s marginal rev14
enue equals its marginal cost
16
200
3200
10
when the quantity of tickets is
14
300
4200
350 tickets per show and the
6
12
400
4800
price is $13 per ticket. The total
2
revenue is 350 tickets  $13,
10
500
5000
2
which is $4,550. The total cost
8
600
4800
of 350 tickets is $3,100. So the
6
6
700
4200
economic profit equals $4,550
10
 $3,100, which is $1, 450.
4
800
3200
12c. The consumer surplus equals
1/2  ($20  $13)  350, which is $1,225. The producer surplus is the area
above the marginal cost curve and below the price. Because the marginal
cost curve is horizontal, this area is a rectangle equal to ($13  $6)  350,
which is $2,450.
12d. When Big Top maximizes its profit, the circus is not efficient. At 360 tickets, the marginal cost of another ticket is $6 and the marginal benefit from
another ticket (which is equal to the maximum a consumer is willing to
pay) is $13. Marginal benefit is greater than marginal cost, so a deadweight
loss exists.
Chapter 14 . Monopoly
12e. If the industry was perfectly competitive, 700 tickets would be sold at a
price of $6 per ticket.
12f. If Big Top offers a child discount, the consumer surplus decreases and the
producer surplus increases. Big Top sells more tickets and so it operates
closer to the efficient level of output.
371
372
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
 Critical Thinking
13a. The NCAA is a legal monopoly. It effectively has purchased 100 percent of
the market for college athletics. If another group tries to sanction a college
sport, the NCAA would expel from all sports any college that joined the
competing group.
13b. The colleges gain because they are able to limit competition and make an
economic profit. The coaches and other participates whose incomes are not
set by the NCAA also gain because they can demand higher income from
the profit the colleges earn.
13c. The system operated by the NCAA is not efficient. It restricts the amount
of athletic competition to less than the efficient quantity.
14a. Competition can be introduced into the market for baseball by declaring it
no longer exempt from the laws designed to limit market power.
14b. If competition is introduced, quite likely the number of teams would increase and each team’s economic profit would decrease. One factor that
suggests otherwise is the point that fans enjoy baseball because it is a competition with an uncertain outcome. If large market teams (such as New
York) totally dominated the sport, fans might lose interest, in which case
the league would contract.
14c. If, on net, the league expanded, then the number of players would increase
and likely their salaries would rise. If the lack of effective competition
amongst teams decreased the size of the league, the number of players
would decrease.
14d. The current situation is inefficient but a “level playing field” amongst
teams is, to some extent, preserved. If the student thinks that making baseball less of a monopoly would not harm the competitive balance, then the
student might favor removing monopoly power. However if the student
believes that removing monopoly power would unduly harm the competitive balance amongst teams, then the student might favor allowing the
league to retain its monopoly power.
15. Before 1991, the Ivy League colleges operated as a monopoly. They set the
price of education equal to the monopoly price. Since 1991, the colleges
have been competitors. The price of education has fallen from what it otherwise would have been. The efficiency of the market increased. Producer
surplus decreased, consumer surplus increased, and deadweight loss decreased.
Chapter 14 . Monopoly
 Web Exercises
16a. Robert Barro’s central argument is that to pay for innovation, firms need a
period of time during which they have a monopoly in the newly innovated
product. So, government intervention that lowers the price decreases the
profit from innovation and slows innovation, which harms consumers.
16b. Your students might or might not agree with Barro’s argument. You might
note that Barro’s argument is consistent with a free-market view that the
government ought not to intervene in the economy.
16c. Barro’s argument suggests that government intervention to limit monopoly power should, itself, be limited. In particular, Barro’s argument strongly
suggests that intervention in rapidly innovating sectors of the economy
should be eliminated.
17a. Microsoft was found to be a monopoly: “…Microsoft enjoys monopoly
power in the relevant market.” This finding is in the “Court's Findings of
Fact (11/5/99)”, at: http://www.usdoj.gov/atr/cases/ms_findings.htm.
17b. To determine that Microsoft is a monopoly, the court defined the relevant
market as computers powered by Intel compatible chips and then noted
Microsoft’s huge market share in operating systems in this market.
17c. The court eventually said that Microsoft can not retaliate against a computer manufacturer who ships computers with non-Microsoft software,
that Microsoft must allow computer manufacturers to create computers
that open to a screen developed by the manufacturer, and that Microsoft
must make available to other software makers information about how to
work well with Windows.
17d. Robert Barro would suggest that the government take no action in the Microsoft case. However, given the relatively limited sanctions imposed on
Microsoft, he likely would not disapprove too strongly of the ultimate result.
18. Although your students’ answers will depend on the information they
gather, what they will find is that the trips with the most restrictions generally have the lowest prices. And the restrictions are generally designed to
separate vacation or leisure travelers from business travelers. The airline’s
goal is to charge the highest price a traveler is willing to pay and business
travelers are almost always willing to pay higher prices than leisure travelers.
373
374
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
ADDITIONAL EXERCISES FOR ASSIGNMENT
 Questions
 CHECKPOINT 14.1 Monopoly and How It Arises
1. Which of the following situations is a monopoly?
1a. The supermarket that stocks the best-quality products
1b. The supermarket that charges the highest prices
1c. The firm that has the largest share of the market sales
1d. The truck stop in the Midwest, miles from anywhere
1e. A firm that produces a good that has a perfectly inelastic demand
1f. The only airline that flies from St. Louis to Kansas City
2.
Which of the cases in Exercise 1 are natural monopolies and which are legal
monopolies? Which can price discriminate, which cannot, and why?
 CHECKPOINT 14.2 Single-Price Monopoly
3. Dolly's Diamond is a single-price monopoly.
The first two columns of the table show the
demand schedule for Dolly's Diamond, and
the middle and third column show the firm's
total cost schedule.
Price
Quantity
Total cost
(dollars per (carats per (dollars per
carat)
day)
day)
2,200
0
2,000
1
3a. Calculate Dolly's total revenue schedule and
1,800
2
marginal revenue schedule.
3b. Sketch Dolly's demand curve and marginal
1,600
3
revenue curve.
1,400
4
3c. Calculate Dolly's profit-maximizing output,
1,200
5
price, and economic profit.
3d. If the government places a fixed tax on Dolly's
Diamond of $1,000 a day, what are Dolly's new profit-maximizing output,
price, and economic profit?
3e. If instead of imposing a fixed tax on Dolly's, the government taxes diamonds at $600 a carat, what are Dolly's new profit-maximizing output,
price, and economic profit?
800
1,600
2,600
3,800
5,200
6,800
Chapter 14 . Monopoly
 CHECKPOINT 14.3 Monopoly and Competition Compared
4. The figure shows an industry. If the market is
perfectly competitive, what is the equilibrium
quantity that will be produced and the equilibrium price? If the market is a single- price monopoly, darken in the area of the deadweight
loss.
 CHECKPOINT 14.4 Price Discrimination
5. What is price discrimination? Give some real-world examples of price
discrimination.
6. Which of the following situations is price discrimination?
6a. The local drug store offers senior citizens a discount on all purchases made
on Tuesdays.
6b. Domino’s offers “Buy 1 pizza for $15 and get a second one for only $1.”
6c. Farmers in Southern California pay a lower price for water than do the residents of Los Angeles.
6d. The U.S. Postal Service charges a lower price to mail a postcard than to mail
a letter.
 Answers
 CHECKPOINT 14.1 Monopoly and How It Arises
1a. The supermarket that stocks only the best-quality products is not a monopoly. The statement does not say that no other markets stock these products.
If indeed it is the only supermarket in the area that stocks these high-quality
products, it still is not a monopoly because there are no barriers to entry to
prevent other supermarkets from also stocking the best-quality products.
1b. A supermarket that charges the highest prices is not a monopoly.
1c. The firm with the largest market share is not necessarily a monopoly.
1d. A truck stop miles from anywhere is a monopoly.
375
376
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
1e. A firm producing a good with perfectly inelastic demand could be a monopoly. Inelastic demand implies that there are no close substitutes for the
good (like insulin), but does not imply that other firms are prevented from
entering the market. Unless there is a barrier to entry, the firm is not a monopoly. But, more generally, simply because the demand for a product is
inelastic does not mean that the producer is a monopoly.
1f. An airline with the only service on a route has monopoly power on that
route.
2.
Because the truck stop is in the middle of nowhere, the market demand for
automobile and truck services is relatively small, so the truck stop is a natural monopoly. If two truck stops supplied the market, costs would be higher. (The truck stop could have a legal monopoly if it has purchased all surrounding land or if it lobbied the government to allow it to have the only
building permit for the area.) The airline might be a legal monopoly if it has
been awarded sole landing rights at one of the airports. The airline can
price discriminate because the service cannot be resold.
 CHECKPOINT 14.2 Single-Price Monopoly
3a. The table showing Dolly’s total
Total
Marginal
revenue and marginal revenue
Price
Quantity revenue
revenue
(dollars per (carats (dollars per (dollars per
schedules is to the right.
carat)
per day)
day)
carat)
2,200
0
0
2,000
1
2,000
1,800
2
3,600
1,600
3
4,800
1,400
4
5,600
1,200
5
6,000
2,000
1,600
1,200
800
400
Chapter 14 . Monopoly
3b. Figure 14.9 illustrates Dolly’s demand and
marginal cost curves.
3c. Dolly’s marginal cost equals marginal revenue
at 2 1/2 carats a day, where both equal $1,200.
From the demand curve, the price is $1,700.
Total cost of 2 1/2 carats a day is $3,200. Dolly’s total revenue equals (2 1/2 carats) 
($1,700) = $4,250. Her total economic profit is
$4,250  $3,200 = $1,050.
3d. As a result of the tax, Dolly’s fixed cost changes, but her marginal cost does not. Her profitmaximizing level of output is still 2 1/2 carats
and her price still equals $1,700. The tax eliminates all but $50 of Dolly’s economic profit.
3e. A $600 a carat tax increases Dolly’s marginal
cost by $600 at every level of output. With the
increase in her marginal costs, Dolly now sells
1 1/2 carats a day because at this quantity marginal cost equals marginal
revenue, which is $1,600. From the demand curve, Dolly’s sets a price of
$1,900 a carat. Her total profit equals her total revenue minus her total cost.
Her total revenue is (1 1/2 carats)  ($1,900) = $2,850. Her total cost is $2,100
plus the tax of $600, which is $2,700. Dolly’s economic profit is $2,850 
$2,700 = $150.

4.
CHECKPOINT 14.3 Monopoly and Competition Compared
If the market is perfectly competitive, 2 units
are produced and the price is $30. The darkened triangle in Figure 14.10 shows the
deadweight loss if the market is a single-price
monopoly.
377
378
Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
 CHECKPOINT 14.4 Price Discrimination
5. Price discrimination is a firm offering the same good for sale at different
prices. Examples are a shoe store offering one pair of shoes for $50 and a
second pair for half price. A restaurant that offers early bird specials for
dinners before 6 pm or a movie theater that offers lower matinee ticket
prices are engaging in price discrimination.
6a. The drug store is price discriminating.
6b. Domino’s is price discriminating.
6c. The residents might not face price discrimination. There could be higher
costs to transport the water to Los Angeles. If the different prices are based
on volume use or if the different prices are based on different types of users, then there is price discrimination.
6d. If the price difference is based on different costs of mailing a letter versus a
postcard, then there is no price discrimination.
Chapter 14 . Monopoly
USING EYE ON THE U.S. ECONOMY
 Airline Price Discrimination
The story provides a good example of how airlines identify many buyer types.
Charging different prices alone does not guarantee price discrimination. Airlines
effectively price discriminate by requiring passengers to show identification. Before security scares, passengers could board a plane without showing identification so airlines could not prevent the resale of tickets. At that time, price discrimination was more difficult. You might see tickets advertised in the newspapers.
There were businesses devoted to reselling low-priced tickets! For example, at
that time, you could buy your grandmother’s ticket for which she paid a reduced
senior citizen fare. Today, even are valid security reasons for showing identification, so it is much easier for airlines to prevent resale of tickets. You can no longer
resell tickets and so airlines can more easily and more effectively price discriminate.
379