Monopoly
Eco 2023
Chapter 10
Fall 2007
Monopoly
• A market with a single seller with a product
that is differentiated from other products.
Characteristics
• Single seller
– Firm and industry are synonymous
• No close substitutes
• Price maker
• Blocked entry
– Barriers to entry keep competitors out of the
market
• Standardized or differentiated
Barriers to Entry
• Any impediment that prevents new firms from
entering an industry and competing on an equal
basis with existing firms
• Types
– Economies of scale
– Legal restrictions
– Control over essential resource
Economies of Scale
• Declining average total cost with
added firm size are extensive
• Long run average total cost will
decline over a wide range of output
• Only a single large firm can
achieve low average total costs
• Protects the firm from competitors
• Natural monopoly
– the market demand curve cuts the
long-run ATC curve where average
total costs are still declining
Legal Restrictions
• Patent
– A legal barriers to entry that grants its holder the exclusive
right to sell a product for 20 years from the date the patent
application is filed
– Innovation
» The process of turning an invention into a marketable
product
• Licenses
– Governments often confer monopoly status by awarding a
single firm the exclusive right to supply a particular good
or service
Control over Essential
Resource
• Firms owns all sources of a resource
– ALCOA – aluminum
– DeBeers – diamonds
Monopoly Demand
• Three assumptions
– Patents, economies of scale or resource
ownership secure our monopolist’s status
– No unit of government regulates the firm
– Single price monopolist,
• Demand curve
– Downward sloping demand curve
– Quantity demanded increases as price
decreases
Implications
• Marginal revenue is less than price
– The downward sloping demand curve means that it
can increase sales by charging a lower price
– Marginal revenue is less than price for every level of
output
– Marginal revenue curve is below the demand curve
– Marginal revenue is positive while total revenue is
increasing.
– When total revenue is decreasing, marginal revenue is
negative
Monopoly
Price
Elastic
Unit Elastic
Inelastic
Demand = Average Revenue
Marginal Revee
Monopoly
• Where demand is price elastic, marginal revenue
is positive
•
Therefore:
•
TR increases as Price decreases
• Where demand is price inelastic, marginal
revenue is negative
•
TR decreases as Price increases
• Where demand is unit elastic, marginal revenue
is zero,
– TR is at a maximum, neither increasing nor
decreasing
Implications
• Price Maker
– When monopolist decides on output level, he
determines price.
• Elastic Region
– Monopolist will never choose a price-quantity
combination where price reductions cause
total revenue to decrease
• Marginal revenue is NEGATIVE
Example
Output
Price
Total Revenue
Average
Revenue
Q
0
$
172.00
PXQ
$
Marginal
Reven
ue
MR
Average Total
Cost
Total Cost
Marginal Cost
Profit or Loss
ATC
TC
MC
TR - TC
-
$ 100.00
$ 162.00
1
$
162.00
$
162.00
$
$ 190.00
$
152.00
$
304.00
$
$ 135.00
$
142.00
$
426.00
$
$ 113.33
4
$
132.00
$
528.00
$
$ 100.00
5
$
122.00
$
610.00
$
$ 94.00
6
$
112.00
$
672.00
$
$ 91.67
7
$
102.00
$
714.00
$
$ 91.43
8
$
92.00
$
736.00
$
$ 93.75
$ 750.00
86.00
$
128.00
$
140.00
$
122.00
$
74.00
$
(14.00)
90.00
$ 640.00
$ 22.00
$
80.00
$ 550.00
$ 42.00
(34.00)
70.00
$ 470.00
$ 62.00
$
60.00
$ 400.00
$ 82.00
(28.00)
70.00
$ 340.00
$ 102.00
$
80.00
$ 270.00
$ 122.00
3
90.00
$ 190.00
$ 142.00
2
$ (100.00)
110.00
Monopoly
• Profit Maximization
– A firm that must find the profit maximizing
price when the demand curve for its output
slopes downward
– Monopolist produces the quantity at which
total revenue > total cost by greatest amount
– Marginal revenue = Marginal cost
Monopoly – short run
Price
Profit
Marginal Cost
Average Total
Cost
P
Marginal
Revenue
Q
Demand = Average Revenue
Monopoly
• Short run
– Economic profits can exist
– Losses
• Can exist
• If the price covers average variable cost, the firm
will produce
• If not, the firm will shut down at least in the short
run
Long run Profit
Maximization
• Long run efficiency in pure competition is
– P = MC = Minimum ATC
• Monopoly
– MR < P, monopolist will sell smaller output at a
higher price than pure competition
– An efficiency loss occurs because
• P > MC
• P > minimum ATC
Long-Run Profit
Maximization
• If a monopoly is insulated from competition
by high barriers that block new entry,
economic profit can persist in the long run.
Monopoly
• Allocation of Resources
– If monopolists are no greedier than perfect
competitors because both maximize profit
– What is the problem with monopoly?
• Lower output
• Higher price
– Than perfect competition
Monopoly
• Price Discrimination
– Increasing profits by charging different groups
of consumers different prices when the price
differences are not justified by differences in
production costs
Monopoly
• Conditions
– Demand must be downward sloping
– At least to separate groups of consumers
• Each with different price elasticity of demand
– Firm must be able to charge each group a different
price for essentially the same product
– The firmmust be able to prevent those who pay the
lower price from reselling the product to those who
pay the higher price
– Each market, the firms equates marginal revenue with
marginal cost