Monopoly
Chapter 7
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Monopoly Structure:
Monopoly
• Market power is the ability to alter the
price of a good or service.
• A monopoly is one firm that produces
the entire market supply of a particular
good or service.
• Since there is only one firm in a
monopoly industry, the firm is the
industry.
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Monopoly = Industry
• The firm’s demand curve is identical to
the market demand curve for the
product.
– Market demand is the total quantity of a
good or service people are willing and
able to buy at alternative prices in a given
time period.
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Price versus
Marginal Revenue
• Marginal revenue (MR) is the change
in total revenue that results from a oneunit increase in quantity sold.
• Price equals marginal revenue only for
perfectly competitive firms.
• Marginal revenue is always less than
price for a monopolist.
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Price versus
Marginal Revenue
• A monopolist can sell additional output
only if it reduces prices.
• The MR curve lies below the demand
curve at every point but the first.
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Figure 7.1
7-6
Profit Maximization
• The monopolist uses the profitmaximization rule to determine its rate
of output.
• According to the rule, a monopolist
maximizes profit at the rate of output
where MR = MC.
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Profit Maximization
• The profit maximization rule applies to
all firms:
– A perfectly competitive firm produces the
quantity where MC = MR (= p)
– A monopolist produces the quantity
where MC = MR (< p)
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Figure 7.2
7-9
The Production
Decision
• Choosing a rate of output is a firm’s
production decision.
• It is the selection of the short-term rate
of output (with existing plant and
equipment).
• A monopolist finds the rate of output
where the marginal revenue and
marginal cost curves intersect.
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The Monopoly Price
• The intersection of the marginal
revenue and marginal cost curves
establishes the profit-maximizing rate
of output.
• The demand curve tells us the highest
price consumers are willing to pay for
that specific quantity of output.
• Only one price is compatible with the
profit-maximizing rate of output.
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Monopoly Profits
• Total profit equals profit per unit times
the number of units produced.
• Profit per unit = price minus average
total cost
Profit per unit = p – ATC
• Total profit = profit per unit times
quantity
Total profit = (p – ATC) x q
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Monopoly Profits
• Profit can also be calculated by
subtracting total cost from total
revenue:
Total profit = TR – TC
LO-3
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Monopoly versus
Competitive Outcomes
• A monopolist produces less and
charges a higher price than would a
competitive industry.
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Figure 7.3
7-15
Barriers to Entry
• Obstacles that make it difficult or
impossible for would-be producers to
enter a particular market.
• Examples include patents, legal
harassment, exclusive licensing,
bundled products, and government
franchises.
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Patent Protection
• A patent is a government grant of
exclusive ownership of an innovation.
• A patent is a source of monopoly
power.
– Polaroid’s patents forced Kodak out of the
instant-photography business.
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Legal Harassment
• Suing potential new entrants can deter
entry into an industry.
• Lengthy legal battles are so expensive
that the threat of legal action may deter
entry into a monopolized market.
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Exclusive Licensing
• Lack of a license makes it difficult for
potential competitors to acquire the
factors of production they need.
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Bundled Products
• Forcing consumers to purchase
complementary products thwarts
competition.
• Bundling products makes it difficult for
competitors to sell their products
profitably.
– Microsoft bundles software applications
with its Windows operating systems
(although the European Union required
Microsoft to offer alternatives to
consumers).
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Government Franchises
• A monopoly granted by a government
license.
– These include local power, telephone, and
cable TV companies.
– Another example is the U.S. Postal
Service, which has a monopoly in
providing first-class mail.
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Comparative Outcomes
• A monopoly’s market power allows it to
change the way the market responds
to consumer demands.
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Competition versus
Monopoly
• In competition, as well as in monopoly,
high prices and profits signal
consumers’ demand for more output.
• In competition, the high profits attract
new suppliers.
• In monopoly, barriers to entry are
erected to exclude potential
competition.
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Competition versus
Monopoly
• In competition, production and supplies
expand, and prices slide down the
market demand curve.
• In monopoly, production and supplies
are constrained, and prices don’t move
down the market demand curve.
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Competition versus
Monopoly
• In competition, a new equilibrium is
established, and average costs of
production approach their minimum.
• In monopoly, no new equilibrium is
established, and average costs are not
necessarily at or near a minimum.
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Competition versus
Monopoly
• In competition, economic profits
approach zero, and price equals
marginal cost throughout the process.
• In monopoly, economic profits are at a
maximum, and price exceeds marginal
cost at all times.
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Competition versus
Monopoly
• In competition, the profit squeeze
pressures firms to reduce costs or
improve product quality.
• In monopoly, there is no profit squeeze
to pressure the firm to reduce costs or
improve product quality.
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Competition versus
Monopoly
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Near Monopolies
• Two or more firms may rig the market
to replicate monopoly outcomes and
profits.
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Near Monopolies
• In duopoly two firms together produce
the industry output.
• In oligopoly several firms dominate
the market.
• In monopolistic competition many
firms each have a monopoly on their
own brand image but must still contend
with competing brands.
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Redeeming Qualities
of Monopolies?
Monopolies could also benefit society.
We must consider:
• Research and Development
• Entrepreneurial Incentives
• Economies of Scale
• Natural Monopolies
• Contestable Markets
• Structure versus behavior
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Research and
Development
• In principle, monopolies have a greater
ability to pursue research and
development.
– They have the resources available to
invest in expensive R&D functions.
• However, they have no clear incentive
for invention and innovation, and can
continue to make profits by maintaining
market power.
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Entrepreneurial
Incentives
• The promise of even greater profits is a
strong incentive for monopolies to
innovate.
• Innovators in perfect competition also
have the ability to earn large profits.
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Economies of Scale
• Economies of scale are present if
average costs fall as the size (scale) of
plant and equipment increases.
• A large firm can produce goods at a
lower unit cost than can a small firm
because of economies of scale.
• Consumers may not benefit from the
lower costs if the monopolist doesn’t
lower its prices.
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Natural Monopoly
• A natural monopoly is an industry in
which one firm can achieve economies
of scale over the entire range of market
supply.
– Examples include local telephone, cable,
and utility services.
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Contestable Markets
• A contestable market is an
imperfectly competitive industry subject
to potential entry if prices or profits
increase.
• How contestable a market is depends
not so much on its structure as it does
on its barriers to entry.
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Structure versus
Behavior
• If potential rivals force a monopolist to
behave like a competitive firm, then
monopoly imposes no cost on
consumers or on society at large.
• The experience with the Model T
suggests that potential competition can
force a monopoly to change its ways.
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Flying Monopoly Air
• Market structure explains why it can be
cheap to fly to one place and expensive
to fly somewhere else of equal
distance.
• From a national perspective, the airline
industry looks pretty competitive.
• However, all of these companies do not
fly to the same places.
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Industry Behavior
• Air fares from airports dominated by
one or two carriers are 45 – 85%
higher than at more competitive
airports.
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Entry Effects
• How fares change when airlines enter
or exit a specific market can be used to
assess the impact of market structure
on prices.
• American Airlines cut its fares when
low-cost carriers entered a market it
dominated—then raised them when the
low-cost carriers left.
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Entry Effects
• Predatory pricing – temporary price
reductions designed to drive out
competition.
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Barriers to Entry
• One of the most formidable entry
barriers to the airline industry is the
ownership of landing rights and gates.
• At Washington, D.C.’s National Airport,
the six largest carriers owned 97
percent of available takeoff/landing
slots in 2000.
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Barriers to Entry
• To offer service from that airport, a new
entrant would have to buy or lease a
slot from one of these firms.
• If existing firms are unwilling to sell or
lease their slots, then competition is
thwarted.
LO-5
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End of
Chapter 7