Monopoly
Chapter 8
LIPSEY & CHRYSTAL
ECONOMICS 12e
Learning Outcomes
• A monopolist sets marginal cost equal to marginal
revenue, but marginal cost is less than price.
• Output is lower under monopoly than under
perfect competition.
• Profit can be increased for a monopolist if it is
possible to charge different prices to different
customers or in separate markets.
• Pure profits exist in the long run under
monopoly, so long as there are entry barriers.
• Cartel can increase the profits of colluding
firms, but individual members have incentives
to break away.
INTRODUCTION - MONOPOLY
A Single-Price Monopolist: price discrimination
• A monopoly is an industry containing a single firm.
• The monopoly firm maximises its profits by equating
marginal cost to marginal revenue, which is less than
price.
• Production under monopoly is less than it would be
under perfect competition, where marginal cost is
equated to price.
INTRODUCTION - MONOPOLY
The Allocative Inefficiency of Monopoly
• Monopoly is allocatively inefficient.
• By producing less than the perfectly competitive output it
transfers some consumers’ surplus to its own profits and
also causes deadweight loss of surplus that would have
resulted from the output that is not produced.
INTRODUCTION - MONOPOLY
A Multi-Price Monopolist
• If a monopolist can discriminate among either different
units or different customers, it will always sell more and
earn greater profits than if it must charge a single price.
• For price discrimination to be possible, the seller must be
able to distinguish individual units bought by a single
buyer or to separate buyers into classes among whom
resale is impossible.
INTRODUCTION - MONOPOLY
Long-run Monopoly Equilibrium
• A monopoly can earn positive profits in the long run if
there are barriers to entry.
• These may be man-made, such as patents or exclusive
franchises, or natural, such as economies of large-scale
production.
INTRODUCTION - MONOPOLY
Cartels as Monopolies
• The joint profits of all firms in a perfectly competitive
industry can always be increased if they agree to restrict
output.
• After agreement is in place, each firm can increase its
profits by violating the agreement. If they all do this,
profits are reduced to the perfectly competitive level.
Total, Average and Marginal Revenue
Price
p=AR
Quantity
q
Total Revenue
TR=p*q
Marginal Revenue
MR = TR/q
(£)
(£)
(£)
(£)
9.10
9
81.90
8.10
9.00
10
90.00
8.90
11
97.90
7.90
The Effect on Revenue of an Increase in Quantity Sold
p0
p1
Addition to
revenues
Reduction
in revenue
q0
q1
Quantity
Total, Average and Marginal Revenue
 Marginal revenue is less than price because price must be
lowered to sell an extra unit.
 For example, consider the marginal revenue of the eleventh unit.
 It is total revenue when eleven units are sold (£97.90) minus total
revenue when 10 units are sold (£90.00) which is £7.90.
 This is less than the £8.90 at which the eleventh unit is sold
because the price on all previous 10 units must be cut by £0.10 to
raise sales by one unit.
The Effect on Revenue of an Increase in Quantity Sold
 Because the demand curve has a negative slope, marginal
revenue is less than price.
 A reduction of price from p0 to p1 increases sales by one unit from
q0 to q1 units.
 The revenue from the extra unit sold is shown as the medium blue
area.
 To sell this unit, it is necessary to reduce the price on each of the
q0 units previously sold.
 The loss in revenue is shown as the dark blue area.
 Marginal revenue of the extra unit is equal to the difference
between the two areas.
Revenue curves and demand elasticity
Elasticity
greater
than one >1
10
Elasticity between
zero and one
0 <  <1
AR
5
50
Unity elasticity
=1
100
MR
-10
Quantity
250
TR
£
0
50
100
Quantity
Revenue curves and demand elasticity
 Rising TR, positive MR, and elastic demand all go together.
 In this example, for outputs from 0 to 50 units, marginal revenue is
positive, elasticity is greater than unity, and total revenue is rising.
 Falling TR negative MR and inelastic demand all go together. In
this example, for outputs from 50 to 100 units, marginal revenue is
negative, elasticity is less than unity, and total revenue is falling.
(All elasticities refer to absolute not algebraic values.)
The Equilibrium of a Monopoly
MC
ATC
p0
c0
AVC
MR
0
q0
Profit-maximizing quantity
D = AR
Quantity
The Equilibrium of a Monopoly
 The monopoly produces the output q0 where marginal revenue
equals marginal cost (rule 2).
 At this output, the price of p0 (which is determined by the
demand curve) exceeds the average variable cost (rule 1).
 Total profit is the profit per unit of p0-c0 multiplied by the output
of q0, which is the yellow area.
No Supply Curve under Monopoly
D”
MC
p1
p0
MR”
0
q0
MR’
D’
The same output at different prices
Quantity
No Supply Curve under Monopoly
 The demand curves D’ and D’’ both have marginal revenue curves
that intersect the marginal cost curve at output q0.
 But because the demand curves are different, q0 is sold at:
 p0 when the demand curve is D’ and at p1 when the demand curve
is D’’.
 Thus under monopoly there is no unique relation between price and
the quantity sold.
The deadweight loss of monopoly
MC [monopoly] = S [competition]
pm
p0
5
Em
Ec
6
Competitive price
1
7
2
D
MR
0
qm
q0
Quantity
The deadweight loss of monopoly
 At the perfectly competitive equilibrium Ec consumers’ surplus is the
sum of the areas 1, 5, and 6.
 When the industry is monopolized, price rises to pm, and consumers
surplus falls to area 5.
 Consumers lose area 1 because that output is not produced.
 They lose area 6 because the price rise has transferred it to the
monopolist.
 Producers’ surplus in the competitive equilibrium is the sum of the
areas 7 and 2.
The deadweight loss of monopoly
 When the market is monopolized and price rises to pm, the surplus
area 2 is lost because the output is not produced.
 However the monopolist gains area 6 from consumers. Area 6 is
known to be greater than 2 because pm maximizes the monopolist
profits.
 Thus although the monopolist gains, society loses areas 1 and 2.
 Areas 1 and 2 are the deadweight loss resulting from monopoly and
account for its allocative inefficiency.
A Price-discriminating Monopolist
D
pm
pd
MR
1
S = MC
2
0
qm
3
qd
qc
Quantity
A Price-discriminating Monopolist
 Initially the monopolist produces output qm which it sells at
pm where MC = MR instead of the competitive output qc
where MC equals demand (which is consumers’ marginal
utility).
 The deadweight loss is the sum of the three areas labelled
1, 2, and 3.
 A second group of consumers is then isolated from the first
(the first group continue to buy qm at pm).
 This new group who would buy nothing at the
original price of pm, will buy an amount that would
increase total output to qd at a price of pd.
 The monopoly firm’s profits now rise by the area
2, which is the difference between its cost curve
and the price pd that is charged to the new group
who buy the amount between qm and qd.
 Consumers’ surplus rises by the area labelled 1
and total deadweight loss falls to the area
labelled 3.
Conflicting forces affecting cartels
MR
ATC
p1
MC
£ per unit
S
E
p0
p1
E
p0
D
0
Q1
Q0
Quantity [thousands of tons]
[i]. Market equilibrium
q1
q0
Quantity [tons]
[ii]. Firm equilibrium
q2
Conflicting forces affecting cartels (i) the market
 Initially the market is in competitive equilibrium, with price p0 and
quantity Q0.
 The cartel is formed and enforces quotas on individual firms that
are sufficient to reduce the industry’s output to Q1, the output that
maximizes the joint profits of the cartel members.
 Price rises to p1.
Conflicting forces affecting cartels (ii) an individual firm
 (Note the change in scale from figures (i) and (ii).
 Initially the individual firm is producing output q0 and is just
covering its total costs at price p0.
 When the cartel restricts production the typical firm’s quota
is q1.
 The firm’s profits rise from zero to the amount shown by the
dark blue area.
Conflicting forces affecting cartels (ii) an individual firm
 Once price is raised to p1 however, the individual firm would
like to increase output to q2, where marginal cost is equal to
the price set by the cartel.
 This would allow the firm to earn profits shown by the blue
hatched area.
 But if all firms violate their quotas in this way, industry
output will rise above Q1, market price will fall, and the profit
earned by each and every firm will fall.