Monopoly - Characteristics
• A firm is considered a monopoly if . . .
. . . it is the sole seller of its product.
. . . its product does not have close
substitutes.
. . . it has some ability to influence the
market price of its product.
Why Monopolies Arise
• The fundamental cause of monopoly is barriers
to entry.
• Barriers to entry have three sources:
 Ownership of key resource
 Legal barriers by government
 Large economies of scale
• Exclusive ownership of an important resource
that cannot be readily duplicated is a potential
source of monopoly.
Government-Created
Monopolies
• Patent and copyright laws are a major
source of government-created
monopolies.
• Governments also restrict entry by giving
a single firm the exclusive right to sell a
particular good in certain markets.
Natural Monopolies
• An industry is a natural monopoly when
a single firm can supply a good or service
to an entire market at a smaller cost than
could two or more firms.
• Because of economies of scale, the
minimum efficient scale of one firm’s
plant is so large that only one firm can
supply the market efficiently.
Monopoly versus Perfect
Competition
• Monopoly
 Is the sole producer
 Has a downwardsloping demand curve
 Is a price maker
 Reduces price to
increase sales
• Competitive Firm
 Is one of many
producers
 Has a horizontal
demand curve
 Is a price taker
 Sells as much or as
little at same price
Monopoly’s Revenue
• Total Revenue
P x Q = TR
• Average Revenue
TR/Q = AR = P
• Marginal Revenue
DTR/DQ = MR
NB : - MR does not equal AR
Monopoly’s, Total, Average,
and Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
£11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=DTR/DQ
£0
10
18
24
28
30
30
28
24
—
£10
9
8
7
6
5
4
3
—
£10
8
6
4
2
0
–2
–4
Monopoly’s Marginal Revenue
• A monopolist’s marginal revenue is
always less than the price of its good.
 The demand curve is downward
sloping.
 When a monopoly drops the price to
sell one more unit, the revenue received
from previously sold units also decreases.
Monopoly’s Marginal Revenue
• When a monopoly increases the amount
it sells, it has two effects on total revenue
(P x Q).
 The output effect—more output is sold, so Q
is higher.
 The price effect—price falls, so P is lower.
Monopoly’s Demand and
Marginal Revenue Curves
Price
£11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
•The marginal
revenue curve lies
below its demand
curve.
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8 Quantity of Water
Profit Maximization of a
Monopoly
• A monopoly maximizes profit by
producing the quantity at which marginal
revenue equals marginal cost.
• It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
A
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
2. ...and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Comparing Monopoly and
Competition
• For a competitive firm, price equals
marginal cost.
P = MR = MC
• For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
Calculating Monopoly Profit
• Profit equals total revenue minus total
costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Average
total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly E
price
B
Monopoly
profit
Average
total cost D
Average total cost
C
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
• The monopolist will receive economic
profits as long as price is greater than
average total cost.
The Welfare Cost of Monopoly
• A monopoly leads to an inefficient allocation of
resources and a failure to maximize total
economic well-being.
• The monopolist produces less than the socially
efficient quantity of output.
• Because a monopoly charges a price above
marginal cost, consumers who value the good
at more than its marginal cost but less than the
monopolist’s price won’t buy it.
The Welfare Cost of Monopoly
• Monopoly pricing prevents some
mutually beneficial trades from taking
place.
The Deadweight Loss
• 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.

 This wedge causes the quantity sold to
fall short of the social optimum.
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
The Deadweight Loss
Price
Deadweight
loss
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
Public Policy Toward
Monopolies
• Government responds to the problem of
monopoly in one of four ways.
 Making monopolized industries
more competitive.
 Regulating the behaviour of monopolies.
 Turning some private monopolies into
public enterprises.
 Doing nothing at all.
Creating a Competitive Market
and Regulation
• Government may implement and enforce
antitrust laws to make the industry more
competitive.
• Government may regulate the prices that the
monopoly charges.
 The allocation of resources will be efficient if price is
set to equal marginal cost.
• There are two practical problems with
marginal-cost pricing.
 Price may be less than average total cost, and the
firm will lose money.
 It gives the monopolist no incentive to reduce cost.
Public Ownership
• Government can turn the monopolist into
a government-run enterprise.
• Government can do nothing at all if the
market failure is deemed small compared
to the imperfections of public policies.
Price Discrimination
• Price discrimination is the practice of
selling the same good at different prices
to different customers.
 Not possible in a competitive market.
• Two important effects of price
discrimination:
 It can increase the monopolist’s profits.
It can reduce deadweight loss.
Examples of Price Discrimination
•
•
•
•
•
Movie tickets
Airline tickets
Discount coupons
Financial aid
Quantity discounts
The Prevalence of Monopoly
• How prevalent are the problems of
monopolies?
 Monopolies are common.
 Most firms have some control over their
prices because of differentiated products.
 Firms with substantial monopoly power
are rare.
 Few goods are truly unique.
Conclusion
• A monopoly is a firm that is the sole seller in its
market.
• It faces a downward-sloping demand curve for
its product.
• Like a competitive firm, a monopoly maximizes
profit by producing the quantity at which
marginal cost and marginal revenue are equal.
• Unlike a competitive firm, its price exceeds its
marginal revenue, so its price exceeds marginal
cost.
Conclusion
• A monopolist’s profit-maximizing level of
output is below the level that maximizes
the sum of consumer and producer
surplus.
• A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.
Conclusion
• Policymakers can try to remedy the
inefficiencies of monopolies with antitrust
laws, regulation of prices, or by turning
the monopoly into a government-run
enterprise.
• If the market failure is small,
policymakers may decide to do nothing at
all.
Conclusion
• Monopolists can raise their profits by
charging different prices to different
buyers based on their willingness to pay.
• Price discrimination can raise economic
welfare and lessen deadweight losses.
(a) A Competitive Firm’s Demand Curve
Price
(b) A Monopolist’s Demand Curve’
Price
Demand
Demand
0
Figure 15-2
Quantity of Output
0
Quantity of Output
Price
£11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Figure 15-3
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8 Quantity of Water
Costs and
Revenue
2. ...and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Figure 15-4
Q1
QMAX
Q2
Quantity
Costs and
Revenue
Marginal cost
Monopoly E
price
B
Monopoly
profit
Average
total cost D
Average total cost
C
Demand
Marginal revenue
0
Figure 15-5
QMAX
Quantity
Costs and
Revenue
Price
during
patent life
Price after
patent
expires
Marginal
cost
Marginal
revenue
0
Figure 15-6
Monopoly
quantity
Competitive
quantity
Demand
Quantity
Price
Marginal cost
Value to
buyers
Cost to
monopolist
Demand
(value to buyers)
Cost to
monopolist
Value to buyers
0
Quantity
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.
Efficient
quantity
Figure 15-7
Price
Deadweight
loss
Marginal cost
Monopoly
price
Marginal
revenue
0
Figure 15-8
Monopoly Efficient
quantity quantity
Demand
Quantity
Price
Average
total cost
Average total cost
Loss
Regulated
price
Marginal cost
Demand
0
Figure 15-9
Quantity
(a) Monopolist with Single Price
Price
(b) Monopolist with Perfect Price Discrimination
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Profit
Marginal
revenue
0
Figure 15-10
Quantity sold
Marginal cost
Marginal cost
Demand
Demand
Quantity
0
Quantity sold
Quantity