MONOPOLY
12
CHAPTER
Objectives
After studying this chapter, you will able to
 Explain how monopoly arises and distinguish between
single-price monopoly and price-discriminating monopoly
 Explain how a single-price monopoly determines its
output and price
 Compare the performance and efficiency of single-price
monopoly and competition
Objectives
After studying this chapter, you will able to
 Define rent seeking and explain why it arises
 Explain how price discrimination increases profit
 Explain how monopoly regulation influences output,
price, economic profit, and efficiency
Market Power
Market power is the ability to influence the market, and in
particular the market price, by influencing the total quantity
offered for sale.
A monopoly is an industry that produces a good or
service for which no close substitute exists and in which
there is one supplier that is protected from competition by
a barrier preventing the entry of new firms.
Market Power
How Monopoly Arises
A monopoly has two key features:
 No close substitutes
 Barriers to entry
Legal or natural constraints that protect a firm from
potential competitors are called barriers to entry.
Market Power
There are two types of barriers to entry: legal and natural.
Legal barriers to entry create a legal monopoly, a market
in which competition and entry are restricted by the
granting of a:
 Public franchise
 Government license
Patent and copyright
Market Power
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.
Figure 12.1 illustrates a
natural monopoly.
Market Power
One firm can produce 4
units of output at 5 cents
per unit.
Two firms can produce 4
units—2 units each—at 10
cents per unit.
Four firms can produce 4
units—1 unit each—at 15
cents per unit.
Market Power
Monopoly Price-Setting Strategies
There are two types of 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.
A Single-Price Monopoly’s Output and
Price Decision
Price and Marginal Revenue
A monopoly is a price setter, not a price taker like a firm in
perfect competition.
The reason is that the demand curve for the monopoly’s
output is the market demand curve.
To sell a larger output, a monopoly must set a lower price.
A Single-Price Monopoly’s Output and
Price Decision
Total revenue, TR, is the price, P, multiplied by the
quantity sold, Q.
Marginal revenue, MR, is the change in total revenue that
results from a one-unit increase in the quantity sold.
For a single-price monopoly, marginal revenue is less than
price at each level of output. That is,
MR < P
A Single-Price Monopoly’s
Output and Price Decision
Marginal Revenue and
Elasticity
A single-price monopoly’s
marginal revenue is related
to the elasticity of demand
for its good:
If demand is elastic, a fall in
price brings an increase in
total revenue.
A Single-Price Monopoly’s
Output and Price Decision
Marginal Revenue and
Elasticity
The rise in revenue from the
increase in quantity sold
outweighs the fall in
revenue from the lower
price per unit, and MR is
positive.
Total revenue increases.
A Single-Price Monopoly’s
Output and Price Decision
If demand is inelastic, a fall
in price brings a decrease in
total revenue.
The rise in revenue from the
increase in quantity sold is
outweighed by the fall in
revenue from the lower
price per unit, and MR is
negative.
A Single-Price Monopoly’s
Output and Price Decision
Total revenue decreases.
A Single-Price Monopoly’s
Output and Price Decision
If demand is unit elastic, a
fall in price brings total
revenue does not change.
The rise in revenue from the
increase in quantity sold
equals the fall in revenue
from the lower price per unit,
and MR = 0.
Total revenue is maximized
when MR = 0.
A Single-Price Monopoly’s
Output and Price Decision
A single-price monopoly never produces an output at
which demand is inelastic.
If it did produce such an output, the firm could increase
total revenue, decrease total cost, and increase economic
profit by decreasing output.
A Single-Price Monopoly’s Output and
Price Decision
Price and Output Decision
The monopoly selects the profit-maximizing level of output
in the same manner as a competitive firm, where MR =
MC.
Table 12.1 provides a numerical example to illustrate the
profit-maximizing output and price decision.
The monopoly may earn an economic profit, even in the
long run, because the barriers to entry protect the firm
from market entry by competitor firms.
A Single-Price Monopoly’s Output and
Price Decision
Figure 12.4 illustrates the
profit-maximizing choices
of a single-price
monopolist.
In part (a), the monopoly
sets the quantity produced
at the level that
maximizes total revenue
minus total cost.
A Single-Price Monopoly’s Output and
Price Decision
In part (b), the firm
produces the output at
which MR = MC and sets
the price to sell that
quantity.
The ATC curve tells us the
average cost.
Economic profit is the
profit per unit multiplied by
the quantity produced—
the blue rectangle.
Single-Price Monopoly and Competition
Compared
Comparing Output and
Price
Figure 12.5 compares the
price and quantity in perfect
competition and monopoly.
The market demand curve,
D, in perfect competition is
the demand curve that the
firm faces in monopoly.
Single-Price Monopoly and Competition
Compared
The market supply curve in
perfect competition is the
horizontal sum of the
individual firm’s marginal
cost curves, S = MC.
This curve is the
monopoly’s marginal cost
curve.
Single-Price Monopoly and Competition
Compared
Equilibrium in perfect
competition occurs where
the quantity demanded
equals the quantity
supplied at quantity QC
and price PC.
Single-Price Monopoly and Competition
Compared
Equilibrium output for a
monopoly, QM, occurs
where marginal revenue
equals marginal cost, MR
= MC.
Equilibrium price for a
monopoly, PM, occurs on
the demand curve at the
profit-maximizing quantity.
Single-Price Monopoly and Competition
Compared
Because marginal
revenue is less than price
at each output level, QM <
QC and PM > PC.
Compared to perfect
competition, monopoly
restricts output and
charges a higher price.
Single-Price Monopoly and Competition
Compared
Efficiency Comparison
Monopoly is inefficient, and
Figure 12.6 shows why.
The demand curve is the
marginal benefit curve, MB,
and the competitive market
supply curve is the
marginal cost curve, MC.
So competitive equilibrium
is efficient: MB = MC.
Single-Price Monopoly and Competition
Compared
Consumer surplus is the
area below the demand
curve and above the price.
Producer surplus is the
area below the price and
above the marginal cost
curve.
The sum of the two
surpluses is maximized
and the efficient quantity
is produced.
Single-Price Monopoly and Competition
Compared
Monopoly is inefficient
because price exceeds
marginal cost so marginal
benefit exceeds marginal
cost.
On all output levels for
which marginal benefit
exceeds marginal cost, a
deadweight loss is
incurred.
Single-Price Monopoly and Competition
Compared
Redistribution of
Surpluses
Monopoly redistributes a
portion of consumer
surplus by changing it to
producer surplus.
Single-Price Monopoly and Competition
Compared
Rent Seeking
The social cost of monopoly may exceed the deadweight
loss through an activity called rent seeking, which is any
attempt to capture consumer surplus, producer surplus, or
economic profit.
There are two forms of rent seeking activity to pursue
monopoly:
1. Buy a monopoly
2. Create a monopoly—political activity(influence).
Single-Price Monopoly and Competition
Compared
Rent-Seeking Equilibrium
only normal profit.
Figure 12.7 shows the
normal profit that result
from rent seeking.
Single-Price Monopoly and Competition
Compared
A potential profit shown by
the blue area gets used up
in rent seeking.
Average total cost
increases and the profits
disappear to become part
of the enlarged deadweight
loss from rent seeking.
Price Discrimination
Price discrimination is the practice of selling different units
of a good or service for different prices.
To be able to price discriminate, a monopoly must:
 Identify and separate different buyer types
 Sell a product that cannot be resold
Price differences that arise from cost differences are not
price discrimination.
Price Discrimination
Price Discrimination and Consumer Surplus
Price discrimination converts consumer surplus into
economic profit.
A monopoly can discriminate
Among units of a good. Quantity discounts are an example.
Among groups of buyers. airline tickets are an example.
Price Discrimination
Profiting by Price
Discriminating
Figures 12.8 and 12.9
show the same market
with a single price and
price discrimination and
show how price
discrimination converts
consumer surplus into
economic profit.
Price Discrimination
As a single-price
monopolist, this firm
maximized profit by
producing 8 units, where
MR = MC and selling them
for $1,200 each.
Price Discrimination
By price discriminating, the
firm can increase its profit.
In doing so, it converts
consumer surplus into
economic profit.
Price Discrimination
Perfect Price Discrimination
Perfect price discrimination
extracts the entire potential
consumer surplus and
converts it to economic profit.
Price Discrimination
With perfect price
discrimination:
1. Output increases to the
quantity at which price
equals marginal cost
2. Economic profit
increases above that
earned by a single-price
monopoly.
3. Deadweight loss is
eliminated
Price Discrimination
Efficiency and Rent Seeking with Price Discrimination
perfect price discrimination achieve efficiency.
But this outcome differs from the outcome of perfect
competition in two ways:
 The monopoly captures the entire consumer surplus.
 The increase in economic profit attracts even more rentseeking activity that leads to an inefficient use of
resources.
Monopoly Policy Issues
Gains from Monopoly
A single-price monopoly creates inefficiency and price
discriminating monopoly captures consumer surplus and
converts it into producer surplus and economic profit.
And monopoly encourages rent-seeking, which wastes
resources.
But monopoly brings benefits.
Monopoly Policy Issues
Product innovation
Patents and copyrights provide protection from
competition and let the monopoly enjoy the profits.
Economies of scale and scope
Where economies of scale or scope exist, a monopoly can
produce at a lower average total cost.
Monopoly Policy Issues
Regulating Natural
Monopoly
Figure 12.11 shows how a
natural monopoly might be
regulated.
Monopoly Policy Issues
With no regulation, the
monopoly maximizes profit.
It produces the quantity at
which marginal revenue
equals marginal cost.
Monopoly Policy Issues
Regulating a natural
monopoly in the public
interest sets output where
MR = MC and the price
equal to marginal cost.
This regulation is the
marginal cost pricing rule,
and it results in an efficient
use of resources.
Monopoly Policy Issues
With price equal to marginal
cost, ATC exceeds price and
the monopoly incurs an
economic loss.
If the monopoly receives a
subsidy to cover its loss,
taxes must be imposed on
other economic activity,
which create deadweight
loss
Monopoly Policy Issues
Another alternative is to
produce the quantity at which
price equals average total
cost and to set the price
equal to average total cost—
the average cost pricing
rule.
THE END