Introduction:
Thinking Like an Economist
CHAPTER 2
CHAPTER 14
12
1
Monopoly and Monopolistic Competition
Monopoly is business at the end of
its journey.
— Henry Demarest Lloyd
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Monopoly and
Monopolistic Competition
14
1
Chapter Goals
 Summarize how and why the decisions facing a
monopolist differ from the collective decisions of
competing firms
 Determine a monopolist’s price, output, and profit
graphically and numerically
 Show graphically the welfare loss from monopoly
 Explain why there would be no monopoly without
barriers to entry
 Explain how monopolistic competition differs from
monopoly and perfect competition
14-2
Monopoly and
Monopolistic Competition
14
1
A Monopolistic Market
 Monopoly is a market structure in which one firm makes up
the entire market
 Barriers to entry into the market prevent competition
 Barriers to entry can be:
• Legal
• Sociological
• Natural
• Technological
 There are no close substitutes for the monopolist’s product
14-3
Monopoly and
Monopolistic Competition
14
1
The Key Difference Between
a Monopolist and a Perfect Competitor
 A monopolistic firm’s marginal revenue is not its price
• Marginal revenue is always below its price
• Marginal revenue changes as output changes
and is not equal to the price
 A monopolistic firm’s output decision can affect price
 There is no competition in monopolistic markets so
monopolists see to it that monopolists, not consumers,
benefit
14-4
Monopoly and
Monopolistic Competition
14
1
Determining the Monopolist’s
Price and Output Numerically
 The goal of the monopolistic firm is to maximize profits,
the difference between total revenue and total cost
 The monopoly maximizes profit when marginal revenue
equals marginal cost
 Marginal revenue (MR) is the change in total revenue
associated with a change in quantity
 Marginal cost (MC) is the change in total cost associated
with a change in quantity
14-5
Monopoly and
Monopolistic Competition
14
1
Determining the Monopolist’s
Price and Output Numerically
 The profit-maximizing condition of a monopolistic firm is:
•
MR = MC
 For a monopolistic firm, MR < P
 A monopolistic firm maximizes total profit, not profit per unit
If MR > MC,
• The monopoly can increase profit by increasing output
If MR < MC,
• The monopoly can increase profit by decreasing its output
14-6
Monopoly and
Monopolistic Competition
Monopolistic Profit Maximization
Table
Q
P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($)
0
36
0
1
33
33
2
30
60
3
27
81
4
24
96
5
21
105
6
18
108
7
15
105
8
12
96
9
9
81
33
27
21
15
9
3
-3
-9
-15
47
48
50
54
62
78
102
142
198
278
1
2
4
8
16
54
40
56
80
---
-47
48.00
-15
25.00
10
18.00
27
15.50
34
15.60
27
17.00
6
20.29
-37
24.75
-102
30.89
-197
14
1
The profitmaximizing
condition is:
MR = MR
If MC < MR,
increase
production
Profit maximizing
quantity is where
MC = MR
If MC > MR,
decrease
production
14-7
Monopoly and
Monopolistic Competition
14
1
Finding the Monopolist’s Price and Output
Draw the marginal revenue,
marginal cost, and demand
curves
P
$36
Monopolist Price:
D at Qprofit max
MC
Find the profit maximizing level
of output, where MR and MC
curves intersect
$24
$20.50
MC = MR
D
MR
Qm (profit max)
Find how much consumers will
pay where Qm intersects
demand; this is the price the
monopolist will charge
Q
14-8
Monopoly and
Monopolistic Competition
14
1
Comparing Monopoly and Perfect Competition
• In a monopoly, P>MR,
• In perfect competition, P=MR=D
• MR=MC is the profit max rule for
both
P
MC
First find the monopoly
Q and P
PM
PPC
DPC= MRPC
DM
MRM
QM QPC
Q
Then find the perfectly
competitive Q and P
Outcome: Monopoly output
is lower and price is higher
than perfect competition
14-9
14
1
Monopoly and
Monopolistic Competition
Find output where
MC = MR, this is the profit
maximizing Q
Determining Profits Graphically:
A Firm with Profit
P
Find how much consumers
will pay where the profit
max Q intersects demand,
this is the monopolist price
Find profit per unit where
the profit max Q
intersects ATC
MC
D at Qprofit max
P
ATC
ATC
Profits
ATC at Qprofit max
MC = MR
Since P>ATC at the
profit maximizing quantity,
this firm is earning profits
D
MR
Qprofit max
Q
14-10
Monopoly and
Monopolistic Competition
Determining Profits Graphically:
A Firm with Zero Profit or Losses
14
1
Find output where
MC = MR, this is the profit
maximizing Q
P
Find how much consumers
will pay where the profit
max Q intersects demand,
this is the monopolist price
MC
ATC
D at Qprofit max
P
=ATC
ATC at Qprofit max
Find profit per unit where
the profit max Q
intersects ATC
MC = MR
D
MR
Qprofit max
Q
Since P=ATC at the
profit maximizing quantity,
this firm is earning
zero profit or loss
14-11
14
1
Monopoly and
Monopolistic Competition
Find output where
MC = MR, this is the profit
maximizing Q
Determining Profits Graphically:
A Firm with Losses
P
Find how much consumers
will pay where the profit
max Q intersects demand,
this is the monopolist price
Find profit per unit where
the profit max Q
intersects ATC
Since P<ATC at the
profit maximizing quantity,
this firm is earning losses
ATC at Qprofit max
ATC
P
MC
ATC
D at Qprofit max
Losses
MC = MR
D
MR
Qprofit max
Q
14-12
Monopoly and
Monopolistic Competition
14
1
Welfare Loss from a Monopoly:
The Normal Monopolist
P
• The welfare loss from a
monopoly is represented by
the triangles B and D
MC
PM
PPC
C
• The rectangle C is a transfer
of surplus from the consumer
to the monopolist
D
B
A
QM QPC
D
MR
Q
• The area A represents the
opportunity cost of diverted
resources, which is not a loss
to society
14-13
Monopoly and
Monopolistic Competition
14
1
The Price-Discriminating Monopolist
 When a monopolist price discriminates, it charges
different prices to different individuals or groups of
individuals
• Consumers with less elastic demands are charged
higher prices.
• Consumers with more elastic demands are
charged lower prices
 Price discrimination increases output and profits
14-14
Monopoly and
Monopolistic Competition
14
1
The Price-Discriminating Monopolist
• A price-discriminating
monopolist produces the
same output as the
combination of all firms in a
competitive market
MC
PC
• All firms in the perfectly
competitive market capture
only area B
A
B
D
QPM = QC
• The price-discriminating
monopolist captures all the
surplus represented by areas
A and B
14-15
Monopoly and
Monopolistic Competition
14
1
The Price-Discriminating Monopolist
 Examples of price discrimination
• Movie discounts to senior citizens and children
• Airline charge more to fly on Fridays and Sundays
• Tracking consumer information and pricing
accordingly
 It might seem unfair for a monopolist to charge
different people different prices, but doing so
eliminates welfare loss from monopoly
 For a price-discriminating monopolist, because it can
charge what consumers are willing to pay, all
consumer surplus is captured by the monopolist
14-16
Monopoly and
Monopolistic Competition
14
1
Barriers to Entry
 Natural Ability
• A firm is better at producing the good than anyone
else
 Natural Monopolies
• Natural monopoly is when a single firm can
produce at a lower cost than can two or more firms
 Government-Created Monopolies
• Patents
 If there were no barriers to entry, profit-maximizing firms
would always compete away monopoly profits
14-17
Monopoly and
Monopolistic Competition
14
1
Average Cost for Natural Monopolist
Average
Cost
• One firm producing Q1 has average cost C1
• If two firms share the market, each produces
Q1/2 and has average cost C2
• If three firms share the market, each
produces Q1/3 has average cost C3
C3
C2
C1
Q 1/3
Q 1/2
Q1
ATC
Q
14-18
Monopoly and
Monopolistic Competition
14
1
Profit of Natural Monopolist
• A natural monopolist produces QM and
charges PM, therefore earning a profit
Average
Cost
• If there is government regulation and a
competitive solution where P = MC is
required, the monopolist produces QC
and charges PC, therefore earning a loss
PM
CM
CC
PC
Profits
Losses
MR
QM
QC
ATC
MC
D
Q
14-19
Monopoly and
Monopolistic Competition
14
1
Government Policy and Monopoly: AIDS
Drugs
 A few companies have patents for AIDS drugs that enable
them to charge high prices because demand is inelastic
Policy Options
• Government regulation where price = marginal cost
benefits society, but discourages research
• Government purchase of the patents and allowing
anyone to produce the drugs so their price = marginal
cost. This is expensive for taxpayers.
14-20
Monopoly and
Monopolistic Competition
14
1
Characteristics of Monopolistic Competition
Four distinguishing characteristics:
1. Many sellers that do not take into account rivals’
reactions
2. Product differentiation where the goods that are sold
aren’t homogenous
3. Multiple dimensions of competition make it harder to
analyze a specific industry, but these methods of
competition follow the same two decision rules as
price competition
4. Ease of entry of new firms in the long run because
there are no significant barriers to entry
14-21
Monopoly and
Monopolistic Competition
14
1
Output, Price, and Profit of a
Monopolistic Competitor
 Like a monopoly,
• The monopolistic competitive firm has some
monopoly power so the firm faces a downward
sloping demand curve
• Marginal revenue is below price
• At profit maximizing output, marginal cost will
be less than price
 Like a perfect competitor, zero economic profits exist in
the long run
14-22
Monopoly and
Monopolistic Competition
14
1
Monopolistic Competition
P
MC
ATC
PMC
D
MR
QMC
Q
• You can see that a
monopolistically competitive
firm prices in the same
manner as a monopolist,
setting quantity where
marginal revenue equals
marginal cost
• But the firm is also a
competitor; competition
implies zero economic profit
in the long run (determined
by ATC)
14-23
Monopoly and
Monopolistic Competition
14
1
Comparing Monopolistic Competition with
Monopoly
 It is possible for the monopolist to make economic
profit in the long run because of the existence of
barriers to entry
 No long-run economic profit is possible in
monopolistic competition because there are no
significant barriers to entry
 For a monopolistic competitor in long-run equilibrium,
(P = ATC) ≥ (MC = MR)
14-24
Monopoly and
Monopolistic Competition
14
1
Monopolistic Competition Compared
with Perfect Competition Graph
P
MC
ATC
PMC
PPC
DPC
DMC
MRMC
QMC QPC
Q
• In monopolistic competition
in the long run, P > min ATC
• In perfect competition in the
long run, P = min ATC
Outcome:
Monopolistic competition
output is lower and
price is higher than
perfect competition
14-25
Monopoly and
Monopolistic Competition
14
1
Advertising and Monopolistic Competition
 Perfectly competitive firms have no incentive to
advertise, but monopolistic competitors do
 The goals of advertising are to increase demand and
make demand more inelastic
 Advertising increases ATC
 The increase in cost of a monopolistically competitive
product is the cost of “differentness”
14-26
Monopoly and
Monopolistic Competition
14
1
Chapter Summary
 A monopolist maximizes profit or minimizes losses where
MR=MC
 To determine a monopolist’s profit or loss: Find output
where MR=MC; Determine price and ATC at that output;
Profit or loss = (P – ATC) * Q
 Because monopolies reduce output and charge P > MC,
monopolies create a welfare loss for society
 Monopoly output is lower and price is higher than in
competitive markets
 Natural monopolies exist in industries with strong
economies of scale
14-27
Monopoly and
Monopolistic Competition
14
1
Chapter Summary
 A price-discriminating monopolist earns more profit than
a normal monopolist by charging a higher price to those
with less elastic demand and a lower price to those with
more elastic demand
 Three important barriers to entry are natural ability,
economies of scale, and government restrictions
 Monopolistic competition is characterized by many
sellers, differentiated products, multiple dimensions of
competition, and ease of entry for new firms
 A monopolistic competitor differs from a monopolist in
that a monopolistic competitor makes zero economic
profit in long-run equilibrium
14-28