Chapter 10
Monopoly
• Monopoly = market with just one
seller but many buyers  market
power  when choosing -max
level of output, faces market demand
curve (which slopes downward),
rather than facing perfectly elastic
horizontal demand curve.
• Implies that q* decision affects P.
• For monopolist: mkt D curve is NOT
same as MR and P  MR.
• Result: Higher P and lower Q than in
perfect competition.
More on Monopoly
• When say monopolist faces the
market down-sloped D curve: means
this firm must consider the market
inverse relationship between P and
Q; I.e., when Q, must P.
• Has implications for AR, MR, and max q* (which equals Q*).
• AR: price per unit sold: this is
market demand curve.
• MR  P since when sell extra Q and
P, this P affects ALL Q sold, not
just last Q sold.
Monopolist’s -max
Decision
• AR is market demand curve.
• MR lies below AR curve (See Figure
10.1 and Table 10.1.)
• Monopolist’s production decisions:
• 1) Pick q* where MR = MC.
• (This is same rule as in PC except in
PC, MR=P.)
• 2) Then get P off of D curve. (At q*,
how much are buyers willing to
pay?)
• Note that   0.
• See Figure 10.2.
PC vs Monopolist
• PC has lower price and higher
quantity, has zero profits in LR,
and is more efficient (efficiency
due to P=MC).
• Monopolist has higher price
and lower quantity, can have
positive profits in LR (due to
restricted firm entry), and is less
efficient; I.e., imposes a
deadweight loss (because
PMC).
– See Figure 10.3
Pricing for a Monopolist
• Eqn. (10.2):
P = MC/[1+(1/Ed)]
Comes from equation (10.1) showing
price mark-up over MC as a % of
price.
Recall for PC: P = MC.
For monopolist: P  MC. So HOW
much is P greater than MC?
Difference depends inversely on Ed.
If demand very elasticlittle markup, so little benefit to operating as a
monopolist. See Figure 10.8.
KEY: Monopolist operates only on
elastic portion of demand curve.
Price vs MR
• Remember two points:
– Monopolist operates only on elastic
portion of demand curve;
– MR  P.
• MR = P[1+1/ED].
• So if ED  -1 then MR  0.
In other words: if D is inelastic, then MR
is negative.
At point that D becomes inelastic, MR
curve drops below horizontal axis.
So monopolist will not operate on
inelastic portion of demand curve.
Examples
• 1. Demand not very elastic; So,
demand not very responsive to P:
Ed = -1.1:
• P = MC/[1+(1/Ed)]
• P = MC/[1+(1/-1.1)]
• P = 10 * MC.
• 2. Demand very elastic:
• Ed=-5.
• P = 1.25 * MC.
• Rule: Monopolist gains most when
operating on least elastic range (of
the elastic portion of D curve).
Other Industry
Structures
• Some industries don’t have zero
market power like PC and not lots of
mkt power like monopoly; they lie
somewhere in between.
• # firms: not huge but not 1.
• Product differentiation.
• Result: firms don’t face perfectly
elastic D curve like in PC but don’t
face full market D curve like in
monopoly.
• See Figure 10.7.
Measuring Market
Power
• By how much will P exceed MC?
• Lerner Index of Monopoly Power:
excess of price over MC as fraction
of price (from eq.1).
• L = (P-MC)/P; 0  L  1.
• L = 0 for PC (when P=MC).
• Remember: L = -1/ED but now this
ED is for a specific firm.
• Examples of two groups of buyers:
supermarket vs convenience store.
• See Figure 10.8.
Sources of Monopoly
Power
• Factors that affect degree to
which a single firm can exert
some control over price?
• 1)  E D   power.
• 2)  # firms   power.
• -Depends on ease of entry for
new firms.
• 3) how firms interact: more
aggressive competition leads to
less market power.
PC vs Monopoly
• I. Compare P and Q: PC has
lower price and higher Q.
• II. Compare PS and CS:
Monopoly involves deadweight
loss (related to loss in efficiency
from non-MC pricing). This
deadweight loss is the social
cost of monopoly.
• See Figure 10.10.
Natural Monopoly
• NM occurs in industry in which
cost structure differs: now cost
advantage to monopoly.
• KEY: strong economies of scale
so that AC slopes down at all
levels of Q.
• So MC  AC at all Q.
• With this cost structure: MORE
efficient to operate as NM than
PC.
• See Figure 10.12.
Exercise
• Given that MC = constant = $10
and the following P and Q
information,:
• Calculate firm’s MR, -max P
and Q.
Info for Exercise
• Price
27
• 24
• 21
• 18
• 15
• 12
• 9
• 6
• 3
• 0
Quantity
0
2
4
6
8
10
12
14
16
18