Market Structures
Monopolies
Characteristics of a Monopoly:



The sole seller of a good that does not have close substitutes
Price Maker
The demand curve for the firm is the demand curve for the entire market
(downward-sloping curve)
Why Monopolies Arise:

Barriers to entry:
o Ownership of a key resource
o Rights to production
o Efficiency of production
Types of Monopolies:
Natural: one firm is able to supply a good or service to an entire market at a smaller cost
than two or more firms could
Government-Created: one firm is given the exclusive right, from the government, to sell a
particular good in certain markets; copyright laws and patents prevent other firms from
competing
A Monopoly’s Revenue:


A monopolist’s marginal revenue is always
less than the price of its good
When a monopoly increases the amount
that it sells there are two effects on total
revenue:
o Output effect = more output sold, Q
is higher
o Price effect = price falls so profit is
lower
Profit Maximization:



A monopoly maximizes profit by producing
the quantity where MR = MC
It then uses the demand curve to find out
consumers to purchase that quantity
For a monopoly firm P > MR = MC
the price that will get
Monopolistic Profit:

The monopolist will receive economic profits as
long as the price is greater than the average
total cost
Deadweight Loss:


Because a monopoly sets its price above
marginal cost there is a gap between what
consumers are willing to pay and the producer’s cost
A monopolist produces less than the socially efficient quantity of output
Market Structures
Monopolies
Government Response to Monopolies

The government can respond to unregulated monopolies in 4 different ways
o Increasing competition in monopolised industries
o Regulating monopolistic behaviours
o Turning private companies into public
o Doing nothing at all
Antitrust Laws




To increase competition, the government introduced antitrust laws
These laws are statutes which give the government the power to restrain monopoly
power
These statutes include the following powers
o Halting mergers of companies in the same industries
o Breaking a large monopoly into smaller companies
o Stopping multiple companies to make the market less competitive
Notable antitrust laws include the Sherman Antitrust Act (1890) and the Clayton
Antitrust Act (1914)
Regulation



The government will often regulate prices that
the monopoly charges.
To make allocation of resources sufficient
the price is set equal to marginal cost.
In practice, regulators will allow
monopolists to keep some of the benefits
from lower costs in the form of higher profit,
a practice that requires some departure from
marginal-cost pricing.
Public Ownership

Sometimes, the government would rather the natural monopoly itself instead of
regulating the monopoly. E.g. Postal Service of the United States
Staying Idle

Governments can choose to do nothing at all if the market failure is deemed to small
compared to the imperfect government policies
Price Discrimination




The business practice of selling the same good at different prices to different
customers despite the same costs.
Price discrimination is not possible in a competitive market, since the firm needs to
have market power
Perfect Price Discrimination: A situation when the monopolist knows exactly the
willingness to pay of each customer and can charge each customer at different prices
Price discrimination increases the monopolist’s profit, and decreases deadweight loss
Market Structures
Monopolies
Monopolies Assignment
(
/20)
Questions:
1. Which of these situations is not an example of price discrimination?
a. Brent works nights so he chooses to buy bread at 7 a.m. rather than at 7 p.m.
b. Bob and Nancy each receive a “$1 off” coupon in the mail, but Bob redeems it while
Nancy does not.
c. Katie buys 12 Cokes for $3 and Josh buys one Coke at a time for $1.
d. Velma likes to go to the movies at a lower afternoon matinee price and Rosemary
would rather pay more for the evening show.
e. Jason and Jen go to a popular nightclub. Because it is “Ladies Night” Jen pays no cover
charge, but Jason must pay to enter the club.
2. Which of the following is a characteristic of a monopoly market?
a. Firms produce a homogeneous product.
b. Barriers to entry exist.
c. Firms are price-taking profit maximizers.
d. Deadweight loss is eliminated through entry of competing firms in the long run.
e. In the long run the firm earns normal profits.
3. A monopolist may be able to maintain long-run positive profit due to
a. Deadweight loss.
b. Economies of scale in production.
c. A price that is set equal to average total cost.
d. Perfectly elastic demand for the product.
e. Entry of new firms that keep the price high.
$
Marginal Cost
d
P5
P4
P3
P2
P1
c
e
f
Average Total
Cost
b
Demand
a
Q1
Marginal
Q2 Revenue
Q3
Output
4. If this firm were a profit-maximizing monopolist, the price, output and profit would be:
A)
B)
C)
D)
E)
PRICE
P5
P5
P4
P1
P3
OUTPUT
Q1
Q1
Q2
Q1
Q3
PROFIT
Q1 * (c-b)
Q1 * P1
Q2 * (P4-P1)
Q1 * (P5-P1)
Q3 * P3
Market Structures
Monopolies
5. Which one of these is an antitrust act?
a. Freeman Act
b. Anti-monopoly act
c. Sherman Act
d. Roosevelt Act
e. Schultz Act
6. Unlike a perfectly competitive firm, a monopoly
a. Will charge the highest price it can on the demand curve
b. Has a horizontal marginal revenue curve
c. Has an upward sloping total revenue curve
d. Faces a downward sloping demand curve
e. Faces a horizontal demand curve
Short Answer: Remember to clearly label all components of a graph and to use a ruler. All
answers should be written in full sentences.
1. In the country of Kold, the marginal cost of producing gloves is constant at $1/pair,
regardless of the industry structure
a) Draw a correctly labeled graph of the glove market that includes a downwardsloping demand curve and marginal revenue curve of a monopoly. Suppose
that the market is controlled by a monopolist. Label as Pm and Qm the price
and quantity that would maximize profits. (5 marks)
b) On the same graph drawn for part a), label as Pc and QC the price and
quantity that would prevail in the long run if the glove market were perfectly
competitive. (3 marks)
c) On the same graph drawn for part a) and b), shade the area that represents
the efficiency loss (or deadweight loss) associated in monopoly. Explain what
efficiency condition is violated by the monopoly. (3 marks)
d) Explain how and why the relationship between the demand curve and the
marginal revenue curve differs between a monopoly and a perfectly
competitive firm. (3 marks)