MONOPOLY
Chapter 25
3 Questions
 What price will the monopolist
charge?
 How much output will the
monopolist produce?
 Are consumers better or worse
off when only one firm controls
an entire market?
Summary
 Monopoly is the only firm in an industry.
 Nobody else is selling anything like what
the monopolist is producing (DeBeers
diamonds…. used to be AT & T… cable?)
 No close substitutes
 Is imperfect competition
 Profit maximizing MC=MR
Summary Continued
The Monopolist
 lowers price to sell more output,
 the price is lowered on ALL units of
output, not just on the last one.
 This drives down MR faster than
price.
 MR curve descends twice as quickly
as the D Curve.
Summary Continued
 The perfect competitor produced at the
most profitable output, which in the LR
always happened to be the most efficient
output.(i.e. at the minimum point of the
ATC curve.
 The monopolist does NOT produce where
output is at its most efficient level (i.e. the
minimum point of the ATC curve.)
Summary Continued
Distinguishing characteristic:
 firm’s demand curve is no longer a
perfectly elastic horizontal line.
 This means that the imperfect
competitor will have to lower price to
sell more.
 Marginal Cost is the additional cost of
producing one more unit of output.
Summary Continued
 Monopolist makes a profit whereas in the
LR the perfect competitor makes normal or
zero profit
 Monopolist operates at less than peak
efficiency- perfect competitor operates at
peak efficiency.
 Perfect competitor charges a lower price
and produces a larger output than the
monopolist.
 http://video.answers.com/chrisanderson-on-monopolies-293408822
Characteristics





No close substitutes – examples?
Single Seller – (Microsoft Office?)
Price Maker – ($300 ?)
Blocked Entry- (Patent?)
Advertising – (Why?)
Monopolies not permitted in
U.S.
WAIT!!!!!!!!!!!!
Don’t we have them anyway?
Sure – (natural and companies
with large percentage of
market.
What keeps monopolies from
forming in our market economy?
 1887 Interstate Commerce Act
 Initially established to curtail abuse by
railroads.
 The Interstate Commerce Act challenged the
philosophy of laissez-faire economics by clearly
providing the right of Congress to regulate
private corporations engaged in interstate
commerce. The Act, with its provision for the
ICC, remains one of America’s most important
documents serving as a model for future
government regulation of private business.
Progression of legislation
Sherman Act – 1890
Clayton Act – 1914
FTC – 1914
Barriers to Entry
 There are six barriers to entry.
 Patents – offers a producer 20 years of
exclusive rights to produce a particular
product. (drugs, inventions, items on cars,
etc)
 Monopoly franchises – governments
also create and maintain monopolies by
giving a single firm the exclusive right to
supply a particular good or service.
(lotteries, liquor stores, licensing,
taxicabs,)
Barriers to Entry Continued
 Control of key inputs – a company
may lock out competition by
securing exclusive access to key
inputs.(bauxite… aluminum, Tiffanydiamonds)
 Lawsuits – may be used to prevent
new companies from successfully
entering an industry.(threaten
patent violation, rich vs poor
company) (Standard Oil vs xyz oil)
Entry Barriers Continued
Acquisition – when all else fails, purchase a
potential competitor. (AOL/Time/Warner)
(Bank of America/Republic Bank)
 Economies of scale – a monopoly may
persist because of cost advantages over
smaller firms (more cost-effective) (Utility
companies in a state – Con Edison- NY,
SW Bell in TX, TV air waves)
OK! Let’s Take a Deeper Look
 Are Monopolies Beneficial to a Market
Economy?
 It is conceivable that monopolies could
benefit society.
 If economies of scale exist, the
monopolist may attain much greater
efficiency than a large number of
competitive firms.
 Economies of scale act as a “natural”
barrier to entry.
 Examples of natural monopolies used to
include local telephone services, and other
local utility services. Local cable is no
longer an example of monopoly due to
Fios.
Only Two Justifications for Monopoly
1. Natural monopoly
Local gas and electric companies… provide
cheaper service as monopolies than could
several competing firms. They are
government regulated to insure against
price gouging.
2. Economies of Scale
Justify bigness because only a firm with a
large output can produce near the
minimum point of its long-run ATC curve
3. Natural monopoly: a single firm can produce
the entire market Q at lower ATC than could
several firms
Example: 1000
homes need
electricity.
ATC is lower if
one firm
services
all 1000 homes
than if two
firms
each service
500 homes.
Cost
Electricity
Economies of
scale due to
huge FC
$80
$50
ATC
500
1000
Q
Deregulation June, 2013
Why are monopolies so bad?
Monopolies tend to be inefficient.
 because the production is Not at the
minimum point of its ATC curve,
 the monopolist restricts output to some
point to the left of that minimum and
 hence prevents resources from being
allocated in the most efficient manner)
(wastes resources!)
 Two terms to remember… allocative
efficiency and productive efficiency.
Why We Don’t Like Monopolies
The idea of only one seller is not
conducive to getting the best price
on the market as compared to
competition.
Look at the Post Office…. Look at
Amtrak….look at trying to get
Microsoft to Repair Outlook
Express…..have to pay
Profit Maximization
$14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Average
total cost
D
Profits
d
Demand
Marginal
cost
1
2
Marginal
revenue
3
4
5
6
7
Quantity (baskets per hour)
8
9
What actually IS Market Power?
 Market power is the ability to alter the
market price of a good or service.
 The demand curve facing the monopoly
firm is identical to the market demand
curve for the product.(the firm IS the
market)
 Monopoly is a firm that produces the
entire market supply of a particular good
or service.
Price and Marginal Revenue
Unlike competitive firms, marginal
revenue for a monopolist is not
equal to price.
 So long as the demand curve is
downward-sloping, MR will always
be less than price.
Quantity
1
2
3
4
5
6
7
Price
$13
12
11
10
9
8
7
Total
Revenue
$13
24
33
40
45
48
49
Marginal
Revenue
—
$11
9
7
5
3
1
Price or Cost (per basket)
Profit Maximization
$14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Average
total cost
D
Profits
d
Demand
Marginal
cost
1
2
Marginal
revenue
3
4
5
6
7
Quantity (baskets per hour)
8
9
 Marginal Revenue/Price
12
11
10
9
8
7
6
5
4
3
2
1
0
C
D
b
E
c
F
G
d
Demand
(= price)
e
f
Marginal revenue
g
1
2
3
4
5
6
7
QUANTITY (baskets per hour)
8
9
10
Declining Marginal Revenue and Price
 Monopolist’s MR from each unit sold does not
remain constant (as does Pure Competitor
 Monopolist has downward sloping demand
curve which means the price that the
monopolist can get for each additional output
must fall as monopolist increases its output.
 Hence MR will fall as Monopolist increases
output.
 If you assume NO price discrimination, then
MR from each unit produced will not equal the
price the monopolist charges.
 Three implications of a
downward sloping demand curve
 1. Price exceeds marginal
revenue
A down sloping demand curve means
that a pure monopoly can increase
its sales ONLY by charging a
lower unit price for its product. The
fact that he must lower price to
boost sales causes MR to be less
than P for every level of output
EXCEPT the first.
For a Monopolist, P > MR
To sell an additional unit of its good,
a monopolist needs to lower price.
This price reduction both gains
revenue and loses revenue for the
monopolist.
In the exhibit, the revenue gained and
revenue lost are shaded and labeled.
Marginal revenue is equal to the
larger shaded area minus the smaller
shaded area.
Demand and Marginal Revenue
Curves
 The demand curve
plots price and
quantity.
 The marginal
revenue curve plots
marginal revenue
and quantity.
 For a monopolist, P
> MR, so the
marginal revenue
curve must lie
below the demand
curve.
How does a monopolist figure profit?
Agreed……..monopolist has to lower
unit price to sell more…for every
level of output but the first… So,
how does he know where to
produce?
Maximize profit :MC= MR
Where should monopolist produce?
Output Price TR
MR
TC
ATC
MC
1
$16
$16
$16
$20
$20
-
2
$15
$30
$14
$30
$15
$10
3
$14
$42
$12
$36
$12
$6
4
$13
$52
$10
$42
$10.50 $ 6
5
$12
$60
$8
$50
$10
6
$11
$66
$6
$63
$10.50 $13
7
$10
$70
$4
$84
$12
$8
$21
Profit Maximization
Output
Price
TR
MR
TC
ATC
MC
1
$16
$16
$16
$20
$20
-
2
$15
$30
$14
$30
$15
$10
3
$14
$42
$12
$36
$12
$6
4
$13
$52
$10
$42
$10.5
0
$6
5
$12
$60
$ 8*
$50
$10
$8*
6
$11
$66
$6
$63
$10.5
0
$13
7
$10
$70
$4
$84
$12
$21
Implication #2
Price Maker
 This means that the imperfectly
competitive markets in which
demand curves are relevant, the
firms have a price policy. Because of
their ability to influence TOTAL
SUPPLY, the output decisions of such
firms necessarily affect product
price.
 The monopolist determines price by
deciding what volume of output to
produce.
 He chooses both price and output
Implication #3
Price Elasticity
The total revenue test for price elasticity of
demand is the third reason for the down
sloping demand curve.
Total revenue test tells us that when
demand is elastic a decline in price
will increase total revenue. P R
When demand is inelastic decrease in
price will decrease total revenue.) P R
Actually, inelastic demand for a product is
not absolutely necessary… but if product
demand is elastic, it not only has to lower
price, but suggests substitutes. Cable
television????
 For inelastic to be the decision, in
order to increase revenue, monopolist
would have to raise price.
*when MR is negative, demand is
inelastic
 Because he has to lower price to sell
more, will attempt to stay in elastic
segment. Decline in P will increase R
Monopolist wants to avoid the
inelastic segment
Why did the Dallas Tollway Raise
Price?
Because they had a monopoly?
No!
Because they had selected clientele?
Very possible
Equilibrium for Monopolist
 Equilibrium output for a monopolist is
determined where MC=MR
 The price the monopolist charges is
determined by taking the point on the
Demand curve directly above the
intersection of the MC and MR curves.
Bottom Line
***The monopolist will never choose a price
quantity combination where TR is
decreasing (or stated another way… MR is
negative.)
Stated another way… the profitmaximizing monopolist will always
want to avoid the inelastic segment of
its demand curve in favor of some
price-quantity combination in the
elastic segment. (in the inelastic
segment, he loses a % of his profit)
Initial Conditions in the Monopolized Computer
Market
$1200
W
C
Average total cost
800
M
B
600
400
0
1000
Price (per computer)
Price (per computer)
1000
200
Monopoly outcome
Monopoly outcome 1200
Competitive
outcome
Marginal
cost
200 400
Demand
curve facing
single plant
Marginal revenue
of single plant
800
1200
Quantity (computers per month)
1600
800
600
Competitive
market supply
A
X
Market
demand
400
200
0
24,000
Quantity
(computers per month)
Monopoly Curve
$1200
W
C
Price (per computer)
1000
Average total cost
800
M
B
600
400
200
0
Marginal
cost
200 400
Demand
curve facing
single plant
Marginal revenue
of single plant
800
1200
1600
Quantity (computers per month)
Monopoly Profits
Marginal cost
Price (per computer)
$1200
W
Average total cost
C
1000
800
Profit
M
600
K
B
Demand curve
facing single plant
400
200
0
Marginal revenue of
single plant
200
400
600
800 1000 1200
Quantity (computers per month)
1400
Misconceptions Concerning Monopoly
Pricing
1) Not the highest Price… Monopolist
will charge the price where he can
obtain maximum total profit….
Not maximum total price.
2) Total…. Not Unit…
Profit……….Monopolist seeks
maximum TOTAL profit, not
maximum UNIT profit.
Continued Misconceptions
3) Monopolist cannot lose money… While the Perfect
competitor is destined for normal profit in the long
run… and no barriers from everyone in the world
entering the purely competitor’s world… which
drives down prices….
But contrary to conventional wisdom, the
monopolist is not immune to changes by the
demands of the consumer… and more important
… the monopolist is not immune from upwardshifting cost curves caused by escalating resource
prices.
Think about the discriminating monopolist
and the non-discriminating monopolist.
Or, stated another way… think about the
various types of discrimination or not that
a monopolist can engage in!!!!
What does this mean? How would the two
types have a different look for their
monopoly graph?
Selling a specific product at more than one
price (remember price differences are not
justified by cost differences)
NON-DISCRIMINATING
Price and Costs
P
Economic profits with
a single MR=MC
price
MC
ATC
MR
Q1
D
Q
Price Discrimination: Give me examples????
Examples: Electric utilities (vary prices amid
some competition in certain areas)
Golf courses (play 18 at prime
time or “off-hours”
Water usage
Movie tickets
Seats for Ranger World Series
Outcomes of Price Discrimination:
More Profit (if the monopolist can identify the
buyers who will pay more… segregate
them, charge the maximum price each
would be willing to pay, TR and economic
profit will increase
PRICE DISCRIMINATION
Price and Costs
P
A perfectly discriminating
monopolist has MR=D,
producing more product
and more profit!
MC
ATC
MR=D
D
Q1
Q2
Q
P
Economic profits
with
price discrimination
MC
ATC
MR=D
D
Q1
Q2
Q
S = MC
Inefficiencies of
A pure monopoly
At MR=MC
A monopolist
will sell fewer
units at a
higher price
than in
competition
The pure competitor
Will produce where
S & D intersect
D
MR
Qm
Qc
Q
What is Rent Seeking
Rent Seeking= transferring income or wealth
to a particular firm or resource supplier at
someone else’s or even society’s expense.
Best example is getting government to
regulate something in the industry that
has monopoly power (special licensing,
special subsidies, anything directed to
help that industry regardless of cost of
resource mix or societal costs. Exxon did
a lot of rent-seeking. What about
pharmaceuticals today? – Solar today?
Regulated Monopolies
NATURAL MONOPOLIES –Example???
Rate Regulation
Socially Optimum Price
P = MC
Fair-Return Price
P = ATC
Dilemma of Regulation
Regulated Monopolies
P
MR = MC
Socially optimum
Is supposed to be
Allocative efficiency
Fair-Return Price
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q
Examples:
 Government Power
 The AT&T Case
 The federal government dismantled AT&T in 1984.
 Prior to the break-up, AT&T supplied 96 percent of all
long-distance service and over 80 percent of local
telephone service.
 Remember, de-regulation of utilities .
 Still have natural gas, local phone service being
regulated.
 Is it possible Health Care will eventually be here?
Government Power Continued
 Government Power Continued
 Antitrust Laws
 Sherman Act (1890) – prohibits “conspiracies in
restraint of trade.
 Clayton Act (1914) – principally aimed at preventing
the development of monopolies by prohibiting price
discrimination, exclusive dealing agreements, certain
types of mergers, and interlocking boards of directors
among competing firms
 The Federal Trade Commission Act (1914) –
created the FTC to study industry structures and
behavior so as to identify anti-competitive practices.
Should Government Regulate the
Chicken Industry
Financial Industry
Airline Industry?
REGULATION IS DUE TO INCREASE… lack of safety,
Health, environment in question today.
Banking,Cap and Trade, CEO salaries, securities, FAA,
FTC, Housing, etc….