Monopoly
Learning Objectives:
• What is a Monopoly?
• What are the sources of Monopoly power?
• How does a Monopoly choose how much to produce and what price to
charge?
• What effect does a Monopoly have on economic efficiency?
• How does a government react to a Monopoly?
Definition of Monopoly
• A market for a product or service with only one firm producing and
selling that particular product or service
• Examples of Monopoly:
• Public utilities (may be local monopolies)
• BCCI
• Indian Railways (till 2009)
• Example: Entering the Aspartame Market
Source of Monopoly Power: Barriers to Entry
• Key input for production under the control of one firm
• Network externalities in the supply of the product
• As more people use the product, its usefulness rises
• Economies of scale giving rise to Natural Monopoly
• One firm can supply the entire market at lower average total cost than many firms
together
• Government imposed entry barrier
• Patent & Copyright
• Public Franchise
Monopolist’s Demand Curve and Marginal Revenue
Curve
Monopolist’s demand
curve is downward
sloping
When a (non price
discriminating)
Monopolist lowers the
price of the product in
order to sell more of it:
More of the product gets sold,
giving extra revenue
Total revenue from all the
previous units decreases due to
lower price being charged for
each unit
How does a Monopoly choose Price and Output?
• A Monopolist maximizes profit
• Profit maximization rule:
• Marginal Revenue (MR) = Marginal Cost (MC)
Profit = Total Revenue – Total Cost
⇒𝜋 𝑄 =𝑃 𝑄 ∗𝑄−𝐶 𝑄
Maximizing profit with respect to output:
𝜕𝜋(𝑄)
𝜕𝑃(𝑄)
𝜕𝐶 𝑄
= 𝑃 𝑄 +
∗𝑄 −
=0
𝜕𝑄
𝜕𝑄
𝜕𝑄
𝜕𝑃(𝑄)
𝜕𝐶 𝑄
⇒ 𝑃 𝑄 +
∗𝑄 =
𝜕𝑄
𝜕𝑄
A Monopolist Maximizing Profit
Profit Maximizing Price and Output:
P* & Q*
Monopolist’s Profit:
□P*Act
A Rule of Thumb for Monopoly Pricing
𝑃 − 𝑀𝐶
1
=−
𝑃
𝜀𝐷
Or,
𝑀𝐶
𝑃=
1
1+
𝜀𝐷
• Markup over marginal cost as a percentage of price for a Monopolist should be
equal to the negative of the inverse of the elasticity of demand for the
monopolist’s product
• If demand for the product is very elastic, the Monopolist will get a lower
markup
Calculating a Monopolist’s Profit Maximizing Price
and Output
Price (P)
Quantity (Q)
Total
Revenue
(P*Q)
Marginal
Revenue
Total Cost
(C)
Δ𝑻𝑹
Δ𝑸
Marginal
Cost
20
0
0
-
41
-
19
1
19
19
45
4
18
2
36
17
50
5
17
3
51
15
56
6
16
4
64
13
63
7
15
5
75
11
71
8
14
6
84
9
80
9
13
7
91
7
90
10
12
8
96
5
101
11
Δ𝑪
Δ𝑸
Social Costs of Monopoly Power
• Fall in Consumer
Surplus
• Rise in Producer
Surplus
• Creation of
Deadweight Loss,
and thus leading to a
fall in Economic
Efficiency
• Example: In Prisons,
Sky-High Phone
Rates and Money
Transfer Fees
Measuring Monopoly Power
• Lerner’s Degree of Monopoly Power
𝑃 − 𝑀𝐶
1
𝐿=
=−
𝑃
𝜀𝐷
• For a Perfectly Competitive firm, P = 𝑀𝐶 ⇒ 𝐿 = 0
Multi-plant Monopoly
• Profit maximization:
𝑀𝑅 𝑄1 + 𝑄2 = 𝑀𝐶1 𝑄1 = 𝑀𝐶2 𝑄2 ,
where 𝑄1 𝑎𝑛𝑑 𝑄2 are output from plants 1 and 2 respectively.
Government Policy towards Monopoly
• Antitrust Laws
• Merger Evaluations
• Price Regulations
• Example: Dollar Tree Crowned Victor In Battle For Family Dollar
• Example: The Death of Google Reader Paves The Way For Real RSS
Businesses