1. What Is A Monopoly?
A monopoly firm is the only seller of a good or service with no close substitutes
Key concept is notion of substitutability
Hall & Leiberman; Economics: Principles And Applications, 2004

2. The Sources of Monopoly
Existence of a monopoly means that something is causing other firms to stay out of the market
What barrier prevents additional firms from entering the market?
Several possible answers
Economies of scale
Legal barriers
Network externalities
Hall & Leiberman; Economics: Principles And Applications, 2004

3. Economies of Scale
If economies of scale persist to the point where a single firm is producing for entire market, the market is a natural monopoly
Unless government intervenes, only one seller would survive—market would naturally become a monopoly
Hall & Leiberman; Economics: Principles And Applications, 2004

4. Figure 1: A Natural Monopoly
Pieces of Clothing per Week
Dollars A 15 B 12
LRATC C 5
DMarket
300
350
Hall & Leiberman; Economics: Principles And Applications, 2004

5. Legal Barriers
Many monopolies arise because of legal barriers including
Protection of intellectual property
Government franchise
Hall & Leiberman; Economics: Principles And Applications, 2004

6. Protection of Intellectual Property
Most important kinds of legal protection for intellectual property are
Patents
Copyrights
Copyrights and patents are often sold to another person or firm, but this does not change monopoly status of the market, since there is still just one seller
Hall & Leiberman; Economics: Principles And Applications, 2004

7. Government Franchise
Large firms we usually think of as monopolies have their monopoly status guaranteed through government franchise
Governments usually grant franchises when they think market is a natural monopoly
Hall & Leiberman; Economics: Principles And Applications, 2004

8. Network Externalities
Exist when an increase in network’s membership increases its value to current and potential members
When network externalities are present, joining a large network is more beneficial than joining a small network
Hall & Leiberman; Economics: Principles And Applications, 2004

9. Monopoly Goals And Constraints
Goal of a monopoly—like that of any firm—is to earn highest profit possible
However, a monopolist faces constraints
Constraint on monopoly’s cost
Technology of production
Price it must pay for its inputs
Demand constraint
Hall & Leiberman; Economics: Principles And Applications, 2004

10. Monopoly Price or Output Decision
When any firm—including a monopoly—faces a downward sloping demand curve, marginal revenue is less than price of output
Monopoly will always produce at an output level where marginal revenue is positive
Hall & Leiberman; Economics: Principles And Applications, 2004

11. Figure 2: Demand and Marginal Revenue
Number of Subscribers
Monthly Price per Subscriber
$60 50 A B 48 C 38 30 20 F G 18
Demand
5,000
15,000
20,000
30,000
6,000 MR
21,000
Hall & Leiberman; Economics: Principles And Applications, 2004

12. The Profit-Maximizing Output Level
To maximize profit, the firm should produce level of output where MC = MR and MC curve crosses MR curve from below
For a monopoly, price and output are not independent decisions
Hall & Leiberman; Economics: Principles And Applications, 2004

13. Figure 3: Monopoly Price and Output Determination
Number of Subscribers
Monthly Price per Subscriber 40
$60 MC E D
10,000
30,000 MR
Hall & Leiberman; Economics: Principles And Applications, 2004

14. Profit And Loss A monopoly earns a profit whenever P > ATC
A monopoly suffers a loss whenever P < ATC
Hall & Leiberman; Economics: Principles And Applications, 2004

15. Figure 4: Monopoly Profit and Loss
Dollars
(a)
Number of Subscribers
(b)
ATC MC
ATC MC
AVC
$50 E E
$40 40 32
Total Loss
Total Profit D D
10,000
10,000 MR MR
Hall & Leiberman; Economics: Principles And Applications, 2004

16. Short-Run Equilibrium
Monopoly may earn an economic profit or suffer an economic loss
What if a monopoly suffers a loss in short-run?
If monopoly suddenly finds that P < AVC, government will usually not allow it to shut down
Hall & Leiberman; Economics: Principles And Applications, 2004

17. Long-Run Equilibrium
Perfectly competitive firms cannot earn a profit in long-run equilibrium
Monopolies may earn economic profit in long-run
A privately owned monopoly suffering an economic loss in long-run will exit the industry
Hall & Leiberman; Economics: Principles And Applications, 2004

18. Comparing Monopoly to Perfect Competition
In perfect competition, economic profit is relentlessly reduced to zero by entry of other firms
In monopoly, economic profit can continue indefinitely
But monopoly differs from perfect competition in another way
Can expect a monopoly market to have a higher price and lower output than an otherwise similar perfectly competitive market
By raising price and restricting output, new monopoly earns economic profit
Consumers lose in two ways
Pay more for output they buy
Due to higher prices they buy less output
Hall & Leiberman; Economics: Principles And Applications, 2004

19. Figure 5a/a: Comparing Monopoly and Perfect Competition
Quantity of Output
Price per Unit
(a) Competitive Market
(b) Competitive Firm
Dollars per Unit
2. and each firm produces 1,000 units, where P = MC. S MC
ATC E
$10
3. When monopoly takes over, the old market supply curve . . .
$10 d D
100,000
1,000
1. In this competitive market of 100 firms, equilibrium price is $10
Hall & Leiberman; Economics: Principles And Applications, 2004

20. Figure 5c: Comparing Monopoly and Perfect Competition
(c) Monopoly
Price per Unit
S = MC
4. becomes the monopoly's MC curve. F
$15 E
5. The monopoly produces where MR = MC, 10
6. with a higher price and lower market output than under perfect competition. MR D
Quantity of Output
100,000
60,000
Hall & Leiberman; Economics: Principles And Applications, 2004

21. Comparing Monopoly to Perfect Competition
Changeover from perfect competition to monopoly benefits owners of monopoly and harms consumers of the product
if all else is equal
Monopolization of a competitive industry leads to two opposing effects
For any given technology of production, monopolization leads to higher prices and lower output
Changes in technology of production made possible under monopoly may lead to lower prices and higher output
Hall & Leiberman; Economics: Principles And Applications, 2004

22. What Happens When Things Change?
Possible events
Change in demand for monopolist’s product
Change in its costs
What might cause a monopolist to experience a shift in demand?
Possible causes are the same as for perfect competition
Hall & Leiberman; Economics: Principles And Applications, 2004

23. An Increase in Demand and a Cost-Saving Technological Advance
Monopolist will react to an increase in demand by
Producing _____ output
Charging a _____ price
Earning a _______ profit
In general, monopoly will pass to consumers only part of benefits from a cost-saving technological change
After change in technology, monopoly’s profits will be _______
Hall & Leiberman; Economics: Principles And Applications, 2004

24. Figure 6: A Change in Demand
Number of Subscribers
Monthly Price per Subscriber A D1
MR1
(b)
10,000 40 MC
Monthly Price per Subscriber
Number of Subscribers MC B A
$47
$40 D1 D2
10,000
MR1
30,000
MR2
11,000
Hall & Leiberman; Economics: Principles And Applications, 2004

25. Figure 7: Monopoly Profit and Loss
Number of Subscribers
Dollars E D MR
10,000
12,000
$40
MC2
MC1 38
Hall & Leiberman; Economics: Principles And Applications, 2004

26. Price Discrimination
Price discrimination occurs when a firm charges different prices to different customers for reasons other than differences in costs
Price-discriminating monopoly it divides its customers into different categories based on their willingness to pay for good
Hall & Leiberman; Economics: Principles And Applications, 2004

27. Requirements for Price Discrimination
Must be a downward-sloping demand curve for the firm’s output
Firm must be able to identify consumers willing to pay more
Firm must be able to prevent low-price customers from reselling to high-price customers
Hall & Leiberman; Economics: Principles And Applications, 2004

28. Price Discrimination That Harms Consumers
Price discrimination always benefits owners of a firm
Can use this ability to increase its profit
When price discrimination raises price for some consumer above price they would pay under a single-price policy it harms consumers
Additional profit for the firm is equal to monetary loss of consumers
Hall & Leiberman; Economics: Principles And Applications, 2004

29. Figure 8a: Price Discrimination
Number of Round-trip Tickets
Dollars per Ticket MC E
ATC
$120 80 MR D 30
Hall & Leiberman; Economics: Principles And Applications, 2004

30. Figure 8b: Price Discrimination
Dollars per Ticket
Additional profit from price discrimination MC
$160
120 MR D
Number of Round-trip Tickets 10 30
Hall & Leiberman; Economics: Principles And Applications, 2004

31. Figure 8c: Price Discrimination
Dollars per Ticket MC
Additional profit from price discrimination
$120 F G
100 H MR D
Number of Round-trip Tickets 30 30
Hall & Leiberman; Economics: Principles And Applications, 2004

32. Price Discrimination That Benefits Consumers
Price discrimination benefits monopoly at the same time it benefits a group of consumers
Since no one’s price is raised, no one is harmed by this policy
Hall & Leiberman; Economics: Principles And Applications, 2004

33. Perfect Price Discrimination
Suppose a firm could somehow find out maximum price customers would be willing to pay for each unit of output it sells
It could increase profits even further by practicing perfect price discrimination
Firm charges each customer the most the customer would be willing to pay for each unit he or she buys
Increases profit at expense of consumers
Perfect price discrimination is very difficult to practice in the real world
Would require firm to read its customers’ minds
Marginal revenue is equal to price of additional unit sold
Firm’s MR curve is same as its demand curve
Hall & Leiberman; Economics: Principles And Applications, 2004

34. Figure 9: Perfect Price Discrimination
Number of Dolls per Day
Dollars per Doll E 20
$30 25 10 30 60 J B
MC = ATC H D MR
MR curve before price discrimination
Hall & Leiberman; Economics: Principles And Applications, 2004