1. Economic Analysis for Managers (ECO 501) Fall: 2012 Semester
Khurrum S. Mughal

2. MONOPOLY
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3. Monopoly
While a competitive firm is a price taker, a monopoly firm is a price maker.

4. A firm is considered a monopoly if
it is the sole seller of its product.
its product does not have close substitutes. 2 2

5. The fundamental cause of monopoly is barriers to entry.
Why Monopolies Arise?
The fundamental cause of monopoly is barriers to entry. 5 3

6. Why Monopolies Arise? Barriers to entry have three sources:
Ownership of a key resource
The government
Costs of production 5 4

7. Monopoly Resources
Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. 9 5

8. Government-Created Monopolies
Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. 10 7

9. Government-Created Monopolies
Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
Patent and copyright laws 10 7

10. Natural Monopolies
An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
A natural monopoly arises when there are economies of scale over the relevant range of output. 11 8

11. Economies of Scale as a Cause of Monopoly…
Average total cost
Quantity of Output
Cost

12. Monopoly versus Competition
Is the sole producer
Has a downward-sloping demand curve
Is a price maker
Reduces price to increase sales
Competitive Firm
Is one of many producers
Has a horizontal demand curve
Is a price taker
Sells as much or as little at same price 13 12

13. Demand Curves for Competitive and Monopoly Firms…
Quantity of Output
Demand
(a) A Competitive Firm’s
Demand Curve
(b) A Monopolist’s
Price 2

14. A Monopoly’s Revenue Total Revenue P x Q = TR Average Revenue
TR/Q = AR = P
Marginal Revenue
∆TR/ ∆Q = MR 15 14

15. A Monopoly’s Total, Average, and Marginal Revenue
Quantity
(Q)
Price
(P)
Total Revenue
(TR=PxQ)
Average
Revenue
(AR=TR/Q)
Marginal Revenue
(MR= )
$11.00
$0.00 1
$10.00 2
$9.00
$18.00
$8.00 3
$24.00
$6.00 4
$7.00
$28.00
$4.00 5
$30.00
$2.00 6
$5.00 7
-$2.00 8
$3.00
-$4.00 Q TR D /

16. price falls, so P is lower.
A Monopoly’s Revenue
When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q).
more output is sold, so Q is higher.
price falls, so P is lower. 15 14

17. Demand and Marginal Revenue Curves for a Monopoly...
Quantity of Water
Price
$11 10 9 8 7 6 5 4 3 2 1 -1 -2 -3 -4
Marginal
revenue
Demand 16 22

18. Profit Maximizing Output and Price
A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.
It then uses the demand curve to find the price that will induce consumers to buy that quantity. 19 23

19. Profit Maximizing Output and Price
Monopoly
price
Quantity
QMAX
Costs and
Revenue
Demand
Average total cost
Marginal revenue
Marginal
cost 20 30

20. Profit Maximizing Output and Price
Monopoly
price
Quantity
QMAX
Costs and
Revenue
Demand
Average total cost
Marginal revenue
Marginal
cost
Economic Profit 20 30

21. Profit Maximizing Output and Price
A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.
It then uses the demand curve to find the price that will induce consumers to buy that quantity. 19 23

22. The Welfare Cost of Monopoly
Monopoly charges a price above the marginal cost.
Consumers: this high price makes monopoly undesirable.
Owners: the high price makes monopoly very desirable. 19 23

23. Evaluating Monopoly Costs and Revenue Price during patent life
Price after patent expires
Marginal cost
Marginal revenue
Demand
Monopoly quantity
Competitive quantity
Quantity

24. Policy Toward Monopolies
Government responds to the problem of monopoly in one of four ways.
Making monopolized industries more competitive.
Regulating the behavior of monopolies.
Turning some private monopolies into public enterprises.
Doing nothing at all. 39 54

25. Income Redistribution
Evaluating Monopoly
Allocative Inefficiency
Income Redistribution 39 54

26. Evaluating Monopoly Deadweight loss Consumer surplus Price Quantity
Quantity
Profit
Demand
Marginal cost
Marginal
revenue Qm Pm Pc Qc 41 72

27. Technical Inefficiency
Evaluating Monopoly
Technical Inefficiency
Rent Seeking 39 54

28. Technical Inefficiency
Evaluating Monopoly
Price
Quantity
Profit
Demand
Marginal cost
Marginal
revenue Qm Pm Pc Qc
Economic Profit
Rent Seeking +
Technical Inefficiency 41 72