1. Market Structures I: Monopoly14
Market Structures I:
Monopoly
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

2. Imperfect Competition
Imperfect competition is where firms differentiate their product in some way and so can have some influence over price.
There are different degrees of imperfect competition.
At one end of the spectrum is the monopoly.
Strictly, a monopoly is a market structure with only one firm and no close substitutes.
In reality firms can exercise monopoly power by being the dominant firm in the market.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

3. Imperfect Competition
Firms might be investigated by regulators if they account for over 25 per cent of market share, because there is a risk that they have too much market power.
Market share is the proportion of total sales in a market accounted for by a particular firm.
Market power is where a firm is able to raise the price of its product and not lose all its sales to rivals.
While a competitive firm is a price taker, a monopoly firm is a price maker.
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4. Why Monopolies Arise
A monopoly is a firm that is the sole seller of a product without close substitutes.
The fundamental cause of monopoly is the presence of barriers to entry.
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5. Why Monopolies Arise Barriers to entry have four sources:
Ownership of a key resource.
The government gives a single firm the exclusive right to produce some good.
Costs of production make a single producer more efficient than a large number of producers.
A firm is able to gain control of other firms in the market and thus grow in size.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

6. Monopoly Resources
Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

7. 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 are two important examples of how government creates a monopoly to serve the public interest.
Laws governing patents and copyrights have benefits and costs.
The benefits are the increased incentive for creative activity must be set against….
Costs of monopoly pricing.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

8. 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 occurs when there are economies of scale, implying that average total cost falls as the firm’s scale becomes larger.
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9. Figure 1 Economies of Scale as a Cause of Monopoly
Cost
Average
total
cost
Quantity of Output

10. How Monopolies Make Production And Pricing Decisions
The key difference between a competitive firm and a monopoly is the monopoly's ability to control price.
A monopoly faces a downward sloping demand curve
A monopoly can increase price and not lose all its sales.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

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

12. Monopoly versus Competition
Is the sole producer
Faces a downward-sloping demand curve
Is a price maker
Reduces price to increase sales
Competitive Firm
Is one of many producers
Faces a horizontal demand curve
Is a price taker
Sells as much or as little at same price
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13. A Monopoly’s Revenue Total Revenue P  Q = TR Average Revenue
TR/Q = AR = P
Marginal Revenue
DTR/DQ = MR
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14. Table 1 A Monopoly’s Total, Average, and Marginal Revenue

15. A Monopoly’s Revenue A Monopoly’s Marginal Revenue
A monopolist’s marginal revenue is always less than the price of its good.
The demand curve is downward sloping.
When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
When a monopoly increases the amount it sells, it has two effects on total revenue (P  Q).
The output effect—more output is sold, so Q is higher.
The price effect—price falls, so P is lower.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

16. Figure 3 Demand and Marginal Revenue Curves for a Monopoly
Price
€11 10 9 8 7 6 5 4 3
Demand
(average
revenue) 2
Marginal
revenue 1 –1 1 2 3 4 5 6 7 8
Quantity of Water –2 –3 –4

17. Profit Maximization
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.
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18. Figure 4 Profit Maximization for a Monopoly
Costs and
and then the demand
curve shows the price
consistent with this quantity.
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity . . .
Marginal revenue
Demand
Monopoly
price
QMAX B
Marginal
cost
Average total cost A Q Q
Quantity

19. Profit Maximization Comparing Monopoly and Competition
For a competitive firm, price equals marginal cost.
P = MR = MC
For a monopoly firm, price exceeds marginal cost.
P > MR = MC
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20. A Monopoly’s Profit Profit equals total revenue minus total costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q)  Q
Profit = (P - ATC)  Q
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21. Figure 5 The Monopolist’s Profit
Costs and
Revenue
Marginal revenue
Demand
Marginal cost
Monopoly
price
QMAX B C E D
Monopoly
profit
Average total cost
Average
total
cost
Quantity

22. A Monopolist’s Profit
The monopolist will receive economic profits as long as price is greater than average total cost.
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23. The Welfare Cost Of Monopoly
In contrast to a competitive firm, the monopoly charges a price above the marginal cost.
From the standpoint of consumers, this high price makes monopoly undesirable.
However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.
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24. Figure 6 The Efficient Level of Output
Price
Marginal cost
Demand
(value to buyers)
Value to
buyers
Cost to
monopolist
Efficient
quantity
Cost to
monopolist
Value to
buyers
Quantity
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.

25. The Deadweight Loss
Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost.
This wedge causes the quantity sold to fall short of the social optimum.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017

26. Figure 7 The Inefficiency of Monopoly
Price
Marginal
revenue
Demand
Marginal cost
Deadweight
loss
Monopoly
price
quantity
Efficient
quantity
Quantity

27. The Deadweight Loss
The Inefficiency of Monopoly
The monopolist produces less than the socially efficient quantity of output.
The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax.
The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.
For use with Mankiw and Taylor, Economics 4th edition © Cengage EMEA 2017