1. CHAPTER 13 Monopoly

2. Competition and Efficiency
Allocative efficiency occurs when no resources are wasted.
This means no individual can be made better off without making someone else worse off.
In the absence of any obstacles, perfect competition leads to allocative efficiency.

3. Obstacles to Efficiency
The three main obstacles to achieving allocative efficiency are:
Public goods (national defense)
Externalities (external costs and external benefits)
Monopoly power

4. Obstacles to Efficiency
Public goods are those that can be consumed simultaneously by everyone and from which no one can be excluded.
Externalities occur when costs or benefits are conferred on other members of society.
Monopoly power is the absence of competition.

5. Public Goods
Public goods cannot be provided efficiently by the private market because of the free rider problem.
A free rider is someone who consumes a good without paying for it.
Because people can consume a public good without paying for it, no one has the incentive to pay for it.
Thus, the government has to provide the good and tax everyone to pay for it.

6. Externalities
External costs are costs not borne by the producer but borne by other members of society.
Pollution imposes external costs.
External benefits are benefits accruing to people other than the buyer of a good.
Education confers external benefits.
Some goods produce both external benefits and costs (e.g., public gardens)

7. Consequences of Externalities
When there are external costs, such as pollution, too much of the good is produced in the private market
When there are external benefits, such as from education, too little of the good is produced in the private market
In both cases, government intervention is warranted to induce less or more of the good to be produced.

8. Possible Government Actions to Deal With Externalities
In the case of external costs, tax the private producer or directly restrict production.
In the case of external benefits, subsidize the producer or directly provide the good.

9. Monopoly
A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.

10. Examples of Monopoly Examples of monopolies include:
Local telephone service (Bell South)
Water service (Metro-Dade)
Cable television
The U.S. Postal Service (regular mail)
Local Electric Power (FPL)
Microsoft (?)
Google(?)
Facebook (?)
eBay (?)

11. Examples of “Monopoly”

12. No Close Substitutes
If there are close substitutes for a good or service, that means there is competition in the market.
Competition in the market means the market cannot be a monopoly by definition.

13. Innovation, Technological Change, and Substitutes
Innovation and technological change create new products, some of which are substitutes for existing products.
Example: FedEx, UPS, fax machines, and are substitutes for the services of the U.S. Postal Service, weakening their monopoly.
Example: Satellite TV is a substitute for Cable TV, weakening its monopoly.

14. Barriers to Entry
Barriers to entry are legal or natural impediments protecting a firm from competition from potential new entrants.
Barriers to entry include:
Legal barriers
Ownership barriers
Natural barriers
Of course, firms can create illegal barriers to entry, but this would be a violation of the Sherman Antitrust Act.

15. Legal Barriers to Entry
Legal barriers to entry create legal monopoly.
A legal monopoly is a market in which competition and entry are restricted by the granting of a public franchise, license, patent or copyright, or in which a firm has legally acquired ownership of a significant portion of a key resource.

16. Legal Barriers: Public Franchises and Licenses
A public franchise is an exclusive right granted to a firm to supply a good or service.
Example: U.S. Postal Service, Cable TV, FPL
A government license controls entry into particular occupations, professions and industries.
Example: licensing of medical doctors and lawyers.

17. Legal Barriers: Patents and Copyrights
A patent is an exclusive right granted to the inventor of a product or service. Patents are good for 20 years.
A copyright is an exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work.

18. Natural Barriers to Entry
Natural barriers to entry give rise to natural monopoly.
Natural monopoly occurs when one firm can supply the entire market at a lower price than two or more firms.
Demand must limit sales to a quantity at which economies of scale exist.

19. Natural Monopoly, Demand and Average Total Cost
The demand curve must intersect the industry ATC curve on a part of the ATC curve that is sloping downward.
If two or more firms supply the market, the per unit cost will be higher than will be the case if a single firm supplies the entire market.

20. Natural Monopoly 5 10 15 Price (cents per kilowatt-hour) D = AR = P 11 2 3 4
Quantity (millions of kilowatt-hours)

21. Natural Monopoly 15 Price (cents per kilowatt-hour) 10 5 ATC
D = AR = P 1 2 3 4
Quantity (millions of kilowatt-hours)

22. Examples of Natural Monopoly
Examples of natural monopoly usually involve economies of scale in distribution:
Natural gas distribution systems
Electric power distribution
Trash collection
Cable television
Microsoft

23. Monopolies are Regulated
Most monopolies are regulated in some way by one or more government agencies.
In the case of unregulated monopolies, the government must either break up the monopoly or make some other change to promote competition and economic efficiency.
First, we study the operation of unregulated monopoly and how it differs from the operation of competitive markets.
Then we discuss pricing strategies for regulated monopolies.

24. Monopoly Price- Setting Strategies
Price discrimination is the practice of selling different units of a good or service for different prices. (ex. pizza, airlines)
A single-price monopoly is a firm that must sell each unit of its output for the same price. (ex. DeBeers)`

25. Single-Price Monopoly
The firm’s demand curve is the market demand curve.
Marginal revenue is not the same as the market price.

26. Single-Price Monopoly
Bobbie’s Barbershop, in Cairo, Nebraska is the sole supplier of haircuts in town.
Let’s examine the market for haircuts in Cairo.

27. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

28. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

29. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

30. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

31. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

32. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

33. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f

34. Demand and Marginal Revenue
Price & marginal revenue
(dollars per haircut)
Quantity (haircuts per hour)

35. Demand and Marginal Revenue
Price & marginal revenue
(dollars per haircut) MR D
Quantity (haircuts per hour)

36. Demand and Marginal Revenue20
Total revenue loss $4 c 16 d
Price & marginal revenue
(dollars per haircut) 14
Price falls from
$16 to $14
Quantity rises from
2 to 3 MR D
2 3
Quantity (haircuts per hour)

37. Demand and Marginal Revenue20
Total revenue loss $4 c 16 d
Price & marginal revenue
(dollars per haircut) 14
Total revenue gain $14
Price falls from
$16 to $14
Quantity rises from
2 to 3 MR D
2 3
Quantity (haircuts per hour)

38. Demand and Marginal Revenue20
Total revenue loss $4 c 16 d
Price & marginal revenue
(dollars per haircut) 14
Total revenue gain $14 10
Marginal revenue $10
Price falls from
$16 to $14
Quantity rises from
2 to 3 MR D
2 3
Quantity (haircuts per hour)

39. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 - 18 14 10 6 2

40. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2

41. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 -

42. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1

43. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3

44. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6

45. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10

46. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

47. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

48. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

49. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

50. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

51. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

52. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

53. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) - 18 14 10 6 2 - 1 3 6 10 15

54. A Monopoly’s Output and Price 10 20 30 40 50
Quantity (haircuts per hour)
Total revenue and total cost
(dollars per hour)

55. A Monopoly’s Output and Price 10 20 30 40 50
Quantity (haircuts per hour)
Total revenue and total cost
(dollars per hour) TR
Note TR curve is not
linear like it is in perfect
competition

56. A Monopoly’s Output and Price 10 20 30 40 50
Quantity (haircuts per hour)
Total revenue and total cost
(dollars per hour) TR
Note slope of TR curve
(which is MR)
declines as Q increases

57. A Monopoly’s Output and PriceTC TR 50
Total revenue and total cost
(dollars per hour) 40
Note slope of TC curve is MC 30 20 10
Quantity (haircuts per hour)

58. A Monopoly’s Output and PriceTC TR 50
Total revenue and total cost
(dollars per hour) 40 30
Note MC increases with Q because of diminishing returns 20 10
Quantity (haircuts per hour)

59. A Monopoly’s Output and PriceTC
Economic
profit = $12 TR 50
Total revenue and total cost
(dollars per hour) 42 30 20 10
Quantity (haircuts per hour)

60. A Monopoly’s Output and PriceTC
Economic
profit = $12 TR 50
Total revenue and total cost
(dollars per hour) 42 30
Note that at maximum profits slope of TR = slope of TC (or MR=MC) 20 10
Quantity (haircuts per hour)

61. A Monopoly’s Output and Price20
Price and cost (dollars per hour) 14 10
D = AR = P
Quantity (haircuts per hour)

62. A Monopoly’s Output and Price20
Price and cost (dollars per hour) 14 10
D = AR = P MR
Quantity (haircuts per hour)

63. A Monopoly’s Output and PriceMC 20
Price and cost (dollars per hour) 14 10
D = AR = P MR
Quantity (haircuts per hour)

64. A Monopoly’s Output and PriceMC 20
Price and cost (dollars per hour) 14
ATC
D = AR = P MR
Quantity (haircuts per hour)

65. A Monopoly’s Output and PriceMC 20
Price and cost (dollars per hour) 14
TR = 14x3 = 42
ATC
D = AR = P MR
Quantity (haircuts per hour)

66. A Monopoly’s Output and PriceMC 20
Price and cost (dollars per hour) 14
ATC 10
D = AR = P MR
Quantity (haircuts per hour)

67. A Monopoly’s Output and PriceMC 20
Price and cost (dollars per hour) 14
ATC 10
TC = 10x3 = 30
D = AR = P MR
Quantity (haircuts per hour)

68. A Monopoly’s Output and PriceMC 20
Profit = $12
($4 x 3 units)
Price and cost (dollars per hour) 14
ATC
Economic
profit = $12 10
D = AR = P MR
Quantity (haircuts per hour)

69. Monopoly Profits
A positive profit is still not guaranteed, even for a monopoly.
Total profit depends on the position of the ATC curve relative to the demand curve.
However, we don’t see many unprofitable monopolies.
If you’re the sole supplier of a good and still can’t make a profit, how long will you stay in the business?

70. Rent Seeking
Because a monopoly creates economic profit in the long-run, people devote a lot of effort to obtain monopoly rights.
This activity is called rent seeking.
The firm is attempting to capture some of the consumer surplus for itself.

71. Comparing Monopoly and Competition
How do the quantities produced, prices, and profits of a monopoly compare with those of a perfectly competitive industry?
Consider a hypothetical example of a perfectly competitive industry which suddenly becomes a monopoly.

72. Comparison of Monopoly and Perfect Competition
Compared to a perfectly competitive market, a single-price monopoly restricts its output and charges a higher price.

73. Price and Output
A perfectly competitive industry will produce the quantity of output and charge the price at the equilibrium point where the industry MC curve intersects the demand curve.
A monopoly will produce the quantity of output dictated by the intersection of the MR and MC curves, charging a price set by the demand curve.

74. Monopoly and Competition Compared
Price PA
Single-price
monopoly
restricts output,
raises price (MR=MC)
S,MC PM
Equilibrium
in competitive
industry (P=MC) PC MR
D=AR=P QM QC
Quantity

75. Inefficiency of Monopoly
Consumer
Surplus under
Competition
Price PA
Perfect
Competition
S, MC PC
D=AR=P QC
Quantity

76. Inefficiency of Monopoly
Consumer
Surplus under
Competition
Price PA
Perfect
Competition
S, MC
Producer
Surplus under
Competition PC
D=AR=P QC
Quantity

77. Inefficiency of Monopoly
Consumer
Surplus under
Monopoly
Price PA
Monopoly
S, MC PM PC
Producer
Surplus under
Monopoly MR
D=AR=P QM QC
Quantity

78. Inefficiency of Monopoly
Consumer
Surplus under
Monopoly
Price PA
Monopoly
S, MC PM
Deadweight loss in
Consumer Surplus PC
Monopoly’s
gain in Producer
Surplus MR
D=AR=P QM QC
Quantity

79. Inefficiency of Monopoly
Consumer
Surplus under
Monopoly
Price PA
Monopoly
S, MC PM
Deadweight loss in
Consumer Surplus PC
Monopoly’s
gain in Producer
Surplus
Deadweight loss in
Producer Surplus MR
D=AR=P QM QC
Quantity

80. Inefficiency of Monopoly Assuming Constant Marginal Cost
Consumer
Surplus Under
Competition
Price PA
Perfect
Competition PC
S, MC
D=AR=P QC
Quantity

81. Inefficiency of Monopoly Assuming Constant Marginal Cost
Consumer
Surplus under
Monopoly
Price PA
Monopoly PM
S, MC PC MR
D=AR=P QM QC
Quantity

82. Inefficiency of Monopoly Assuming Constant Marginal Cost
Consumer
Surplus under
Monopoly
Price PA
Monopoly
Loss in Consumer
Surplus under
Monopoly PM
S, MC PC MR
D=AR=P QM QC
Quantity

83. Inefficiency of Monopoly Assuming Constant Marginal Cost
Consumer
Surplus under
Monopoly
Price PA
Monopoly PM
S, MC PC
Monopoly’s
gain in
Producer Surplus MR
D=AR=P QM QC
Quantity

84. Inefficiency of Monopoly Assuming Constant Marginal Cost
Consumer
Surplus under
Monopoly
Price PA
Monopoly
Deadweight loss
Under Monopoly PM
S, MC PC
Monopoly’s
gain in
Producer Surplus MR
D=AR=P QM QC
Quantity

85. Monopoly Policy Issues
Regulating Natural Monopoly
When demand and cost conditions create natural monopoly, government agencies regulate the monopoly.
This figure shows how a natural monopoly might be regulated.

86. Monopoly Policy Issues
With no regulation, the monopoly maximizes profit.
It produces the quantity at which marginal revenue equals marginal cost.
In this case, profits=$4, calculated as (P-ATC)xQ=(20-18)x2=$4

87. Monopoly Policy Issues
This regulation is the marginal cost pricing rule, and it results in an efficient use of resources.
Regulating a natural monopoly in the public interest sets output where MB = MC and thus the price equal to marginal cost (D=AR=P=MC). 14

88. Monopoly Policy Issues
But with price equal to marginal cost, ATC exceeds price and the monopoly incurs an economic loss.
In this case, the loss=-$16, calculated as (P-ATC)xQ=(10-14)x4=-$16
If the monopoly receives a subsidy to cover its loss, taxes must be imposed on other economic activity, which create deadweight loss. 14

89. Monopoly Policy Issues
Where possible, a regulated natural monopoly might be permitted to price discriminate to cover the loss from marginal cost pricing.
Another alternative (which is easy to implement in practice) is to produce the quantity at which price equals average total cost and to set the price equal to average total cost—the average cost pricing rule (P=ATC).
With this pricing rule, the natural monopoly earns only normal profits (economic profits are zero). This is because (P-ATC)xQ=(15-15)x3=0