0. Chapter 15: Monopoly
Econ 2100
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1. What works in the public sector?
Course Outline
What; why; who?
How markets work?
Are markets good?
How firms behave?
Chapters
Why are you hired?
What works in the public sector?

2. Chapter 15 Outline MONOPOLY Monopolies: What & Why Why MR < P
Profit Max Decisionmaking
Impact on society’s
well-being
Gov’t Role in Monopoly Markets
Price Discrimination
MONOPOLY

3. Introduction
A monopoly is a firm that is the sole seller of a product without close substitutes.
In this chapter, we study monopoly and contrast it with perfect competition.
The key difference: A monopoly firm has market power, the ability to influence the market price of the product it sells. A competitive firm has no market power.
Most students already know that monopoly means the firm is the only seller of its product. But the definition here has another very important part: In order for the firm to be considered a monopoly, the product it sells must have no close substitutes available from other firms.
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4. Why Monopolies Arise
The main cause of monopolies is barriers to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s diamond mines
2. The govt gives a single firm the exclusive right to produce the good.
E.g., patents, copyright laws
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5. ATC slopes downward due to huge FC and small MC
Why Monopolies Arise
3. Natural monopoly: a single firm can produce the entire market Q at lower cost than could several firms.
Example: homes need electricity
Electricity Q
Cost
ATC
ATC slopes downward due to huge FC and small MC
ATC is lower if one firm services all 1000 homes than if two firms each service 500 homes.
The horizontal axis of the graph measures number of homes provided electricity. The vertical axis measures the average total cost of providing electricity per home.
500
$80
1000
$50
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6. Chapter 15 Outline MONOPOLY Monopolies: What & Why Why MR < P
Profit Max Decisionmaking
Impact on society’s
well-being
Gov’t Role in Monopoly Markets
Price Discrimination
MONOPOLY

7. Monopoly vs. Competition: Demand Curves
In a competitive market, the market demand curve slopes downward.
But the demand curve for any individual firm’s product is horizontal at the market price.
The firm can increase Q without lowering P,
so MR = P for the competitive firm.
A competitive firm’s demand curve P Q
A competitive firm is a price-taker, can sell as much as it wants at the market price.
In effect, the competitive firm sells a product for which there are many perfect substitutes, so demand for its product is perfectly elastic; if it raises its price above the market price, demand for its product falls to zero.
The relationship between P and MR is what distinguishes a competitive firm from a monopoly firm, in terms of both firm behavior and welfare implications. D
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8. Monopoly vs. Competition: Demand Curves
A monopolist is the only seller, so it faces the market demand curve.
To sell a larger Q, the firm must reduce P.
Thus, MR ≠ P.
A monopolist’s demand curve P Q D
This slide introduces the notion that MR is not equal to P for the monopolist. The next slide presents an exercise to lead students to see for themselves what this relationship looks like.
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9. Common Grounds’ D and MR Curves
P, MR $ 5
1.50 6
2.00 5
2.50 4
3.00 3
3.50 2
4.00 1
$4.50 MR P Q –1 $4
Demand curve (P) 4 MR 3 2 1
The numbers in the table are from the preceding exercise. Students can see either from the table or the graph that, at any Q, MR < P. -1 -2 -3 Q 1 2 3 4 5 6 7
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10. Understanding the Monopolist’s MR
Increasing Q has two effects on revenue:
Output effect: higher output raises revenue
Price effect: lower price reduces revenue
To sell a larger Q, the monopolist must reduce the price on all the units it sells.
Hence, MR < P
MR could even be negative if the price effect exceeds the output effect (e.g., when Common Grounds increases Q from 5 to 6).
Note that a competitive firm has the output effect but not the price effect: the competitive firm does not need to reduce its price in order to sell a larger quantity, so, for the competitive firm, MR = P.
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11. Chapter 15 Outline MONOPOLY Monopolies: What & Why Why MR < P
Profit Max Decisionmaking
Impact on society’s
well-being
Gov’t Role in Monopoly Markets
Price Discrimination
MONOPOLY

12. Profit-Maximization
Like a competitive firm, a monopolist maximizes profit by producing the quantity where MR = MC.
Once the monopolist identifies this quantity, it sets the highest price consumers are willing to pay for that quantity.
It finds this price from the D curve.
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13. Profit-Maximization 1. The profit- maximizing Q is where MR = MC.
Quantity
Costs and Revenue
1. The profit- maximizing Q is where MR = MC.
2. Find P from the demand curve at this Q. D MR MC P Q
Profit-maximizing output
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14. The Monopolist’s Profit
Quantity
Costs and Revenue
ATC D MR MC
As with a competitive firm, the monopolist’s profit equals
(P – ATC) x Q P
ATC Q
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15. A Monopoly Does Not Have an S Curve
A competitive firm
takes P as given
has a supply curve that shows how its Q depends on P.
A monopoly firm
is a “price-maker,” not a “price-taker”
Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand curve.
So there is no supply curve for monopoly.
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16. CASE STUDY: Monopoly vs. Generic Drugs
The market for a typical drug
Patents on new drugs give a temporary monopoly to the seller.
When the patent expires, the market becomes competitive, generics appear.
Quantity
Price D MR PM QM
PC = MC QC
Here, we assume constant marginal cost for simplicity.
PM and QM denote the monopoly price and quantity, respectively.
PC and QC denote the competitive price and quantity, respectively.
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17. Chapter 15 Outline MONOPOLY Monopolies: What & Why Why MR < P
Profit Max Decisionmaking
Impact on society’s
well-being
Gov’t Role in Monopoly Markets
Price Discrimination
MONOPOLY

18. The Welfare Cost of Monopoly
Recall: In a competitive market equilibrium, P = MC and total surplus is maximized.
In the monopoly eq’m, P > MR = MC
The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC).
The monopoly Q is too low – could increase total surplus with a larger Q.
Thus, monopoly results in a deadweight loss.
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19. The Welfare Cost of Monopoly
Competitive eq’m:
quantity = QC
P = MC
total surplus is maximized
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
Quantity
Price
Deadweight loss D MR MC P MC QM
P = MC QC
It’s worth mentioning the following:
Most people know that monopoly changes the way the economic “pie” is divided: by charging higher prices, the monopoly gets more surplus and consumers get less surplus.
The analysis on this slide shows that the monopoly also reduces the size of the economic pie – by producing less than the socially efficient quantity and causing a deadweight loss.
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20. Chapter 15 Outline MONOPOLY Monopolies: What & Why Why MR < P
Profit Max Decisionmaking
Impact on society’s
well-being
Gov’t Role in Monopoly Markets
Price Discrimination
MONOPOLY

21. Price Discrimination
Discrimination: treating people differently based on some characteristic, e.g. race or gender.
Price discrimination: selling the same good at different prices to different buyers.
The characteristic used in price discrimination is willingness to pay (WTP):
A firm can increase profit by charging a higher price to buyers with higher WTP.
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22. Perfect Price Discrimination vs. Single Price Monopoly
Here, the monopolist charges the same price (PM) to all buyers.
A deadweight loss results.
Consumer surplus
Quantity
Price D MR
Deadweight loss PM QM
Monopoly profit MC
To keep the graph simple, this example assumes constant marginal cost.
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23. Perfect Price Discrimination vs. Single Price Monopoly
Here, the monopolist produces the competitive quantity, but charges each buyer his or her WTP.
This is called perfect price discrimination.
The monopolist captures all CS as profit.
But there’s no DWL.
Quantity
Price
Monopoly profit D MR MC Q
Here, there is no horizontal price line. The “price line”, if you will, is the demand curve:
At each Q, the height of the demand curve shows the marginal buyer’s willingness to pay, which is the price the monopolist charges that buyer under perfect price discrimination.
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24. Price Discrimination in the Real World
In the real world, perfect price discrimination is not possible:
No firm knows every buyer’s WTP
Buyers do not announce it to sellers
So, firms divide customers into groups based on some observable trait that is likely related to WTP, such as age.
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25. Examples of Price Discrimination
Movie tickets Discounts for seniors, students, and people who can attend during weekday afternoons. They are all more likely to have lower WTP than people who pay full price on Friday night.
Airline prices Discounts for Saturday-night stayovers help distinguish business travelers, who usually have higher WTP, from more price-sensitive leisure travelers.
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26. Public Policy Toward Monopolies
Increasing competition with antitrust laws
Ban some anticompetitive practices, allow govt to break up monopolies.
E.g., Sherman Antitrust Act (1890), Clayton Act (1914)
Regulation
Govt agencies set the monopolist’s price.
For natural monopolies, MC < ATC at all Q, so marginal cost pricing would result in losses.
If so, regulators might subsidize the monopolist or set P = ATC for zero economic profit.
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27. Public Policy Toward Monopolies
Public ownership
Example: U.S. Postal Service
Problem: Public ownership is usually less efficient since no profit motive to minimize costs
Doing nothing
The foregoing policies all have drawbacks, so the best policy may be no policy.
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28. CONCLUSION: The Prevalence of Monopoly
In the real world, pure monopoly is rare.
Yet, many firms have market power, due to:
selling a unique variety of a product
having a large market share and few significant competitors
In many such cases, most of the results from this chapter apply, including:
markup of price over marginal cost
deadweight loss
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29. Test Bank Questions
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30. Questions 2 & 3
2. One difference between a perfectly competitive firm and a monopoly is that a perfectly competitive firm produces where
3. A monopoly a.
can set the price it charges for its output and earn unlimited profits. b.
takes the market price as given and earns small but positive profits. c.
can set the price it charges for its output but faces a downward-sloping demand curve so it cannot earn unlimited profits. d.
can set the price it charges for its output but faces a horizontal demand curve so it can earn unlimited profits. a.
marginal cost equals price, while a monopolist produces where price exceeds marginal cost. b.
marginal cost equals price, while a monopolist produces where marginal cost exceeds price. c.
price exceeds marginal cost, while a monopolist produces where marginal cost equals price. d.
marginal cost exceeds price, while a monopolist produces where marginal cost equals price.
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31. Questions 5 & 8
5. Which of the following are necessary characteristics of a monopoly?
8. Which of the following is not a reason for the existence of a monopoly?
(i)
The firm is the sole seller of its product.
(ii)
The firm's product does not have close substitutes.
(iii)
The firm generates a large economic profit.
(iv)
The firm is located in a small geographic market. a.
sole ownership of a key resource b.
patents c.
copyrights d.
diseconomies of scale a.
(i) and (ii) only b.
(i) and (iii) only c.
(i), (ii), and (iii) only d.
(i), (ii), (iii), and (iv)
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32. Questions 4 & 5
4. When a firm operates under conditions of monopoly, its price is
5. In order to sell more of its product, a monopolist must a.
sell to the government. b.
sell in international markets. c.
lower its price. d.
use its market power to force up the price of complementary products. a.
not constrained. b.
constrained by marginal cost. c.
constrained by demand. d.
constrained only by its social agenda.
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33. Questions 65, 66 & 67
65. Refer to Figure What price will the monopolist charge? a. A b. B c. C d. F
66. Refer to Figure How much output will the monopolist produce? a. O b. J c. K d. L
67. Refer to Figure What area measures the monopolist’s profit? a.
(B-F)*K b.
(A-H)*J c.
(B-G)*K d.
0.5[(B-F)*(L-K)]
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34. Questions 30, 31 & 32
30. Refer to Figure What is the socially efficient price and quantity? a.
price = F; quantity = A b.
price = G; quantity = B c.
price = G; quantity = A d.
price = D; quantity = A
31. Refer to Figure What is the monopoly price and quantity?
32. Refer to Figure What is the area of deadweight loss? a.
price = F; quantity = A b.
price = G; quantity = B c.
price = G; quantity = A d.
price = D; quantity = A a.
the rectangle (F-D)xA b.
the triangle 1/2[(F-D)x(B-A)] c.
the triangle 1/2[(F-G)x(B-A)] d.
the rectangle (F-D)xA plus the triangle 1/2[(F-D)x(B-A)]
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35. Question 4 & 17
4. The practice of selling the same goods to different customers at different prices, but with the same marginal cost, is known as a.
price segregation. b.
price discrimination. c.
arbitrage. d.
monopoly pricing.
17 If the monopoly firm perfectly price discriminates, then consumer surplus amounts to a.
$0. b.
$250. c.
$500. d.
$1,000.
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36. Questions 1 & 2
1. Which of the following may eliminate some or all of the inefficiency that results from monopoly pricing?
2. Antitrust laws have economic benefits that outweigh the costs if they a.
prevent mergers that would decrease competition and lower the costs of production. b.
prevent mergers that would decrease competition and raise the costs of production. c.
allow mergers that would decrease competition and raise the costs of production. d.
None of the above is correct because antitrust laws never have economic benefits that outweigh the costs. a.
The government can regulate the monopoly. b.
The monopoly can be prohibited from price discriminating. c.
The monopoly can be forced to operate at a point where its marginal revenue is equal to its marginal cost. d.
None of the above would eliminate any inefficiency associated with a monopoly.
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