CHAPTER

15

Monopoly

Economics
PRINCIPLES OF

N. Gregory Mankiw

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In this chapter, look for the answers to
these questions:
▪ Why do monopolies arise?
▪ Why is MR < P for a monopolist?
▪ How do monopolies choose their P and Q?
▪ How do monopolies affect society’s well-being?

CHAPTER 15 MONOPOLY 1
 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.

CHAPTER 15 MONOPOLY 2
 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

CHAPTER 15 MONOPOLY 3
 Why Monopolies Arise
3. Natural monopoly: a single firm can produce
the entire market Q at lower ATC than could
several firms.

CHAPTER 15 MONOPOLY 4
Monopoly vs. Competition: Demand Curves
In a competitive market,
the market demand curve
slopes downward.
A competitive firm’s
but the demand curve demand curve
for any individual firm’s P
product is horizontal
at the market price.
The firm can increase Q D
without lowering P,
so MR = P for the
competitive firm. Q

CHAPTER 15 MONOPOLY 5
Monopoly vs. Competition: Demand Curves

A monopolist is the only

seller, so it faces the
market demand curve.
A monopolist’s
To sell a larger Q, demand curve
P
the firm must reduce P.
Thus, MR ≠ P.

D
Q

CHAPTER 15 MONOPOLY 6
A Monopoly’s Total, Average, and Marginal Revenue

CHAPTER 15 MONOPOLY 7
CHAPTER 15 MONOPOLY 8
 Understanding the Monopolist’s MR
▪ Increasing Q has two effects on revenue:
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers 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

CHAPTER 15 MONOPOLY 9
 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.

CHAPTER 15 MONOPOLY 10
 Profit-Maximization

Costs and
1. The profit- Revenue MC
maximizing Q
is where P
MR = MC.
2. Find P from
the demand D
curve at this Q. MR

Q Quantity

Profit-maximizing output
CHAPTER 15 MONOPOLY 11
 The Monopolist’s Profit

Costs and
Revenue MC

As with a P
ATC
competitive firm, ATC
the monopolist’s
profit equals D
(P – ATC) x Q MR

Q Quantity

CHAPTER 15 MONOPOLY 12
CHAPTER 15 MONOPOLY 13
CHAPTER 15 MONOPOLY 14
 The Welfare Cost of Monopoly
Competitive eq’m:
Price Deadweight
quantity = QE loss MC
P = MC
total surplus is P
P = MC
maximized
MC
Monopoly eq’m:
D
quantity = QM
P > MC MR
deadweight loss Q M QE Quantity

CHAPTER 15 MONOPOLY 15
 Exercises
▪ TC= 1/8 Q2 + 8Q +2,800
▪ Demand curve: P=-1/2 Q +128
▪ Identify Price and Q for profit maximization of monopoly
▪ Calculate the DWL
▪ If government imposes a tax of $20 per unit, calculate P,Q, profit
and tax collected by government.

CHAPTER 15 MONOPOLY 16
CHAPTER 15 MONOPOLY 17
CHAPTER 15 MONOPOLY 18
 Price Discrimination
▪ Discrimination is the practice of treating people
differently based on some characteristic, such as
race or gender.
▪ Price discrimination is the business practice of
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.

CHAPTER 15 MONOPOLY 19
 Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist Consumer
charges the same Price
surplus
price (PM) to all
Deadweight
buyers. PM loss
A deadweight loss
results. MC
Monopoly
profit D
MR

QM Quantity

CHAPTER 15 MONOPOLY 20
 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.

CHAPTER 15 MONOPOLY 21
 Examples of Price Discrimination
Discount coupons
People who have time to clip and organize
coupons are more likely to have lower income
and lower WTP than others.
Need-based financial aid
Low income families have lower WTP for
their children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.

CHAPTER 15 MONOPOLY 22
 Examples of Price Discrimination
Quantity discounts
A buyer’s WTP often declines with additional
units, so firms charge less per unit for large
quantities than small ones.
Example: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s
twice as big.

CHAPTER 15 MONOPOLY 23
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

CHAPTER 15 MONOPOLY 24
CHAPTER SUMMARY
▪ A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry,
including: government-granted monopolies, the
control of a key resource, or economies of scale
over the entire range of output.
▪ A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it must
reduce price to sell a larger quantity, which causes
marginal revenue to fall below price.

CHAPTER 15 MONOPOLY 25
CHAPTER SUMMARY
▪ Monopoly firms maximize profits by producing the
quantity where marginal revenue equals marginal
cost. But since marginal revenue is less than
price, the monopoly price will be greater than
marginal cost, leading to a deadweight loss.
▪ Policymakers may respond by regulating
monopolies, using antitrust laws to promote
competition, or by taking over the monopoly and
running it. Due to problems with each of these
options, the best option may be to take no action.

CHAPTER 15 MONOPOLY 26
CHAPTER SUMMARY
▪ Monopoly firms (and others with market power) try
to raise their profits by charging higher prices to
consumers with higher willingness to pay. This
practice is called price discrimination.

CHAPTER 15 MONOPOLY 27