Monopoly

Chapter 15

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IN THIS CHAPTER
• Cause of Monopoly
− No substitutes
− Market power: Price maker
− Barriers to entry

• P> MR= MC
− Price maker!

• Monopoly Revenue
− 1) Quantity effect: Q ↑ > P ↓ → TR ↑
− 2) Price effect: P ↓ > Q ↑ → TR ↓
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IN THIS CHAPTER
• Competitive market vs Monopolies
− Price: Price taker and Price maker
− Demand curve: Horizontal and Downward
− Equilibrium Q: P = MR = MC and P > MR = MC
• DWL occurs!

• Price discrimination

• Public Policy Toward Monopolies

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 Why do Monopolies Arise?
• A firm that is the sole seller of a product without close
substitutes

• Has market power

− The ability to influence the market price of the product it
sells: “price maker”

• Arise due to barriers to entry

− Other firms cannot enter the market to compete with it

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 Three Barriers to Entry
1. Monopoly resources
• A single firm owns a key resource.

2. Government regulation
• The government gives a single firm the exclusive right
to produce the good.
− Patent and copyright laws

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 Three Barriers to Entry
3. The production process: natural monopoly
• A single firm can produce the entire market Q at lower
cost than could several firms
• Arises when there are economies of scale over the
relevant range of output
• Distribution of water, electricity, etc.

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 EXAMPLE 1: Natural monopoly
You live in a small town where 1,000 homes need electricity.
ATC is lower if one firm services all 1,000 homes than if two
firms each service 500 homes.

Cost Electricity
• Economies of
Scale as a Cause ATC slopes downward due
of Monopoly to huge FC and small MC
$80
$50 ATC
Q
500 1000
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Monopoly and Competitive firm
• Monopoly
− Price maker
− Sole producer
− Downward sloping demand, faces the entire market
demand

• Competitive firm
− Price taker
− One producer of many
− Demand is a horizontal line (Price), perfectly elastic
demand
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Demand Curves for Competitive and Monopoly Firms

P A competitive firm’s P A monopolist’s

demand curve demand curve

P = MR
D
The market
demand curve D
Q Q
The firm can increase To sell a larger Q, the
Q without lowering P, firm must reduce P.
so MR = P for the Thus, MR ≠ P.
competitive firm.
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Production and Pricing Decisions
• A monopoly’s total revenue
− Total revenue = price times quantity

• A monopoly’s average revenue

− Revenue per unit sold
− Total revenue divided by quantity
− Always equals the price

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Active Learning 1: Jason’s Hair Shop Revenue
Jason owns the only hair Q P TR AR MR
salon in town. 0 $60
The table shows the 1 55
market demand for 2 50
haircuts. 3 45
Fill in the missing spaces 4 40
of the table. 5 35
What is the relation 6 30
between P and AR? 7 25
Between P and MR? 8 20
9 15
10 10
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Active Learning 1: Jason’s Hair Shop revenue
Q P TR AR MR
P = AR,
0 $60 $0 n/a
same as for a 55
1 55 55 55
competitive firm. 45
2 50 100 50
35
3 45 135 45
25
4 40 160 40
MR < P, whereas MR = 15
5 35 175 35
5
P for a competitive firm. 6 30 180 30
-5
7 25 175 25
-15
8 20 160 20
-25
9 15 135 15
-35
10 10 100 10
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EXAMPLE 2: MR and demand curves
Q P MR P, MR
0 $60
$60
55 50
1 55 Demand curve (P)
45 40
2 50
35 30
3 45
25 20
4 40
15 10
5 35 MR
5 0
6 30
-5 -10
Q
7 25
-15 -20
8 20
-25
9 15 -30
-35 0 1 2 3 4 5 6 7 8 9 10
10 10
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A Monopolist’s Revenue
• Increasing Q has two effects on revenue
− 1) Output effect
• Q is higher: increase total revenue
− 2) Price effect
• P is lower: decrease total revenue
• Because MR < P
− Marginal-revenue curve is below the demand curve
− To sell a larger Q, the monopolist must reduce the price
on all the units it sells
− Is negative if price effect > output effect
• e.g., when Jason’s increases Q from 6 to 7 14
Monopoly Profit Maximization
• Produce Q where MR = MC
− Sets the highest price consumers are willing to pay for
that quantity
− Finds this price on the D curve
− P > MR = MC
• Price exceeds marginal cost

• A monopoly’s profit
− Profit = TR – TC = (P – ATC) ˣ Q
− If P > ATC, the monopoly earns a profit
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Monopoly Profit Maximization
Costs and
Revenue MC

At this Q, find P on P
the demand curve.

The profit-maximizing D
Q is where MR = MC.
MR

Q Quantity

Profit-maximizing output

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The Monopolist’s Profit

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

Q Quantity

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The Monopolist’s Profit
IMPORTANT!

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A Monopoly Does Not Have a Supply 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”

− Q does not depend on P
− Q and P are jointly determined by MC, MR, and the
demand curve
− Hence, no supply curve for monopoly.

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The Welfare Cost of Monopolies
• Monopoly: At P > MR = MC
− Produce quantity where MC = MR
− Produces less than the socially efficient quantity of
output
− Charge P > MC
− Deadweight loss
• Triangle between the demand curve and MC curve

• Competitive market equilibrium: At P = MC

− Maximizes total surplus
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The Inefficiency of Monopoly

Competitive equilibrium:
Price Deadweight
• quantity = QC
loss MC
• PC = MC
• total surplus is maximized PM
PC

Monopoly equilibrium:
D
• quantity = QM
• PM > MC MR

• deadweight loss Q M QC Quantity

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The monopoly’s profit: a social cost?
• Monopoly profit is not in itself necessarily a problem for
society
− Greater producer surplus for monopoly
− Smaller consumer surplus
− Transfer of surplus from consumers to monopoly

• The inefficiency:
− Monopoly produces Q < efficient quantity
− Deadweight loss

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Price discrimination
• Price discrimination:
− Sell the same good at different prices to different
buyers
− A firm can increase profit by charging a higher price to
buyers with higher willingness to pay
− Requires the ability to separate customers according to
their willingness to pay
− Can raise economic welfare

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Price discrimination
• Perfect price discrimination
− Charge each customer a different price
• Exactly his or her willingness to pay
− Monopoly firm gets the entire surplus (Profit)
− No deadweight loss

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Price Discrimination in the Real World
• Perfect price discrimination
− Not possible in the real world
• No firm knows every buyer’s WTP
• Buyers do not reveal it to sellers

• Price discrimination
− Firms divide customers into groups
based on some observable trait
that is likely related to willingness to pay (WTP), such
as age
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Examples of price discrimination
A. Movie tickets
• Discounts for seniors, students, and people who can
attend during weekday afternoons.
• Lower WTP than people who pay full price on Friday
night

B. Airline prices
• Discounts for Saturday-night stayovers
• Business travelers (higher WTP) vs. more price-
sensitive leisure travelers
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Welfare with and without Price Discrimination

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Without price discrimination
• Single price > MC
• Consumer surplus
• Producer surplus (Profit)
• Deadweight loss

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Public Policy Toward Monopolies
1. Increasing competition with antitrust laws
2. Regulation
3. Public ownership
4. Do nothing

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Public Policy Toward Monopolies
1. Increasing competition with antitrust laws
• Prevent mergers
• Break up companies
• Prevent companies
• from coordinating their activities to make markets less
competitive

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Public Policy Toward Monopolies
2. Regulation
• Regulate the behavior of monopolists
− Price
• Common in case of natural monopolies
• Marginal-cost pricing
− May be less than ATC
− No incentive to reduce costs

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Marginal-Cost Pricing for a Natural Monopoly

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Public Policy Toward Monopolies
3. Public ownership
• How the ownership of the firm affects the costs of
production
• Private owners
− Incentive to minimize costs
• Public owners (government)
− If it does a bad job, losers are the customers and
taxpayers

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Public Policy Toward Monopolies
4. Do nothing
• Some economists argue that it is often best for the
government not to try to remedy the inefficiencies of
monopoly pricing
• Determining the proper role of the government in the
economy requires judgments about politics as well as
economics

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Summary!

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 CHAPTER IN A NUTSHELL
• Monopoly: the sole seller in its market.
• Monopoly arises when:
− A single firm owns a key resource
− The government gives a firm the exclusive right to
produce a good
− A single firm can supply the entire market at a lower
cost than many firms could.
• Monopoly faces a downward-sloping demand curve for its
product: MR < P

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CHAPTER IN A NUTSHELL
• Monopoly maximizes profit
− Produce Q where MR = MC, but Q is not efficient
− For this Q, the price is on the demand curve.
− So P > MR = MC
− Causes deadweight loss
• Price discrimination: charge different prices for the same
good based on a buyer’s willingness to pay.
− Can raise economic welfare by getting the good to
some consumers who would otherwise not buy it.

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CHAPTER IN A NUTSHELL
• Perfect price discrimination
− No deadweight loss
− The entire surplus in the market goes to the monopoly
producer.
• Policymakers can:
− Use the antitrust laws to try to make the industry more
competitive.
− Regulate the prices that the monopoly charges.
− Turn the monopolist into a government-run enterprise.
− Do nothing at all.
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