Lecture 6: Monopoly

Graduate School of Management and Economics

Sharif University of Technology

Mohammad Vesal
EMBA, Fall 2024
What is a monopoly?

• 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
• Arise due to barriers to entry
▪ Other firms cannot enter the market to compete with it
• Examples?

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Barriers to entry

1. Monopoly resources
▪ A single firm owns a key resource.
o E.g., DeBeers owns most of the world’s
diamond mines

2. Government regulation
▪ The government gives a single firm the exclusive right to produce the good.
o E.g., patents, copyright laws

3. The production process

▪ Natural monopoly: a single firm can produce the entire market Q at
lower cost than could several firms

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Example: Natural monopoly

• ATC of electricity provision to various number of homes

ATC slopes
Cost downward due
to huge FC and
small MC

$80
$50 ATC
Q
500 1000

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Monopoly vs. Competition: Demand Curves

P A competitive firm’s P A monopolist’s

demand curve demand curve

D
Q Q
Activity 1: Demand and MR curves

P, MR
Q P MR
$5
0 $4.50
$4 4
Demand curve (P)
1 4.00 3
3
2 3.50 2
2 1
3 3.00
1 0
4 2.50
0 -1 MR
5 2.00 -2
–1
6 1.50 -3
0 1 2 3 4 5 6 7 Q
Monopolist MR

• Increasing Q has two effects on revenue:

▪ Output effect: higher output raises revenue
▪ Price effect: lower price reduces revenue
• Marginal revenue, MR < P
▪ To sell a larger Q, the monopolist must reduce the price on all the units it sells
▪ Is negative if price effect > output effect
• In math
𝜕𝑃
Δ𝑇𝑅 = 𝑃 ⋅ Δ𝑄 + ⋅ 𝑄 ⋅ Δ𝑄
𝜕𝑄
+ Output effect - Price effect

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Profit maximization

• Profit 𝑃 ⋅ 𝑄 − 𝑇𝐶(𝑄)
• As before profit is maximized when Costs and
MR=MC Revenue MC

• However, MR is not the price. It is always P

ATC
less than P. ATC

D
MR

Q Quantity

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Supply curve for a monopolist

• 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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Welfare cost of monopoly

• Competitive market equilibrium: P = MC and total surplus is maximized

• Monopoly equilibrium, 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.
▪ Monopoly results in a deadweight loss

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The Welfare Cost of Monopoly

Price Deadweight
• Competitive equilibrium:
loss MC
quantity = QC
P = MC P
total surplus is maximized P = MC
MC
• Monopoly equilibrium:
D
quantity = QM
P > MC MR
deadweight loss QM QC Quantity

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Price discrimination

• A firm can increase profit by charging a higher price to buyers with higher
willingness to pay
• But, how would the firm separate customers based on WTP?
• Perfect price discrimination
▪ Charge each customer a different price equal to her WTP
▪ Monopoly firm gets the entire surplus (Profit)
▪ No deadweight loss
• Perfect price discrimination is not possible in the real world
▪ No firm knows every buyer’s WTP
▪ Buyers do not reveal it to sellers
• But price discrimination is very common.
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Examples of Price Discrimination
• Movie tickets
▪ Discounts for seniors, students, and people who can attend during weekday afternoons.
o Lower WTP than people who pay full price on Friday night

• Airline prices
▪ Discounts for Saturday-night stayovers
o Business travelers (higher WTP) vs. more price-sensitive leisure travelers

• 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
• Quantity discounts

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The prevalence of monopoly

• Pure monopoly – rare in the real world

• 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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Example: Gilead Sciences and Sovaldi

• Gilead Sciences, a biopharmaceutical company, developed Sovaldi, a

breakthrough drug for treating Hepatitis C.
• $1,000 per pill in the United States→ $84,000 for a 12-week course
• production cost was around $100 per pill.
• Profit per Pill: $1,000 (price) - $100 (cost) = $900
• Total Profit: For 300,000 patients, the profit would be $22.5 billion (300,000
patients x $900 profit per pill x 84 pills).
• Price discrimination: Developing countries sometimes as low as $10 per pill.
• Sources: Knowledge at Wharton; U.S. Senate Finance Committee Report;

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Public policy toward monopolies

1. Increasing competition with antitrust laws

▪ Sherman Antitrust Act, 1890, Clayton Antitrust Act, 1914
▪ Prevent mergers, Break up companies, Prevent companies from coordinating
2. Regulation
▪ Marginal-cost pricing would result in losses with high FC
▪ Might reduce incentives to innovate
3. Public ownership
▪ Private owners: incentive to min costs
▪ But public owners are usually less efficient
4. Do nothing

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Summary

• In this lecture we studied the monopolist’s decision making

▪ Similar to other firms, the monopolist equates MR to MC to maximize profits

▪ However, MR is less than P which results in smaller quantity than the competitive
market.

▪ This creates a deadweight loss.

▪ Government policy can reduce the deadweight loss.

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