Lecture 11

Monopoly – Part I
(Chapter 12)

Econ 100 – Spring 2025

1
Motivation #1:

Perfect competition

1. Many sellers (firms) and buyers (consumers)

2. They can’t influence price
3. Homogeneous good
4. Free entry/exit

Q1: Why don’t we observe more examples of PC

markets?
Q2: If you were the seller, why would you stay in
this market?
2
Motivation #2:

Monopoly

• ‘Monopolist’ has a negative connotation!

• We will learn why: less quantity, higher prices.
• Monopolist increases profits at the expense of the
consumer.

Q: are monopolies always bad to society?

3
Lecture roadmap:

Lecture Roadmap
1. A common framework: optimizing firms (today)
2. Monopoly and sources of its market power (today)
3. The monopolist’s problem (today)
4. The cost of monopoly: inefficiency/DWL (next lecture)
5. Price discrimination (next lecture)

4
1. A common framework: optimizing firms

All firms want to optimize!

• Move away from the “naïve” perspective of perfect
competition vs. monopoly (vs. oligopoly)
• All firms want to optimize, maximize profits: whether
in perfect competition, monopoly, oligopoly, or
monopolistic competition
• But the optimal behavior will depend on what the
market allows them to do

5
1. A common framework: optimizing firms

All firms want to optimize!

• Perfect competition: firms wants to sell their goods at
higher price, but they can’t because they lose all
buyers
• Monopolistic competition: firms can increase the
price ‘somewhat’ (goods are not homogeneous but
similar)
• Oligopoly: firms also want to raise price, but they
need to consider what other competitors will do.
• Similarly, the monopolist also wants to optimize!

6
1. A common framework: optimizing firms

Porter’s 5 forces model

7
Monopoly: definition

Monopoly
A single seller (no free entry) with the ability to set the
price or quantity. Produces a good with no close substitutes
(vs. homogeneous goods)

Price makers (vs. price takers)

Sellers set the price of a good (or quantity to influence the
price). They have market power. We start with uniform
pricing (same price for all units sold)

8
Monopoly: definition

• Be careful with the “definition” of monopoly

o A market with a single seller: will the seller
necessarily have monopoly power?
§ Threats of new entry? What’s the source of “barriers to entry”?
o How do we define “market”? Broad vs. Narrow.
§ When you narrow the market, a seller can always be a single
seller, but won’t have much power! (i.e., close substitutes
available)

9
2. Monopoly and sources of its market power

Why do monopolies exist?

Barriers of entry: potential competitors cannot
enter the market (or it’s not profitable to enter)
1. Legal market power: patents (Claritin), copyrights (authors
for books), licensing (Pret-a-manger at UC)
2. Natural market power:
a. Controls a key resource (e.g., diamond mines), owns
network externalities (e.g., facebook)
b. Economies of scale: when there are very large fixed
costs (electricity transmission) – natural monopoly
10
2. Monopoly and sources of its market power

Economies of scale in natural monopolies

Q: assume fixed costs and constant MC curves. How
does the ATC curve look like?
Natural monopoly: emerges because it enjoys
economies of scale over a very large range of output

11
3. The monopolist’s problem: profit

Profit maximization
Just like a firm in perfect competition: monopolist
also wants to maximize profits!
1. Profit: still defined as revenue minus cost
2. Revenue side: price times quantity
3. Cost side: a production function that turns inputs
into output

12
3. The monopolist’s problem: cost

Profit maximization: cost curves

• What determines the shape of the different cost
curves?
• The technology & the production function! The
cost curves are independent of the market
structure.

13
3. The monopolist’s problem: revenue

Profit maximization: revenue curves

• The monopolist is a price maker. So, can a
monopolist charge any price he wants to and sell
any quantity he wants?
• No!
• The monopolist faces the market demand curve.
• Price maker: it can choose the price OR quantity it
wants. It is constrained by the demand curve and
cannot choose both!
• The monopolist faces a “trade-off” between price
and quantity
14
3. The monopolist’s problem: revenue

Profit maximization: revenue curves

• The monopolist might want to try to reduce
quantity to influence price upwards (uniform
pricing).
• You should ask yourself, but why? Why lose the
revenue by selling less?
• Because he can charge a higher price on
inframarginal units!
• Less revenue on the marginal unit but gain
revenue on the inframarginal units.
• The monopolist’s optimizing behavior is about this
trade-off 15
3. The monopolist’s problem: revenue

• In PC, it is as if an individual firm faced a perfectly

elastic demand curve! (the perceived demand curve)
• Monopolist faces the entire market demand curve.
• Monopolist can charge more or less, and quantity
demanded will go up or down the demand curve
16
3. The monopolist’s problem: revenue

What happens
Constant MC.
to MR (with
Decreasing ATC
rounding) as
price decreases? 17
3. The monopolist’s problem: revenue

MR decreases Constant MC.

with price! Decreasing ATC
18
3. The monopolist’s problem: revenue

Why is MR below demand?

Numerical example: The monopolist is selling 200 units at a price of $5 each.

To sell 400 units, it has to lower the price to $4
Source of additional revenue: selling 200 more units at $4 each = $800.

Source of decreased revenue: charging $1 less on 200 units already being

sold before = -$200
Additional revenue: $600
MR=$600/200=$3 < $4
19
3. The monopolist’s problem: revenue

Graphically…
• Additional revenue is the
quantity effect
• Reduced revenue is the price
effect
• Net effect on revenue
depends on these two effects
• Thus, MR can also become
negative!

The Quantity Effect and the Price Effect on Revenues

20
3. The monopolist’s problem: revenue

Why is MR below demand?

Economic intuition:
• Start from a given price level 𝑝!
• What’s the definition of marginal revenue?
• Revenue from selling one additional unit
• If a monopolist wants to sell one more unit, what
does he have to do to the price?
• Decrease it (𝑝" < 𝑝! ). So there is additional
revenue from selling the unit at a lower price.
• But the monopolist has to charge this lower price
for all the units sold before. This reduces the
revenue! We are assuming uniform pricing!
• Thus, MR will be below this price 𝑝" 21
3. The monopolist’s problem: revenue

• Explain the shape of the bottom

graph.
• Total revenue must increase if MR
is positive.
• Vice versa when MR is negative.
22
3. The monopolist’s problem: profits

Profit maximization
• In PC, we learned MC=MR as the
profit max rule.
• Does it still apply? Why or why
not?
• What happens if MC > MR?
• What happens if MC < MR?
• Yes, it still applies
• Unless we have MC=MR, profit
can always be increased.

Marginal Revenue and Marginal Cost

23
3. The monopolist’s problem: setting the optimal price

Setting the optimal price

• Monopolist will choose where
MC=MR
• Monopolist can choose either the
price or quantity where the
condition is satisfied.
• The market demand curve
determines the other.

Choosing the Profit-Maximizing Price

24
3. The monopolist’s problem: optimal profit, graphically

• MC=MR pins down price (p) and

quantity (q)
• Total revenue = p * q
• Total cost = ATC * q
• Profit = (p – ATC) * q
• In this example, there’s positive
economic profit
• Will this profit be sustained in
the long-run?
• Yes! Because of barriers to entry
Computing Profits for a Monopolist

25
3. The monopolist’s problem: profit maximization and elasticity
Elastic Inelastic
• Relationship between price elasticity of
demand and revenue
• When demand is price elastic, revenue
increases when price falls
• When demand is price inelastic,
revenue falls when price falls

• Will a profit maximizing monopolist

ever choose a quantity that has
negative MR? Why?
• Negative MR means inelastic demand.
So a profit maximizing monopolist will
never be on the inelastic portion of the
demand curve.
26