In this chapter, look for the answers to

these questions:
 Why do monopolies arise?
Chapter 7  Why is MR < P for a monopolist?

Pure monopoly  How do monopolies choose their P and Q?

 How do monopolies affect society’s well-
being?
 What can the government do about
Le Thi Kim Dung, M.E monopolies?
 What is price discrimination?
1

Introduction Why Monopolies Arise

 A monopoly is a firm that is the sole The main cause of monopolies is barriers
seller of a product without close to entry – other firms cannot enter the
substitutes. market.

 In this chapter, we study monopoly and Three sources of barriers to entry:

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.
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.
2
E.g., patents, copyright laws 3

Monopoly vs. Competition: Demand

Why Monopolies Arise
Curves
3. Natural monopoly: a single firm can In a competitive market,
produce the entire market Q at lower the market demand
ATC than could several firms. curve slopes downward.
A competitive
Example: 1000 homes but the demand curve firm’s demand
Electricity for any individual firm’s P
need electricity. Cost curve
Economies of product is horizontal
ATC is lower if scale due to at the market price.
one firm services huge FC D
$80 The firm can increase Q
all 1000 homes without lowering P,
than if two firms $50 ATC
each service so MR = P for the
Q
500 1000 competitive firm. Q
500 homes.
4 5

1
 Perfect Competition Perfect Competition
 Review of Perfect Competition
• P = LMC = LRAC P Market P Individual Firm
• Normal profits or zero economic D S
LMC LRAC
profits in the long run
• Large number of buyers and sellers
• Homogenous product P0 P0
D = MR = P
• Perfect information
• Firm is a price taker

Q0 Q q0 Q
6 7

Monopoly vs. Competition: Demand

Monopoly
Curves
 Monopoly A monopolist is
1) One seller - many buyers the only seller, so
it faces the market A monopolist’s
demand curve
2) One product (no good substitutes) demand curve. P

3) Barriers to entry To sell a larger Q,

the firm must
reduce P.
D = AR
Thus, MR ≠ P
Q

8 9

ACTIVE LEARNING 1: ACTIVE LEARNING 1:

A monopoly’s revenue Answers
Moonbucks is
the only seller of
Q P TR AR MR Here, P = AR, Q P TR AR MR
cappuccinos in 0 $4.50 n.a. same as for a 0 $4.50 $0 n.a.
town. $4
1 4.00 competitive 1 4.00 4 $4.00
3
The table shows the
2 3.50 firm. 2 3.50 7 3.50
market demand for 2
cappuccinos. 3 3.00 Here, MR < P, 3 3.00 9 3.00
1
Fill in the missing 4 2.50 whereas MR = P 4 2.50 10 2.50
0
spaces of the table. 5 2.00 for a 5 2.00 10 2.00
competitive –1
What is the relation 6 1.50 6 1.50 9 1.50
between P and AR? firm.
Between P and MR? 10 11

2
 Moonbuck’s D and MR Curves
P, MR (D): P = a + bQ
$5
TR = P. Q
4
Demand curve (P) = AR
3 = (a + bQ). Q
2
1
TR = aQ + bQ2
0 MR = a + 2bQ
-1 MR
-2
-3
0 1 2 3 4 5 6 7 Q

12 13

Profit-Maximization Profit-Maximization
 Like a competitive firm, a monopolist
maximizes profit by producing the Costs and
1. The profit- Revenue MC
quantity where MR = MC. maximizing Q
P
 Once the monopolist identifies this is where
quantity, it sets the highest price MR = MC.
consumers are willing to pay for that D=AR
2. Find P from
quantity. MR
the demand
 It finds this price from the D curve. curve at this Q. Q Quantity

Profit-maximizing output
14 15

Short- Run Losses and the

The Monopolist’s Profit
Shutdown Decision
Costs and
As with a Costs and Revenue ATC
Revenue MC ATC MC
competitive  Being a monopolist AVC
firm, the P is no guarantee of P
ATC
monopolist’s ATC economic profit.
Why?
profit equals
D • If P > AVC, the D
(P – ATC) x Q firm will operate.
MR MR
• If P < AVC, the
Q Quantity firm will shut Q Quantity
down at least
temporarily.
16 17

3
 Monopoly Monopoly

The Monopolist’s Output Decision The Monopolist’s Output Decision

 An Example  An Example

Cost  C (Q)  50  Q 2 Demand  P(Q)  40  Q

C R(Q)  P(Q)Q  40Q  Q 2
MC   2Q
Q R
MR   40  2Q
Q
18 19

Monopoly Monopoly

The Monopolist’s Output Decision The Monopolist’s Output Decision

 An Example  An Example
• By setting marginal revenue equal
MR  MC or 40  2Q  2Q to marginal cost, it can be verified
Q  10 that profit is maximized at P = $30
and Q = 10.
When Q  10, P  30 • This can be seen graphically:

20 21

Example of Profit Maximization Example of Profit Maximization

$ C $/Q
t' R
400 40 MC

300 30

c’
Profit
AC
200 t 20
Profits AR
150 15

100 10

50 MR
c
0 5 10 15 20 Quantity 0 5 10 15 20
22 Quantity 23

4
 Elasticity of Demand and Price
Example of Profit Markup
Maximization
$/Q The more elastic is $/Q
 Observations $/Q demand, the less the
markup.
• AC = $15, Q = 10, 40 MC P*
MC MC
TC = AC x Q = 150
• Profit = TR - TC = 30
P*
$300 - $150 = $150 AC
Profit AR
or 20 P*-MC
AR
• Profit = (P - AC) x 15
MR
Q = ($30 - $15)(10) 10 MR
= $150 AR

0 5 10 15 20 MR
Quantity
Q* Quantity Q* Quantity

24 25

Elasticity, Total Revenue, and

Monopoly
Expenditure
 Monopoly pricing compared to perfect
competition pricing:
• Monopoly
P > MC
• Perfect Competition
P = MC

26 27

A Monopoly does not have an S Price Discrimination

curve
 Discrimination: the practice of treating people
 Observations differently based on some characteristic, such
as race or gender.
• Shifts in demand usually cause a
 Price discrimination is the business practice
change in both price and quantity.
of selling the same good at different prices to
• A monopolistic market has no supply different buyers.
curve.  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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5
 Perfect Price Discrimination vs. Perfect Price Discrimination vs.
Single Price Monopoly Single Price Monopoly
Here, the monopolist
Here, the Consumer
Price produces the Price
monopolist charges surplus Monopoly
competitive quantity,
the same price (PM) profit
Deadweight but charges each
to all buyers. PM loss buyer his or her WTP.
A deadweight loss This is called perfect
results. MC MC
Monopoly price discrimination.
profit D D=MR
The monopolist
MR captures all CS
as profit.
QM Quantity Quantity
But there’s no DWL. Q
30 31

Examples of Price Discrimination 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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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.
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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.

34 35