ECON 101:

Introduction to
Microeconomics
Lesson 20
Chapter 15: Monopoly

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Objectives
By the end of this lesson, students will be able to answer the
following questions:
• Why do monopolies arise?
• Why is MR < P for a monopolist?
• How do monopolies choose their P and Q?

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Rationale
• This chapter covers the circumstances under which monopolies
arise, and the outcome for consumers in such a market.

• By identifying and understanding the differences in outcomes for

consumer, we obtain an understanding of why governments
must intervene to prevent monopolies from abusing their market
power.

• This chapter covers the fundamentals of profit maximization for

monopolies.

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Prior Knowledge
An understanding of:
• Production function and diminishing marginal returns and how
they are related
• Various costs and how they are related to each other and to
outputs
• What marginal revenue is and how is it related to total and
average revenue
• How a competitive firm determines the quantity that maximizes
profits

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Short Answer: Quantity of Output
How do firms identify the profit maximizing quantity of output?

Type your response

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Monopoly
• While a competitive firm is a price taker, a monopoly
firm is a price maker.
• A firm is considered a monopoly if . . .
– It is the sole seller of its product.
– Its product does not have close substitutes.
• All this means that a monopoly has market power

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WHY MONOPOLIES ARISE

• The fundamental cause of monopoly is barriers to entry.

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WHY MONOPOLIES ARISE
• Barriers to entry have three sources:
– Ownership of a key resource
– The government gives a single firm the exclusive right to
produce some good
– Costs of production make a single producer more efficient
than a large number of producers

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Monopoly Resources
• Although exclusive ownership of a key resource is a potential
source of monopoly, in practice monopolies rarely arise for this
reason.
• E.g., DeBeers owns most of the world’s diamond mines

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Government-Created Monopolies
• Governments may restrict entry by giving a single firm the exclusive
right to sell a particular good in certain markets.
• Patent and copyright laws are two important examples of how
government creates a monopoly to serve the public interest.

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Natural Monopolies
• An industry is a natural monopoly when a single firm can supply a
good or service to an entire market at a smaller cost than could
two or more firms.
• A natural monopoly arises when there are economies of scale over
the relevant range of output.

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Natural Monopolies

Example: 1,000 homes

need electricity. Cost Electricity
Economies of
ATC is lower if scale due to
one firm services huge FC
all 1,000 homes $80
than if two firms $50 ATC
each service
Q
500 homes. 500 1,00
0
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HOW MONOPOLIES MAKE PRODUCTION AND
PRICING DECISIONS
• Monopoly versus Competition
– Monopoly
• Is the sole producer
• Faces a downward-sloping demand curve
• Is a price maker
• Reduces price to increase sales
– Competitive Firm
• Is one of many producers
• Faces a horizontal demand curve
• Is a price taker
• Sells as much or as little at same price 13
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Monopoly Versus Competition: Demand
Curves
A competitive firm’s
In a competitive market, the demand curve
market demand curve slopes P
downward.
But the demand curve
for any individual firm’s product is D
horizontal at the market price.
The firm can increase Q without
lowering P, so MR = P for the Q
competitive firm.
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Monopoly Versus Competition: Demand
Curves
A monopolist’s
A monopolist is the only seller, demand curve
so it faces the market demand P
curve.
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P. D
Q

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A Monopoly’s Revenue
• Total Revenue
• P  Q = TR
• Average Revenue
• TR/Q = AR = P
• Marginal Revenue
• ∆TR/∆ Q = MR

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ACTIVE LEARNING 1: A Monopoly’s Revenue
Q P TR AR MR
Moonbucks is the only seller 0 $4.50 n.a.
of cappuccinos in town.
1 4.00
The table shows the market
demand for cappuccinos. 2 3.50
Fill in the missing spaces of 3 3.00
the table. 4 2.50
What is the relation between
5 2.00
P and AR? Between P and
MR? 6 1.50

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Short Answer: Moonbuck’s D and MR Curves
What is the marginal revenue of the 1st unit?

Type your response.

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Short Answer: Moonbuck’s D and MR Curves
What is the marginal revenue of the 4th unit?

Type your response.

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Whiteboard: Moonbuck’s D and MR Curves

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A Monopoly’s Revenue
• A Monopoly’s Marginal Revenue
• A monopolist’s marginal revenue is always less than the price
of its good.
• The demand curve is downward sloping.
• When a monopoly drops the price to sell one more unit, the
revenue received from previously sold units also decreases.

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A Monopoly’s Revenue
• A Monopoly’s Marginal Revenue
• When a monopoly increases the amount it sells, it has two
effects on total revenue (P  Q).
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers revenue

• This happens because the monopolist is subject to the Law of

Demand.
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A Monopoly’s 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
(e.g., when Moonbucks increases Q from 5 to 6).

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Moonbuck’s D and MR Curves
P, MR
$5
4
Demand curve (P)
3
2
1
0
-1 MR
-2
-3
0 1 2 3 4 5 6 7 Q
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Monopolist’s Demand and Marginal
Revenue Curves

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Profit Maximization
• A monopoly maximizes profit by producing the quantity at which
MR = MC.

• It then uses the demand curve to find the price that will induce
consumers to buy that quantity.

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Figure 4: Profit Maximization for a Monopoly
Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity
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Profit Maximization
• Comparing Monopoly and Competition
• For a competitive firm, price equals marginal cost.
• P = MR = MC
• For a monopoly firm, price exceeds marginal cost.
• P > MR = MC

• Remember, all profit-maximizing firms set

MR = MC.

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Poll: Demand Curve - Monopolist

Refer to the table which illustrates the demand

curve for a monopolist. Suppose the firm’s marginal
cost is constant at $5. This monopolist will produce:
A. 5 units of outputs and charge a price of $10
B. 4 units of outputs and charge a price of $12
C. 3 units of outputs and charge a price of $14
D. 2 units of outputs and charge a price of $16

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Whiteboard: Demand Curve - Monopolist

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Poll: Price
Refer to the figure. This monopolist
will charge a price of:
A. P5 and produce quantity Q3
B. P2 and produce quantity Q2
C. P1 and produce quantity Q1
D. P3 and produce quantity Q2

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Whiteboard: Price

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A Monopoly’s Profit
• Profit equals total revenue minus total costs:
• Profit = TR – TC
• Profit = (TR/Q – TC/Q)  Q
• Profit = (P – ATC)  Q

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Figure 5: The Monopolist’s Profit
Costs and
Revenue

Marginal cost

Monopoly E B
price

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue

0 QMAX Quantity
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A Monopolist’s Profit
• The monopolist will receive economic profits as long as price is
greater than average total cost.

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A Monopoly Does Not Have an S 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,” not a “price-taker”
• Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So, there is no supply curve for monopoly.
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Case Study: Monopoly Versus Generic
Drugs The market for
Price a typical drug
Patents on new drugs
give a temporary
monopoly to the seller. PM

When the patent expires, PC = MC

the market becomes D
competitive, generics
appear. MR

QM Quantity
QC
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1-MINUTE RESPONSE

What was the most important thing you learned today

and what did you understand the least?
Respond in the online classroom.

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Summary of this Lesson
• A monopoly is a firm that is the sole seller in its market.
• It faces a downward-sloping demand curve for its product.
• A monopoly’s marginal revenue is always below the price of its
good.
• Like a competitive firm, a monopoly maximizes profit by
producing the quantity at which marginal cost and marginal
revenue are equal.
• Unlike a competitive firm, its price exceeds its marginal revenue,
so its price exceeds marginal cost.

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Post-work for Lesson 20
• After the Live Lecture, please review your notes and reflect on
the lesson content. Then, go to the online classroom for details
about the required resources.

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To Prepare for the Next Lesson
• Complete the post-work for Lesson 20
• Complete the prework for Lesson 21
• Read the required readings for Lesson 21

Go to the online classroom for details.

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