Economics For Today 9th Edition

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Chapter 9
Monopoly
CHAPTER SUMMARY

The characteristics of the monopoly are introduced. The fact that a monopoly is a single seller and
there are very strong barriers to entry is central to this market structure. The barriers to entry may include
ownership of an essential resource, legal barriers, and economies of scale. A natural monopoly arises
because of extensive economies of scale.
Because the monopoly is a single seller then it is a price maker--it sets the price in the market by
producing that output level which maximizes its profits, thereby effectively determining market supply,
which in turn sets the market price. The monopolist is faced with the market demand curve. Therefore, the
monopolist's marginal revenue curve lies below the market demand curve it faces. The profit-maximizing
quantity to produce is the same for any other firm. Long-run economic profits are likely for a monopolist
because of the strong barriers to entry which limit others from entering and competing in the market.
Monopolies may price discriminate in order to increase their profits if they are able to do so. Price
discrimination means the firm is charging different prices to different people where those price
differences are not a reflection of cost differences.
This chapter concludes with a critique of monopolies from society's perspective.

NEW CONCEPTS INTRODUCED

monopoly price maker arbitrage

natural monopoly price discrimination network good

LEARNING OBJECTIVES
After completing this chapter, you should be able to:

1. Describe the characteristics of monopoly.

2. Define natural monopoly.
3. Define the marginal revenue curve.
4. Explain monopolist profit-maximizing.
5. Explain monopolist loss-minimization.
6. Define price discrimination and arbitrage.
7. Explain conditions for price discrimination.
8. Compare monopoly and perfect competition.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
2 Economics for Today

CHAPTER OUTLINE

9-1 The Monopoly Market Structure

a. Single Seller
b. Unique Product
c. Impossible Entry
d. Ownership of a Vital Resource
e. Legal Barriers
f. Economies of Scale
g. Network good

Exhibit 1 "Minimizing Costs in a Natural Monopoly"

9-2 Price and Output Decisions for a Monopolist

a. Marginal Revenue, Total Revenue, and Price Elasticity of Demand

Exhibit 2 "Demand, Marginal Revenue, and Total Revenue for a Monopolist"

Global Economics: Analyze the Issue

"Monopolies around the World” Applicable Concept: monopoly

b. Short Run Profit Maximization for a Monopolist Using the Total Revenue-Total Cost Method

Exhibit 3 "Short-Run Profit Maximization Schedule for Computech as a Monopolist"

Exhibit 4 "Short-Run Profit Maximization for a Monopolist Using the Total Revenue-Total
Cost Method"

c. Short Run Profit Maximization for a Monopolist Using the Marginal Revenue Equals Marginal
Cost Method

Exhibit 5 "Short-Run Profit Maximization for a Monopolist Using the Marginal Revenue
Equals Marginal Cost Method"

d. A Monopolist facing a Short-Run Loss

Exhibit 6 "Short-Run Loss Minimization for a Monopolist Using the Marginal

Revenue-Marginal Cost Method"

e. Monopoly in the Long Run

You're The Economist: Analyze the Issue

"The Standard Oil Monopoly" Applicable Concept: monopoly

9-3 Price Discrimination

a. Conditions for Price Discrimination

Exhibit 7 "Price Discrimination"

b. Is Price Discrimination Unfair?

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in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 9: Monopoly 3

9-4 Comparing Monopoly and Perfect Competition

Checkpoint: "Why Don't Adults Pay More for Popcorn at the Movies?

a. The Monopolist as a Resource Misallocator

Exhibit 8 "Comparing a Perfectly Competitive Firm and a Monopolist"

b. Perfect Competition Means More Output For Less

Exhibit 9 "The Impact of Monopolizing an Industry"

9-5 The Case against and for Monopoly

You're The Economist: Analyze the Issue

"New York Taxicabs: Where Have All the Fare Flags Gone?" Applicable Concept: perfect
competition versus monopoly

Summary of Conclusion Statements

a. Because of economies of scale, a single firm in an industry will produce output at a lower per-unit
cost than two or more firms.
b. The greater the number of people connected to a network goods system, the more benefits of the
product to each person are increased.
c. The demand and the marginal revenue curves of the monopolist are downward sloping, in
contrast to the horizontal demand and corresponding marginal revenue curves facing a perfectly
competitive firm.
d. The marginal revenue curve for a straight-line demand curve intersects the quantity axis
halfway between the origin and the quantity axis intercept of the demand curve.
e. A monopolist always maximizes profit by producing at a price on the elastic segment of its
demand curve.
f. If the positions of a monopolist's demand and cost curves give it a profit and nothing disturbs
these curves, the monopolist will earn profit in the long run.
g. A monopolist is characterized by inefficiency because resources are underallocated to the
production of its product.
h. Monopoly harms consumers on two fronts. The monopolist charges a higher price and produces
a lower output than would result under a perfectly competitive market structure.

HINTS FOR EFFECTIVE TEACHING

1. Have students add to the list of potential barriers to entry. For example: financial, technological,
threat of violence, ability to differentiate (create a niche for) the good or service, etc.

2. Have students think of some additional examples of network goods.

3. Have students think of some additional examples of price discrimination. For example, golf courses,
doctors, movie theaters...

4. You may want to use the 5-step process suggested in the last chapter to analyze this and all other
market environments.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
4 Economics for Today

5. Again, try not to get too bogged down in the graphs. Approach this material in an intuitive way.

6. Ask students to identify some examples of markets which are "monopolized." Some examples may
include local telephone services, local cable TV, and the utilities companies. Note that most
monopolies are found at the local level (e.g. the only gas station in town). In fact, defining what is
the relevant market is often critical in determining the degree of competition in any real-world
market. Is the relevant market the local market or the entire global economy?

7. Point out that many real-world monopolies are natural monopolies which are government created
and government regulated.

8. Point out that the investigation of the monopoly model is practical in that other firms who possess at
least some monopoly power (e.g. oligopolies and monopolistically competitive markets) will
exercise some of the same tendencies described in this chapter.

9. Stress the negative social outcomes associated with monopolized markets.

10. You may want to point out that government uses anti-trust legislation to combat the growth of
monopoly power. Moreover, this is the most effective way to combat monopoly power. Regulation
of non-competitive markets (except for natural monopolies) has usually only made matters worse
because government laws and regulation often only act as a barrier to entry themselves in practice.
Finally, it may be interesting to mention "the capture theory of regulation" that may exist in practice.

CRITICAL THINKING/GROUP DISCUSSION QUESTIONS

1. What are some relevant public policy questions when government considers breaking up a
monopoly?
How large are the social costs associated with the monopoly? How costly is it for government
to intervene? What are the estimated benefits associated with busting up the monopoly? As with
all rational decisions, undertake an activity only if the benefits exceed the costs and continue to
do so only for as long as the marginal benefits exceed the marginal costs.

2. Can a monopoly lose money?

Yes. Like any other firm if costs are relatively high or demand is relatively weak then a
monopoly could lose money. The shut down rule remains the same.

3. If a monopoly is losing money then when should it shut down?

Like any firm, a monopoly would shut down if price is less than average variable costs (or when
operating losses exceed total fixed costs; or, otherwise stated, when price is total revenue is less
than total variable costs).

4. How long can a monopoly earn economic profits?

For as long as it is successful in preventing potential competitors from entering its market---
assuming continued demand for its output.

5. Why does a monopolist produce less and charge a higher price compared to a competitive market?
Because MR = MC at a lower output. Less supplied by a monopolist, because it is the market
supplier, results in a higher price charged.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 9: Monopoly 5

6. What evidence suggests that some government regulation may reduce competition in practice?
Whenever government talks about deregulating some industry, usually the first ones to oppose
that move are the regulated firms in that industry.

7. How can a monopoly maintain its single-seller status?

By maintaining the present barriers to entry, or creating new ones which are successful in
preventing potential competitors from moving into the market.

8. Why don't monopolists charge the highest possible price market demand will bear?
Because by doing so, the monopolist would sell only one unit of output, and that is not likely to
be the most profitable output level.

9. If a company charges different prices to different customers as a result of differences in providing

the product to these different customers then is that price discrimination?
No. Price discrimination exists only when different prices are charged to different customers
and these price differences are not a reflection of costs differences.

CLASSROOM GAMES

Approximately 170 non-computerized economic games (experiments) for use in the classroom are
available for free at http://www.marietta.edu/~delemeeg/games/. The following games are recommended
to help teach some of the concepts in this chapter:

Game #8—Objective: To experimentally demonstrate monopoly power.

Game #34—Objective: To illustrate the nature of competitive and monopoly outcomes.
Game #35 and 36—Objective: To demonstrate the effects of monopolization on a competitive market.
Game #40—Objective: To demonstrates how a monopolist chooses different prices for different
consumers in order to maximize profits.
Game #95—Objective: To illustrate the fundamental issues associated with market power.
Game #159—Objective: To illustrate the social welfare consequences of price discrimination.

ANSWERS TO: "You're the Economist” and “Global Economics:” “Analyze the Issue"

MONOPOLIES AROUND THE WORLD

There is no "Analyze the Issue" for this "You're the Economist."

THE STANDARD OIL MONOPOLY

There is no "Analyze the Issue" for this "You're the Economist."

NEW YORK TAXICABS: WHERE HAVE ALL THE FARE FLAGS GONE?

Use a graph to explain the price and output of medallion yellow cabs in New York City before and after
the 1920s.

The medalliion yellow cabdrivers have monopoly power over hailed cab services in New York City
and they charge the monopoly equilibrium price Pm and Qm where the marginal cost and marginal
revenue curves intersect. In the 1920s, taxis used flags and the market for cab rides approximated

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
6 Economics for Today

perfect competition. Assuming the marginal cost curve is equal to the industry supply curve under
perfect competition, the equilibrium price falls to Pc and equilibrium quantity increases to Qc.
Hence, the impact of monopoly is to raise the price and restrict the quantity of cab rides exchanged
in this market.

ANSWERS TO EVEN-NUMBERED "Study Questions and Problems"

2. A perfectly competitive firm must accept the going market price because it is only one of so many
firms in an industry. The monopolist is the industry because it is the only firm in the industry. As a
result, the monopolist faces the entire downward-sloping demand curve for its product.

4. All three statements are false.

(a) A monopoly can exist by owning an essential resource or achieving economies of scale.
(b) A monopolist maximizes profit and not price.
(c) Demand conditions in the short run can cause a monopolist to incur a loss when the MR = MC
price is below the ATC curve.

6. See the following table and graph.

____________________________________________________________
Price Quantity Total Marginal Price elasticity
demanded revenue revenue of demand
____________________________________________________________
$5.00 0 $ 0 ---- elastic
4.50 1 4.50 $ 4.50 elastic
4.00 2 8.00 3.50 elastic
3.50 3 10.50 2.50 elastic
3.00 4 12.00 1.50 elastic
2.50 5 12.50 .50 unit elastic
2.00 6 12.00 -.50 inelastic
1.50 7 10.50 -1.50 inelastic
1.00 8 8.00 -2.50 inelastic
.50 9 4.50 -3.50 inelastic
0 10 0 -4.50 inelastic
_____________________________________________________________

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 9: Monopoly 7

Figure 9A-1

8. In the inelastic range of the demand curve, MR is negative while MC is positive. Because the
monopolist will profit maximize by setting MR equal to MC, it will always operate where demand is
elastic.

10. The monopolist shown in the graph would shut down because the price is below AVC at the MR =
MC output.

12. See Figure 9A-2 below. Before the takeover, the price of candy bars is Pc and the output is Qc. Since
Pc = MC, the allocation of resources to the perfectly competitive candy industry is efficient. After the
takeover, the price rises to Pm, and the quantity supplied falls to Qm. To profit maximize, the
monopolist equates MR and MC, with P > MC. As a result, resources are underallocated to a
monopolistic candy bar industry.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
8 Economics for Today

Figure 9A-2

CHAPTER 9 SUMMARY QUIZ

1. A monopolized market is characterized by:

a. a sole seller of a product for which there are few suitable substitutes.
b. very strong barriers to entry.
c. a single firm facing the market demand curve.
d. all of the above.

2. A monopoly will price its product:

a. where total revenue is maximized.
b. where total costs are minimized.
c. at that point on the market demand curve corresponding to an output level in which marginal
revenue equals marginal cost.
d. at that point on the market demand curve which intersects the marginal cost curve.

3. A monopoly:
a. faces the market demand curve which is downward sloping.
b. has a marginal revenue curve which slopes downward and lies below its demand curve.
c. will maximize profits by producing an output level where MR = MC.
d. all of the above.

4. One of the necessary conditions for price discrimination to occur is that:

a. buyers in different markets have different elasticities of demand.
b. the demand curve is upward sloping.
c. buyers must be allowed to resell the good at a higher price elsewhere.
d. all of the above are necessary for price discrimination to occur.

ANSWERS TO CHAPTER 9 SUMMARY QUIZ

1. d
2. c
3. d
4. a

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
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