Monopoly: Introduction

Monopoly - Part 1

Dr. Saima Khan (SaKn)

ECO 101: Introduction to Microeconomics

Department of Economics, School of Business,

North South University

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 Monopoly: Introduction

Features of a Monopoly

1. 1 firm (that has no competition)

2. 1 good (no close substitutes)
3. No entry - strict barriers to entry

 Because of the above features, the firm will be a PRICE

MAKER.
I The firm has market power.
I Note that the firm cannot just choose any price it wants to -
the price it sets is still limited by consumer willingness to pay!

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 Monopoly: Introduction

Sources of Barriers to Entry

 Patent, copyright laws (to encourage firms to innovate)

 Single firm owns a key input

I Often, if a firm can get control of the input, it can dominate
the market.
I e.g. DeBeers own most of the diamond mines and thus controls
diamond production worldwide.

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 Monopoly: Introduction

Sources of Barriers to Entry

 Natural Monopoly - economies of scale - cheaper to make larger

quantities that to break it up and have n firms produce a share
of the market output.
I Delivery of water to households through pipes - usually have
one company providing water in an area.
I Say you have a lake in your backyard and want to supply water
to households ⇒ if you approach that water company and ask
to use their pipes, they will say NO ⇒ so you will have to lay
down another set of pipes which is VERY COSTLY.

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 Profit Maximization

Monopoly - Determining P and Q

Table 1: Revenues of a Monopoly Firm

Q P TR AR MR
(units) (per unit) ($) ($) ($)

0 6.00 0.00 - -
1 5.50 5.50 5.50 5.50
2 5.00 10.00 5.00 4.50
3 4.50 13.50 4.50 3.50
4 4.00 16.00 4.00 2.50
5 3.50 17.50 3.50 1.50
6 3.00 18.00 3.00 0.50
7 2.50 17.50 2.50 -0.50
8 2.00 16.00 2.00 -1.50
9 1.50 13.50 1.50 -2.50
10 1.00 10.00 1.00 -3.50

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 Profit Maximization

Monopoly - Revenue Structure

 The P column does NOT mean that the firm charges $5.50 for
the 1st unit, $5.00 for the 2nd unit, $4.5 for the 3rd unit ...

I It means that if the firm wants to sell 3 units it must charge

$4.5, to sell all 8 units it must lower the P to $2 and so on and
so forth.
 Note that P will always equal AR

We know TR = P × Q
TR P×Q
Thus AR = = = P ⇒ AR = P
Q Q

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 Profit Maximization

Monopoly - Revenue Structure

 Look at MR column⇒ MR < P

I Recall that in Perfectly Competitive market, for each firm

P=MR
 Every time the firm sold an additional unit, it got $6
⇒ MR = $6
 This was because firm was price taker which could sell all Q
produced at the market price.

I But for a Monopoly firm, to sell an additional unit, it must

lower price for every unit it sells.
 So it’s MR has to go down.

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 Profit Maximization

Graphing the D and MR curve

 General Rule: For a linear

D curve
I the MR curve has
the same vertical
intercept as the
D-curve

I MR curve has twice

the slope as the D
curve (twice as steep
as the D curve)

I Holds for PC firm as

well (see class notes).

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 Profit Maximization

Profit Maximization - Choosing Q∗

 Recall, the firm chooses that Q where profit is maximized, i.e.,
where MC = MR
 So let’s combine the cost and revenue curves in one diagram

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 Profit Maximization

Profit and Loss in a Monopoly

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 Supply Curve: Perfect Competition vs Monopoly

Supply Curve: Monopoly vs Perfect Competition

 The Monopoly firm has NO SUPPLY CURVE.

 Recall that for a PC firm - the MC is the supply curve - Why?
I It takes price as given
I When market price is P1 , profit is maximized at q1 where
MC = MR1 (= P1 )
I When market price is P2 , profit is maximized at q2 where
MC = MR2 (= P2 )
I Thus for every price, we get a quantity the PC firm will produce
⇒ thus, the MC curve (above shutdown point) is the supply
curve.

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 Supply Curve: Perfect Competition vs Monopoly

Supply Curve: Monopoly vs Supply Curve

 But, for the Monopoly, 3 different curves are involved in deciding
Q and P.
 While the MC curve helps decide the quantity to produce, we
need the D = AR curve to determine the price.
I Thus no ONE curve that related price to quantity.

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 Supply Curve: Perfect Competition vs Monopoly

Short Run vs Long Run

 Since STRICT BARRIERS TO ENTRY in Monopoly

I If Monopoly firm is making a profit - then no fear that new
firms will enter.
I So will not have a scenario as in PC - will not be faced with
new firms entering and driving profits down.
I Thus both in SR and LR, Monpoly equilibrium can look the
same.

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 Deadweight Loss: Perfect Competition vs Monopoly

Revisiting CS, PS and DWL

 CS = A
 PS = B+D
 DWL =C + E
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 Price Discrimination

Price Discrimination

 Monopoly might be able to make even more profit if it charged

different prices
 Price Discrimination - when a firm charges different prices to
different groups for the same exact product.
 Firms can price discriminate based on:
I age - senior citizen discount/student discount
I geography - BATA prices change based on location in Dhaka
city

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 Price Discrimination

3 Types of Price Discrimination

 Perfect price discrimination: when every individual is charged the

maximum price that they are willing to pay.
I Monopolist extracts full consumer Suplus ⇒ CS = 0

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 Price Discrimination

3 Types of Price Discrimination

 Second-degree price discrimination: When a monopolist charges

a uniform price per unit for one specific quantity, a lower price
for an additional quantity, and so on.
 when the firm gives discounts based on the quantity bought.
I Example 1, the monopolist might sell the first 10 units for $10
each, the next 20 units for $9 each, and so on.
I Discounts at Walmart for buying in bulk.

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 Price Discrimination

3 Types of Price Discrimination

 Third-degree price discrimination: When monopolist charges

different prices in various markets or charges different prices to
various segments of the buying population
I movie tickets priced differently for senior citizens versus
students;
I financial aid (given out based on income)

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 Price Discrimination

Third Degree Price Discrimination

 Say firm could identify 2 groups that have different willingness

to pay.
 Let’s make some simplifying assumptions
 Let’s say the MC curve is constant
 Further, let the FC=0 ⇒ MC=ATC

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