Monopoly
Lecture #9
William A. Branch
Outline
Contents
1 Sec. 1 1
2 Intro to Monopolies 2
3 Monopolist Decisons 3
4 Profit Max. 4
5 Welfare cost 4
6 Price discrimination 4
7 Gov’t. Policies 5
8 Final thoughts 5
1 Overview
Main idea
• Monopoly: a firm that is the sole seller of a product without a close substitute.
• Some firms are the only manufacturer of a product.
– ⇒ Apple only makes iPhones.
1
• Monopolists do not behave like competitive firms.
• Competitive firms produce at point where MC = P. For Apple, MC of iPhone
≈ $300, but sell for ≈ $700, so P > MC.
2 Why do Monopolies exist?
Why do monopolies exist?
• Typically, barriers to entry prevent other firms from entering and competing
away some profits.
• Where do barriers come from?
1. monopoly resources – a single firm owns a key resource.
2. gov’t. created monopolies – gov’t gives one person exclusive right to
sell some good or service.
– patents - sole right to manufacture for 20 years.
– copyright
– used when gov’t wants to encourage risky investment.
3. natural monopolies – monopoly arises b/c a single firm can supply a
good or service to an entire market at the lowest cost than two or more
firms.
Natural monopolies
• if one company has economies of scale their average total cost decreases as
the quantity produced increases.
• Thus, better to have one company with low average cost than a bunch of
smaller firms selling at a higher avg. cost.
• Example: electricity, cable
• Natural monopolies do not require gov’t protection since potential entrants
know they can’t produce at a smaller cost than the natural monopoly.
2
3 Monopolist Production/Pricing Decisions
Monopolist Production/Pricing Decisions
• competitive firms are price-takers.
• monopolists can affect price by lowering production.
• Can see how the demand for a single firm’s product differs between compet-
itive market and a monopoly.
Example: Tom has a monopoly in coconuts Assume the demand curve is...
Table 1: Demand for Tom’s coconuts
Q P Total Rev. (TR) Avg Rev. (AR) Marginal Rev. (MR)
0 7
1 6
2 5
3 4
4 3
5 2
Example: Tom has a monopoly in coconuts Assume the demand curve is...
Table 2: Demand for Tom’s coconuts
Q P Total Rev. (TR) Avg Rev. (AR) Marginal Rev. (MR)
0 7 0 – –
1 6 6 6 6
2 5 10 5 4
3 4 12 4 2
4 3 12 3 0
5 2 10 2 -2
• Note: MR < P.
• Demand is same as Avg. Revenue.
3
4 Profit Maximization
Profit Maximization
• Firm maximizes profits where MR = MC.
• For monopolist MR and Demand are not the same.
• Can see this in a general graph...
Main Result
Result 1. monopolist’s profit maximizing quantity at MR = MC.
• compare to competitive firms:
– comp. firm: P = MR = MC.
– monop. firm: P > MR = MC.
• Why not a supply curve?
– supply curve says how much to produce at a given P.
– monopolists though set their price same time as quantity.
5 Welfare cost of monopolies
Welfare cost of monopolies
• Recall, efficient level of output maximizes consumer and producer surplus.
• Monopoly sets higher price, so sell less, and there is a deadweight loss.
• See in graph...
6 Price discrimination
Price discrimination Example: hardcover vs. softcover books
• Suppose 100, 000 fans willing to pay $30 for a new Harry Potter.
• There’s an additional 400, 000 casual fans willing to pay $5.
• Then:
4
1. charge $30, sell 100, 000 earn $3m.
2. charge $5, sell 500, 000 eearn $2.5m.
• First release hardcover and sell for $30. Later, release paperback/e-book and
sell for $5.
• By price-discriminating earn $30 × 100, 000 + $5 × 400, 000 = $5m.
• Result. No deadweight loss, and monopolist captures all surplus.
7 Government Policies
Government Policies monopoly is another example of how gov’t can improve
market outcomes.
1. anti-trust laws prevent firms from accumulating too much market power.
• prevent mergers, e.g. airlines.
• split up monopolies, e.g. AT& T.
• prevent from “uncompetitive practices” like forcing PC manufacturers
from installing internet explorer on all machines.
2. regulation, especially for natural monopolies. Gov’t determines price that
they can charge.
3. public ownership
8 Some final thoughts
Some final thoughts
• In this course, looked at
1. perfect competition – price-taking firms producing identical goods.
2. monopoly – single firm producing a good without close substitutes.
• These are two extremes, and most industries lie in between:
– monopolistic competition – many firms sell products that are similar
but not identical, e.g. TV’s.
5
– oligopoly – only a few sellers offer similar or identical goods, e.g. gaso-
line.
• 2 chapters in the textbook, not covered in this course, that study these situa-
tions.
