CHAPTER 10:

MONOPOLY AND IMPERFECT

COMPETITION

FIGURE TEXT
 Table 10.1: Total average and marginal
revenue

 Marginal revenue is less than price because price must be

lowered to sell an extras unit.
 For example, consider the marginal revenue of the eleventh unit.
 It is total revenue when eleven units are sold (£97.90) minus total
revenue when 10 units are sold (£90.00) which is £7.90.
 This is less than the £8.90 at which the eleventh unit is sold
because the price on all previous 10 units must be cut by £0.10 to
raise sales by one unit.
 Figure 10.1: The effect on revenue on an
increase in quantity sold.

 Because the demand curve has a negative slope, marginal

revenue is less than price.
 A reduction of price from p0 to p1 increases sales by one unit from
q0 to q1 units.
 The revenue from the extra unit sold is shown as the medium
blue area.
 To sell this unit, it is necessary to reduce the price on each of the
q0 units previously sold.
 The loss in revenue is shown as the dark blue area.
 Marginal revenue of the extra unit is equal to the difference
between the two areas.
 Figure 10.2: Revenue curves and demand
elasticity

 Rising TR, positive MR and elastic demand all go together,

 In this example, for outputs from 0 to 50 units, marginal revenue is
positive, elasticity is greater than unity, and total revenue is rising.
 Falling TR negative MR and inelastic demand all go together.
 In this example, for outputs from 50 to 100 units, marginal revenue
is negative, elasticity is less than unity, and total revenue is falling.
(All elasticities refer to absolute not algebraic values.)
Figure 10.3: The equilibrium of a monopoly

 The monopoly produces the output q0 where marginal revenue

equals marginal cost (rule 2).
 At this output, the price of p0 (which is determined by the
demand curve) exceeds the average variable cost (rule 1).
 Total profit is the profit per unit of p0-c0 multiplied by the output
of q0, which is the dark blue area.
 Figure 10.5: No supply curve under
monopoly

 The demand curves D’ and D’’ both have marginal revenue curves
that intersect the marginal cost curve at output q0.
 But because the demand curves are different, q0 is sold at:
 p0 when the demand curve is D’
 and at p1 when the demand curve is D’’.
 Thus under monopoly there is no unique relation between price and
the quantity sold.
 Figure 10.6: The deadweight loss of
monopoly

 At the perfectly competitive equilibrium Ec consumers’ surplus is the

sum of the areas 1, 5, and 6.
 When the industry is monopolized, price rises to pm, and consumers
surplus falls to area 5.
 Consumers lose area 1 because that output is not produced.
 They lose area 6 because the price rise has transferred it to the
monopolist.
 Producers’ surplus in the competitive equilibrium is the sum of the
areas 7 and 2.
 Figure 10.6: The deadweight loss of
monopoly (cont’d)

 When the market is monopolized and price rises to pm, the surplus
area 2 is lost because the output is not produced.
 However the monopolist gains area 6 from consumers.
 Area 6 is known to be greater than 2 because pm maximizes the
monopolist profits.
 Thus although the monopolist gains, society losses areas 1 and 2.
 Areas 1 and 2 are the deadweight loss resulting from monopoly and
account for its allocative inefficiency.
 Figure 10.7: A price-discriminating
monopolist
 Initially the monopolist produces output qm which it sell at pm where MC = MR
instead of the competitive output qc where MC equals demand (which is
consumers’ marginal utility).
 The deadweight loss is the sum of the three areas labelled 1, 2, and 3.
 A second group of consumers is then isolated from the first (the first group
continue to buy qm at pm).
 This new group who would buy nothing at the original price of pm, will buy an
amount that would increase total output to qd at a price of pd.
 The monopoly firm’s profits now rise by the area 2, which is the difference
between its cost curve and the price pd that is charged to the new group who
buy the amount between qm and qd.
 Consumers’ surplus rises by the area labelled 1 and total deadweight loss
falls to the area labelled 3.
 Figure 10.8: Conflicting forces affecting
cartels (i) the market

 Initially the market is in competitive equilibrium, with price p0 and

quantity Q0.
 The cartel is formed and enforces quotas on individual firms that
are sufficient to reduce the industry’s output to Q1, the output that
maximizes the joint profits of the cartel members.
 Price rises to p1,
 Figure 10.8: Conflicting forces affecting
cartels (ii) an individual firm

 (Note the change in scale from figures (i) and (ii).)

 Initially the individual firm is producing output q0 and is just covering its
total costs at price p0.
 When the cartel restricts production the typical firm’s quota is q1.
 The firm’s profits rise from zero to the amount shown by the dark blue
area.
 Once price is raised to p1 however, the individual firm would like to
increase output to q2, where marginal cost is equal to the price set by the
cartel.
 This would allow the firm to earn profits shown by the blue hatched area.
 But if all firms violate their quotas in this way, industry output will rise
above Q1, market price will fall, and the profit earned by each and every
firm will fall.