CH 13

CHAPTER 13
Monopoly
Competition and Efficiency
 Allocative efficiency occurs when no
resources are wasted.
 This means no individual can be
made better off without making
someone else worse off.
 In the absence of any obstacles,
perfect competition leads to
allocative efficiency.
Obstacles to Efficiency
 The three main obstacles to
achieving allocative efficiency
are:
 Public goods (national defense)
 Externalities (external costs and
external benefits)
 Monopoly power
Obstacles to Efficiency
 Public goods are those that can be
consumed simultaneously by
everyone and from which no one can
be excluded.
 Externalities occur when costs or
benefits are conferred on other
members of society.
 Monopoly power is the absence of
competition.
Public Goods
 Public goods cannot be provided
efficiently by the private market because
of the free rider problem.
 A free rider is someone who consumes a
good without paying for it.
 Because people can consume a public
good without paying for it, no one has the
incentive to pay for it.
 Thus, the government has to provide the
good and tax everyone to pay for it.
Externalities
 External costs are costs not borne by
the producer but borne by other
members of society.
 Pollution imposes external costs.
 External benefits are benefits
accruing to people other than the
buyer of a good.
 Education confers external benefits.
 Some goods produce both external
benefits and costs (e.g., public
gardens)
Consequences of Externalities
 When there are external costs, such
as pollution, too much of the good is
produced in the private market
 When there are external benefits,
such as from education, too little of
the good is produced in the private
market
 In both cases, government
intervention is warranted to induce
less or more of the good to be
produced.
Possible Government
Actions to Deal With
Externalities
 In the case of external costs, tax the
private producer or directly restrict
production.
 In the case of external benefits,
subsidize the producer or directly
provide the good.
Monopoly
 A monopoly is an industry that
produces a good or service for which
no close substitute exists and in
which there is one supplier that is
protected from competition by a
barrier preventing the entry of new
firms.
Examples of Monopoly
 Examples of monopolies include:
 Local telephone service (Bell South)
 Water service (Metro-Dade)
 Cable television
 The U.S. Postal Service (regular mail)
 Local Electric Power (FPL)
 Microsoft (?)
 Google(?)
 Facebook (?)
 eBay (?)
Examples of “Monopoly”
No Close Substitutes
 If there are close substitutes for a
good or service, that means there is
competition in the market.
 Competition in the market means the
market cannot be a monopoly by
definition.
Innovation, Technological
Change, and Substitutes
 Innovation and technological change
create new products, some of which
are substitutes for existing products.
 Example: FedEx, UPS, fax machines,
and e-mail are substitutes for the
services of the U.S. Postal Service,
weakening their monopoly.
 Example: Satellite TV is a substitute
for Cable TV, weakening its monopoly.
Barriers to Entry
 Barriers to entry are legal or natural
impediments protecting a firm from
competition from potential new
entrants.
 Barriers to entry include:
 Legal barriers
 Ownership barriers
 Natural barriers
 Of course, firms can create illegal
barriers to entry, but this would be a
violation of the Sherman Antitrust Act.
Legal Barriers to Entry
 Legal barriers to entry create legal
monopoly.
 A legal monopoly is a market in
which competition and entry are
restricted by the granting of a public
franchise, license, patent or
copyright, or in which a firm has
legally acquired ownership of a
significant portion of a key resource.
Legal Barriers: Public
Franchises and Licenses
 A public franchise is an exclusive
right granted to a firm to supply a
good or service.
 Example: U.S. Postal Service, Cable TV,
FPL
 A government license controls entry
into particular occupations,
professions and industries.
 Example: licensing of medical doctors
and lawyers.
Legal Barriers: Patents
and Copyrights
 A patent is an exclusive right granted
to the inventor of a product or
service. Patents are good for 20
years.
 A copyright is an exclusive right
granted to the author or composer of
a literary, musical, dramatic, or
artistic work.
Natural Barriers to Entry
 Natural barriers to entry give rise to
natural monopoly.
 Natural monopoly occurs when one
firm can supply the entire market at a
lower price than two or more firms.
 Demand must limit sales to a
quantity at which economies of scale
exist.
Natural Monopoly, Demand
and Average Total Cost
 The demand curve must intersect the
industry ATC curve on a part of the
ATC curve that is sloping downward.
 If two or more firms supply the
market, the per unit cost will be
higher than will be the case if a
single firm supplies the entire
market.
Natural Monopoly
Price (cents per kilowatt-hour)
15
10
D = AR = P
0 1 2 3 4
Quantity (millions of kilowatt-hours)
Natural Monopoly
Price (cents per kilowatt-hour)
15
10
5 ATC
D = AR = P
0 1 2 3 4
Quantity (millions of kilowatt-hours)
Examples of
Natural Monopoly
 Examples of natural monopoly
usually involve economies of scale in
distribution:
 Natural gas distribution systems
 Electric power distribution
 Trash collection
 Cable television
 Microsoft
Monopolies are Regulated
 Most monopolies are regulated in some
way by one or more government agencies.
 In the case of unregulated monopolies, the
government must either break up the
monopoly or make some other change to
promote competition and economic
efficiency.
 First, we study the operation of
unregulated monopoly and how it differs
from the operation of competitive markets.
 Then we discuss pricing strategies for
regulated monopolies.
Monopoly Price-
Setting Strategies
 Price discrimination is the practice of
selling different units of a good or
service for different prices. (ex. pizza,
airlines)
 A single-price monopoly is a firm
that must sell each unit of its output
for the same price. (ex. DeBeers)`
Single-Price Monopoly
 The firm’s demand curve is the
market demand curve.
 Marginal revenue is not the same as
the market price.
Single-Price Monopoly
Bobbie’s Barbershop, in Cairo,

Nebraska is the sole supplier
of haircuts in town.
Let’s examine the market for
haircuts in Cairo.
Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue ( MR  TR / Q )
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut)
a 20 0 0
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18 18
c 16 2 32 14
d 14 3 42
e 12 4 48
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18 18
c 16 2 32 14
d 14 3 42 10
e 12 4 48
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18 18
c 16 2 32 14
d 14 3 42 10
e 12 4 48 6
f 10 5 50
Quantity Marginal
a 20 0 0 -
b 18 1 18 18
c 16 2 32 14
d 14 3 42 10
e 12 4 48 6
f 10 5 50 2
(dollars per haircut)
Price & marginal revenue
Quantity (haircuts per hour)

MR D

20 Total revenue loss $4
c
16 d
14
Price falls from

$16 to $14
Quantity rises from
2 to 3
MR D
2 3
c
16 d
14 Total revenue gain $14
Price falls from

$16 to $14
Quantity rises from
2 to 3
MR D
2 3
c
16 d
14 Total revenue gain $14
10 Marginal revenue $10
Price falls from

$16 to $14
Quantity rises from
MR D 2 to 3
2 3
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue ( MR  TR / Q ) cost ( MC  TC / Q ) Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut)(haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 -
18 1 18 18
16 2 32 14
14 3 42 10
12 4 48 6
10 5 50 2
and Price Decision
Marginal Marginal
20 0 0 - 20
18 1 18 18 21
16 2 32 14 24
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21
16 2 32 14 24
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21 1
16 2 32 14 24
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21 1
16 2 32 14 24 3
14 3 42 10 30
12 4 48 6 40
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21 1
16 2 32 14 24 3
14 3 42 10 30 6
12 4 48 6 40
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21 1
16 2 32 14 24 3
14 3 42 10 30 6
12 4 48 6 40 10
10 5 50 2 55
and Price Decision
Marginal Marginal
20 0 0 - 20 -
18 1 18 18 21 1
16 2 32 14 24 3
14 3 42 10 30 6
12 4 48 6 40 10
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1
16 2 32 14 24 3
14 3 42 10 30 6
12 4 48 6 40 10
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3
14 3 42 10 30 6
12 4 48 6 40 10
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6
12 4 48 6 40 10
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6 +12
12 4 48 6 40 10
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6 +12
12 4 48 6 40 10 +8
10 5 50 2 55 15
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6 +12
12 4 48 6 40 10 +8
10 5 50 2 55 15 -5
and Price Decision
Marginal Marginal
20 0 0 - 20 - -20
18 1 18 18 21 1 -3
16 2 32 14 24 3 +8
14 3 42 10 30 6 +12
12 4 48 6 40 10 +8
10 5 50 2 55 15 -5
A Monopoly’s Output and Price
Total revenue and total cost
(dollars per hour)
50
40
30
20
10
0 1 2 3 4 5
(dollars per hour)
50 TR
40
Note TR curve is not
30 linear like it is in perfect
competition
20
10
0 1 2 3 4 5
(dollars per hour)
50 TR
40
Note slope of TR curve
30 (which is MR)
declines as Q increases
20
10
0 1 2 3 4 5
(dollars per hour) TC
50 TR
40
Note slope of TC
30 curve is MC
20
10
0 1 2 3 4 5
50 TR
40
30 Note MC increases
with Q because of
20 diminishing returns
10
0 1 2 3 4 5
Economic
profit = $12 TR
50
42
30
20
10
0 1 2 3 4 5
Economic
profit = $12 TR
50
42
30
Note that at maximum profits
20 slope of TR = slope of TC (or
MR=MC)
10
0 1 2 3 4 5
Price and cost (dollars per hour)
20
14
10
D = AR = P
0 1 2 3 4 5
20
14
10
D = AR = P
MR
0 1 2 3 4 5
MC
20
14
10
D = AR = P
MR
0 1 2 3 4 5
MC
20
14
ATC
D = AR = P
MR
0 1 2 3 4 5
MC
20
14
ATC
TR = 14x3 = 42 D = AR = P
MR
0 1 2 3 4 5
MC
20
14
ATC
10
D = AR = P
MR
0 1 2 3 4 5
MC
20
14
ATC
10
D = AR = P
TC = 10x3 = 30
MR
0 1 2 3 4 5
MC
20
Profit = $12
($4 x 3 units)
14
Economic ATC
profit = $12
10
D = AR = P
MR
0 1 2 3 4 5
Monopoly Profits
 A positive profit is still not
guaranteed, even for a monopoly.
 Total profit depends on the position of
the ATC curve relative to the demand
curve.
 However, we don’t see many
unprofitable monopolies.
 If you’re the sole supplier of a good and
still can’t make a profit, how long will
you stay in the business?
Rent Seeking
 Because a monopoly creates economic
profit in the long-run, people devote a lot
of effort to obtain monopoly rights.
 This activity is called rent seeking.
 The firm is attempting to capture some of
the consumer surplus for itself.
Comparing Monopoly
and Competition
 How do the quantities produced,
prices, and profits of a monopoly
compare with those of a perfectly
competitive industry?
 Consider a hypothetical example of a
perfectly competitive industry which
suddenly becomes a monopoly.
Comparison of Monopoly
and Perfect Competition
 Compared to a perfectly competitive
market, a single-price monopoly
restricts its output and charges a
higher price.
Price and Output
 A perfectly competitive industry will
produce the quantity of output and
charge the price at the equilibrium
point where the industry MC curve
intersects the demand curve.
 A monopoly will produce the quantity
of output dictated by the intersection
of the MR and MC curves, charging a
price set by the demand curve.
Monopoly and
Competition Compared
Price
PA Single-price
monopoly
restricts output,
raises price (MR=MC)
S,MC
PM
Equilibrium
PC in competitive
industry (P=MC)
MR D=AR=P
0 QM QC Quantity
Inefficiency of Monopoly
Consumer
Price
Surplus under
PA Competition Perfect
Competition
S, MC
PC
D=AR=P
0 QC Quantity
Consumer
Price
Surplus under
PA Competition Perfect
Competition
S, MC
Producer
PC Surplus under
Competition
D=AR=P
0 QC Quantity
Consumer
Price
Surplus under
PA Monopoly Monopoly
S, MC
PM
PC
Producer
Surplus under
Monopoly
MR D=AR=P
0 QM QC Quantity
Consumer
Price
Surplus under
S, MC
PM
Deadweight loss in
Consumer Surplus
PC
Monopoly’s
gain in Producer
Surplus
MR D=AR=P
0 QM QC Quantity
Consumer
Price
Surplus under
S, MC
PM
Deadweight loss in
Consumer Surplus
PC
Monopoly’s Deadweight loss in
gain in Producer Producer Surplus
Surplus
MR D=AR=P
0 QM QC Quantity
Assuming Constant Marginal Cost
Price
Consumer
PA Surplus Under Perfect
Competition Competition
PC S, MC
D=AR=P
0 QC Quantity
Consumer
Price
Surplus under
PM
PC S, MC
MR D=AR=P
0 QM QC Quantity
Consumer
Price
Surplus under
Loss in Consumer
Surplus under
Monopoly
PM
PC S, MC
MR D=AR=P
0 QM QC Quantity
Consumer
Price
Surplus under
PM
PC S, MC
Monopoly’s
gain in
Producer Surplus
MR D=AR=P
0 QM QC Quantity
Consumer
Price
Surplus under
Deadweight loss
Under Monopoly
PM
PC S, MC
Monopoly’s
gain in
Producer Surplus
MR D=AR=P
0 QM QC Quantity
Monopoly Policy Issues
Regulating Natural
Monopoly
When demand and cost
conditions create natural
monopoly, government
agencies regulate the
monopoly.
This figure shows how a
natural monopoly might
be regulated.
With no regulation, the

monopoly maximizes
profit.
It produces the quantity
at which marginal revenue
equals marginal cost.
In this case, profits=$4,
calculated as
(P-ATC)xQ=(20-18)x2=$4
This regulation is the
marginal cost pricing rule,
and it results in an
efficient use of resources.
Regulating a natural
monopoly in the public
interest sets output where 14
MB = MC and thus the
price equal to marginal
cost (D=AR=P=MC).
But with price equal to
marginal cost, ATC
exceeds price and the
monopoly incurs an
economic loss.
In this case, the loss=-
$16, calculated as
(P-ATC)xQ=(10-14)x4=-$16
If the monopoly receives
14
a subsidy to cover its loss,

taxes must be imposed on
other economic activity,
which create deadweight
loss.
Where possible, a regulated
natural monopoly might be
permitted to price discriminate
to cover the loss from marginal
cost pricing.
Another alternative (which is
easy to implement in practice) is
to produce the quantity at which
price equals average total cost
and to set the price equal to
average total cost—the average
cost pricing rule (P=ATC).
With this pricing rule, the
natural monopoly earns only
normal profits (economic profits
are zero). This is because (P-
ATC)xQ=(15-15)x3=0

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CH 13

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CHAPTER 13

Bobbie’s Barbershop, in Cairo,

Quantity (haircuts per hour)

Quantity (haircuts per hour)

Price falls from

Price falls from

10 Marginal revenue $10

Price falls from

With no regulation, the

a subsidy to cover its loss,

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