Econ 311

Monopoly
 Perfect Competition
• Is this always a reasonable assumption?
 Imperfect Competition
• Is this always a reasonable assumption?
– Some examples of producers that do have to
worry if they produce more, they will drive down
the market price:
 Imperfect Competition
• Is this always a reasonable assumption?
– Some examples of producers that do have to
worry if they produce more, they will drive down
the market price:
• Sports leagues
– If they play more games, the ticket price for each game will
probably go down
• Actors
– If they only say yes to the best roles, they’ll be able to charge
more for each role
 Imperfect Competition
• What do you think all the producers that have
to worry about this have in common?
 Imperfect Competition
• What do you think all the producers that have
to worry about this have in common?

– They make something unique or at least “locally

unique”
– Because their goods can’t be easily obtained
elsewhere, just one firm’s production will impact
the price of the good they sell
 Imperfect Competition
• In the extreme case, where a producer makes
something that is completely unique, this is
called monopoly.
 Imperfect Competition
• Can you think of any cases where consumers
aren’t price takers?

– In other words, when could the level of my

demand will have a meaningful impact on the
market price?
 Imperfect Competition
• This is much rarer.

• The only really good example comes from the

market for labor.
 Imperfect Competition
• This is much rarer.

• The only really good example comes from the

market for labor.
– Imagine a small town where there’s only one
employer.
 Imperfect Competition
• This is much rarer.

• The only really good example comes from the

market for labor.
– Imagine a small town where there’s only one big
employer.
– That employer’s demand will in a large part
determine wages in the town.
 Imperfect Competition
• This is much rarer.

• Or imagine that there’s only one firm that

hires people with a specific skill.
– If that firm needs a lot of those types of people,
this will drive up wages for people that get that
skill
 Imperfect Competition
• In the extreme case, where only one
demander exists, we call this Monopsony.

• Only ever used to talk about labor markets (to

my knowledge).
 Monopoly
• We’re going to understand how monopoly
firms (Monopolists) choose how much to
produce (and thus set the market price).
 Monopoly
• We’re going to understand how monopoly
firms (Monopolists) choose how much to
produce (and thus set the market price).

– In fact, the key insight behind monopoly relative

to perfect competition is that for a monopolist:
choosing a quantity to produce and choosing a
market price is the same thing
 Monopoly
• It turns out that this is actually easiest to
understand (in my opinion) mathematically.

• Conveniently, if the only thing you remember

about monopoly is the following
mathematical fact, you’re fully prepared to
deal with them.
 Monopoly
• Monopolist profit function:

• It starts out the same: revenue minus cost

 Monopoly
• But, we have to recognize now, that the
monopolist is not a price-taker. They are a
price-setter.
 Monopoly
• But, we have to recognize now, that the
monopolist is not a price-taker. They are a
price-setter.

• Whatever Q the monopolist chooses will, in

conjunction with the demand curve,
immediately determine the market price.
 Monopoly
• Whatever Q the monopolist chooses will, in
conjunction with the demand curve,
immediately determine the market price.

– Eg:

– If the monopolist produces Q = 60, the price must

be 40 to sell all of it
 Monopoly
• Whatever Q the monopolist chooses will, in
conjunction with the demand curve,
immediately determine the market price.

– Eg:

– If the monopolist produces Q = 30, the price must

be 70 to sell all of it
 Monopoly
• So instead of just having a “p” in the profit
function that they can’t change, what goes
into the monopolists profit function instead of
p?
 Monopoly
• So instead of just having a “p” in the profit
function that they can’t change, what goes
into the monopolists profit function instead of
p?

• The demand curve

 Monopoly
• So instead of just having a “p” in the profit
function that they can’t change, what goes
into the monopolists profit function instead of
p?

• The demand curve

– The monopolist chooses Q to maximize profit,
knowing that their choice of Q will determine p
 Monopoly
• Mathematically, generally:
 Monopoly
• Mathematically:
 Monopoly
• Solve in the same way:
 Monopoly
• Compare this to Q and p under perfect
competition:

– Basically, compare it to the same firm, but

ignoring the fact that they’re a price-setter instead
of a price taker.
 Monopoly
• Compare this to Q and p under perfect
competition:
 Monopoly
• Compare this to Q and p under perfect
competition:

– Monopolists produce less and charge more than a

market of perfectly competitive firms would.
 Monopoly
• Important note:

– Monopolists set MR(Q) = MC(Q) to maximize

profits, just like firms in perfectly competitive
markets.
 Monopoly
• Important note:

– Monopolists set MR(Q) = MC(Q) to maximize

profits, just like firms in perfectly competitive
markets.

• In perfectly competitive markets, MR(Q) = p because

one firm’s production has no effect on the marginal
return (price taking)
 Monopoly
• Important note:

– Monopolists set MR(Q) = MC(Q) to maximize

profits, just like firms in perfectly competitive
markets.

• A monopolist’s MR(Q) does not equal the price since

their production does affect the marginal return (price
setter)
 Monopoly
• What is a monopolist’s marginal revenue?

– Let’s assume a linear demand curve:

 Monopoly
• What is a monopolist’s marginal revenue?
 Monopoly
• What is a monopolist’s marginal revenue?
 Monopoly
• A monopolist’s MR(Q) curve is just like the
demand curve, except it’s twice as steep:
Monopoly
Monopoly
 Monopoly
• Remembering that the monopolist sets MR =
MC to maximize profits, let’s add MC to this
graph:
Monopoly
 Monopoly
• Here’s the tricky part of this graph:

– When the monopolist sets MR(Q) = MC(Q), does

that intersection determine the quantity they set
or the price that they set?
 Monopoly
• Here’s the tricky part of this graph:

– When the monopolist sets MR(Q) = MC(Q), does

that intersection determine the quantity they set
or the price that they set?

– QUANTITY: both MR and MC are functions of Q

Monopoly
 Monopoly
• So the point on the Q axis where MR = MC is
the quantity that the monopolist produces.

– What determines the price at this point?

 Monopoly
• So the point on the Q axis where MR = MC is
the quantity that the monopolist produces.

– What determines the price at this point?

• The demand curve.
• Remember: the monopolist chose it’s quantity
specifically by knowing that their quantity choice
determines market price through the demand curve
Monopoly
Monopoly
 Monopoly
• Summary of graph so far:

– You can use a demand curve to calculate a MR

curve.
– The monopolist produces the quantity at which
MR = MC
– The price is where that quantity level hits the
demand curve
 Monopoly
• How does this compare to perfect
competition?

– We already showed that monopolists produce less

and charge more.
 Monopoly
• How does this compare to perfect
competition?

– We already showed that monopolists produce less

and charge more.

– Where on the graph is the quantity and price in

perfect competition?
 Monopoly
• How does this compare to perfect
competition?

– Where on the graph is the quantity and price in

perfect competition?
• Remember that the MC curve is equal to the supply
curve in perfect competition
 Monopoly
• How does this compare to perfect
competition?

– Where on the graph is the quantity and price in

perfect competition?
• Remember that the MC curve is equal to the supply
curve in perfect competition
• So the perfect competition price and quantity is where
demand equals supply
Monopoly
 Monopoly
• Why do monopolists restrict supply?

– It makes them higher profits

• You can show this easily by plugging the monopoly
price and quantity into the profit function and
comparing that to what happens when you plug in
perfect competition price and quantity
 Monopoly
• What about “everyone makes zero profit in
the long run”? Why aren’t monopolies just
eliminated by competition in the long run?
 Monopoly
• What about “everyone makes zero profit in
the long run”? Why aren’t monopolies just
eliminated by competition in the long run?

– Two explanations:
 Monopoly
• What about “everyone makes zero profit in
the long run”? Why aren’t monopolies just
eliminated by competition in the long run?

– Two explanations:
• Monopolies can only exist when there are barriers to
entry that other firms can’t overcome.
• These tend to be either physical (like infrastructure) or
legal (no one allowed to join)
 Monopoly
• What about “everyone makes zero profit in
the long run”? Why aren’t monopolies just
eliminated by competition in the long run?

– Two explanations:
• Even when there are multiple firms in the market, they
“collude” with one another and act as if they are a
monopoly
• This is called a Cartel
 Monopoly
• Either way, we have plenty of monopolies that
exist.

• When modeling a market, it is crucial to

consider whether firms are price takers or
price setters.
 Monopoly
• Example:
– Find the supply curve and market equilibrium
price and quantity assuming this firm is a price
taker
– Find the monopoly price and quantity
– Show that profits are higher for the monopoly
– Graph the demand curve, the marginal revenue
curve, the marginal cost curve, and the average
cost curve
– Add price, quantity and profits from both models
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