Monopoly

Monopoly

While a competitive firm is a

price taker, a monopoly firm is
a price maker.
 Monopoly

 A firm is considered a monopoly if . . .

it is the sole seller of its product.
its product does not have close
substitutes.
 Features of Monopoly

 Single seller in the market

 No close substitutes
 No competition
 Price maker
 Entry barriers
 No difference between firm and industry
 Can fix both price and quantity by himself
 Why Monopolies Arise

The fundamental cause of

monopoly is barriers to entry.
 Why Monopolies Arise
Barriers to entry have three sources:
 Ownership of a key resource.
 The government gives a single firm the
exclusive right to produce some good.
 Costs of production make a single producer
more efficient than a large number of
producers.
 Monopoly Resources

Although exclusive ownership of a key

resource is a potential source of
monopoly, in practice monopolies
rarely arise for this reason.
 Government-Created Monopolies

Governments may restrict entry by giving a

single firm the exclusive right to sell a
particular good in certain markets.
Government-Created Monopolies

Patent and copyright laws are two

important examples of how
government creates a monopoly to
serve the public interest.
 Natural Monopolies

An industry is a natural monopoly when a

single firm can supply a good or service to
an entire market at a smaller cost than
could two or more firms.
 Natural Monopolies

A natural monopoly arises when there

are economies of scale over the relevant
range of output.
 Economies of Scale as a Cause of
Monopoly...
Cost

Average
total
cost

0 Quantity of Output
 Monopoly versus Competition

Monopoly
 Is the sole producer
 Has a downward-sloping demand curve
 Is a price maker
 Reduces price to increase sales
 Competition versus Monopoly

Competitive Firm
 Is one of many producers
 Has a horizontal demand curve
 Is a price taker
 Sells as much or as little at same price
 Demand Curves for Competitive and
Monopoly Firms...

(a) A Competitive Firm’s (b) A Monopolist’s

Demand Curve Demand Curve
Price Price

Demand

Demand

0 Quantity of 0 Quantity of
Output Output
 A Monopoly’s Revenue

 Total Revenue
P x Q = TR
 Average Revenue
TR/Q = AR = P
 Marginal Revenue
TR/Q = MR
 A Monopoly’s Marginal Revenue

A monopolist’s marginal revenue is

always less than the price of its good.
 The demand curve is downward sloping.
 When a monopoly drops the price to sell one
more unit, the revenue received from
previously sold units also decreases.
 A Monopoly’s Total, Average, and
Marginal Revenue

Average
Quantity Price Total Revenue Revenue Marginal Revenue
(Q) (P) (TR=PxQ) (AR=TR/Q) (MR=TR / Q )
0 $11.00 $0.00
1 $10.00 $10.00 $10.00 $10.00
2 $9.00 $18.00 $9.00 $8.00
3 $8.00 $24.00 $8.00 $6.00
4 $7.00 $28.00 $7.00 $4.00
5 $6.00 $30.00 $6.00 $2.00
6 $5.00 $30.00 $5.00 $0.00
7 $4.00 $28.00 $4.00 -$2.00
8 $3.00 $24.00 $3.00 -$4.00
Demand and Marginal Revenue Curves
for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
Profit Maximization of a Monopoly

 A monopoly maximizes profit by

producing the quantity at which
marginal revenue equals marginal cost.
 It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
 Profit-Maximization for a Monopoly...
2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
John D. Rockefeller
The story of D. Rockefeller epitomizes the 19th
century monopolist. He saw visions of riches in
the fledging oil industry and began to organise oil
refineries.

He persuaded the railroads to give him the supply

information of his competitors. He bought
competitors and consolidated his hold on the oil
industry. By 1878, he controlled over 95% of the
pipelines and oil refineries in the US. Prices were
raised and stabilized, ruinous competition was
ended, and monopoly was achieved.
 The Sherman Anti-Trust Act – 1890

 Division of Standard Oil

 Standard Oil of New Jersey (EXXON)
 Standard Oil Company of New York (MOBIL)
 Standard Oil of California (SOCAL)
 GULF Oil Company
 Texas Company (TEXACO)
 Comparing Monopoly and
Competition

 For a competitive firm, price equals

marginal cost.
P = MR = MC
 For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
 A Monopoly’s Profit

Profit equals total revenue minus total costs.

Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
 The Monopolist’s Profit...
Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro

Average total cost

on f
op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 The Monopolist’s Profit

The monopolist will receive

economic profits as long as price is
greater than average total cost.
 The Market for Drugs...
Costs and
Revenue

Price
during
patent life

Price after Marginal

patent cost
expires Marginal
revenue Demand

0 Monopoly Competitive Quantity

quantity quantity
 The Welfare Cost of Monopoly

 In
contrast to a competitive firm, the
monopoly charges a price above the
marginal cost.
 From the standpoint of consumers, this high
price makes monopoly undesirable.
 However, from the standpoint of the owners

of the firm, the high price makes monopoly

very desirable.
The Efficient Level of Output...
Price
Marginal cost

Value Cost to
to monopolist
buyers

Value
Cost to to Demand
monopolist buyers (value to buyers)
0 Efficient Quantity
quantity

Value to buyers is greater Value to buyers is less

than cost to seller. than cost to seller.
 The Deadweight Loss

Because a monopoly sets its price above

marginal cost, it places a wedge between
the consumer’s willingness to pay and the
producer’s cost.
This wedge causes the quantity sold to
fall short of the social optimum.
 The Inefficiency of Monopoly...
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
The Inefficiency of Monopoly

The monopolist produces less

than the socially efficient
quantity of output.
US Rail-Road Entrepreneurs
 The railroaders of the American west
frontier were among the most
unscrupulous entrepreneurs on record.
The transcontinental railroads were
funded with vast federal land grants,
aided by bribes and stock gifts to
numerous members of Congress and the
cabinet.

Shortly after the civil war, the railroad

entrepreneur Mr. Jay Gould attempted to
corner the entire gold supply of the US,
and with it the nation’s money supply.
Gould later promoted his railroad by
describing the route of his northern line-
snowbound much of the year – as a
tropical paradise, filled with orange
groves, banana plantations and wild life.
By the end of the century, all the bribes,
Jay Gould land grants, and fantastic promises had
led to the greatest rail system in the
(A pioneer American rail- road world.
owner)
Public Policy Toward Monopolies

Government responds to the problem of

monopoly in one of four ways.
 Making monopolized industries more
competitive.
 Regulating the behavior of monopolies.
 Turning some private monopolies into public
enterprises.
 Doing nothing at all.
 Increasing Competition with
Antitrust Laws
 Antitrust laws are a collection of statutes aimed at
curbing monopoly power.
 Antitrust laws give government various ways to
promote competition.
 They allow government to prevent mergers.
 They allow government to break up companies.
 They prevent companies from performing activities
which make markets less competitive.
 Regulation

Government may regulate the prices

that the monopoly charges.
 The allocation of resources will be
efficient if price is set to equal
marginal cost.
 Marginal-Cost Pricing for a Natural
Monopoly...
Price

Average
total cost Average total cost
Loss
Regulated
price Marginal cost

Demand

0 Quantity
 Regulation

In practice, regulators will allow

monopolists to keep some of the benefits
from lower costs in the form of higher
profit, a practice that requires some
departure from marginal-cost pricing.
 Public Ownership

Rather than regulating a natural

monopoly that is run by a private firm,
the government can run the monopoly
itself. (e.g. Post and Telegraph,
Railways,…).
 Doing Nothing

Government can do nothing at all

if the market failure is deemed
small compared to the
imperfections of public policies.
 Case Study – De Beers
According to the New York Times, the Central Selling Organisation, controlled by De
Beers Consolidated Mines Ltd, is ‘probably the world’s most successful
monopoly’. De Beers founded in 1880 by Cecil Rhodes in South Africa, controlled
over 99 % of world’s diamond production until 1900. At present, the firm mines
only about 15% of the world’s diamonds, but it still controls the sales of over 80% of
the gem quality diamonds through its central selling organisation which markets the
output of other major producing countries like Zaire, Soviet Union, Botswana,
Namibia and Australia, as well as its own production. In the first half of 1989, its
sales stood over $2 billion.

No one doubts that De Beers controls the price of diamonds. Buyers are offered small
boxes of assorted diamonds at a price set by De Beers on ‘Take it all or leave it’
basis. If the demand for diamond falls, as it did in early 1980’s, De Beers stands
ready to buy diamonds to support the price. Between 1979 to 1984, its stock of
diamonds increased about $360 million to about $2billion. In the first half of 1992,
its earnings fell by about 25% because global recession had reduced the demand for
diamonds.

Besides limiting the quantity supplied, De Beers also works hard and cleverly to push
the demand curve for diamonds to the right. An important part of its sales campaign
has been to link diamonds and romance (according to its 50 year old slogan ‘A
diamond is forever’), of course, this has also been helpful in keeping diamonds once
sold, off the market. De Beers policies have been paid off very substantial profits,
but the consumer has paid higher prices than if the diamond market were
competitive.
 Price Discrimination

Price discrimination is the practice of

selling the same good at different
prices to different customers, even
though the costs for producing for the
two customers are the same.
 Price Discrimination

Price discrimination is not possible

when a good is sold in a competitive
market since there are many firms all
selling at the market price. In order to
price discriminate, the firm must have
some market power.
Perfect Price Discrimination

Perfect price discrimination

refers to the situation when the
monopolist knows exactly the
willingness to pay of each
customer and can charge each
customer a different price.
 Price Discrimination

 Two important effects of price

discrimination:
 It can increase the monopolist’s profits.
 It can reduce deadweight loss.
Examples of Price Discrimination
 Personal Discrimination
 Doctor’s/Lawyer’s Fee
 PDS – BPL Card holders
 Local Discrimination
 Dumping
 Duty Free Shopping @ airports and military canteens
 Based on usage
 Electricity supply to agriculture
 Water supply to residence and to commercial
establishments
 Product Discrimination
 Surf Excel – Surf Excelmatic
 Colgate White – Colgate Gel
 Age Discrimination
 Transportation Sector (Children / Senior Citizens)
 Size Discrimination
 500 ml Shampoo and 2 ml shampoo
Case Study - Suzanne MTC
Located in a posh area of South Delhi, Suzanne MTC, is one and only one of its kind
throughout Delhi. Viewers in the complex can view five movies at a time showing in
various theaters within the complex. The management has a clear-cut decision of
showing only the latest movies (both Hindi and English). The complex is made further
attractive by the provision of snacks and magazines which a movie-goer can buy while
waiting for the show to start. Tickets are, however steely priced.

On studying demand pattern, the management found that most movie lovers come to the
theatre on Fridays, Saturdays and Sundays. On further analysis it was found that the
late evening show on Fridays and morning, noon and evening shows on Sundays drew
the largest number of people. The following rates for tickets were fixed (for all the
movie halls) based on the following data.

Rs. 105 per ticket from Monday to Thursday

Rs. 125 per ticket for Friday and Saturday
Rs. 140 per ticket on Sunday’s

Questions:
1. Do you think the management has been rational by deciding to charge different
prices on different days?
2. What other steps can the management take in the given situation, to further
improve its profit figures?
 The Prevalence of Monopoly

 How prevalent are the problems of

monopolies?
 Monopolies are common.
 Most firms have some control over their
prices because of differentiated products.
 Firms with substantial monopoly power are
rare.
 Few goods are truly unique.
 Summary

 A monopoly is a firm that is the sole

seller in its market.
 It faces a downward-sloping demand
curve for its product.
 A monopoly’s marginal revenue is
always below the price of its good.
 Summary

 Like a competitive firm, a monopoly

maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.
 Unlike a competitive firm, its price
exceeds its marginal revenue, so its
price exceeds marginal cost.
 Summary

 A monopolist’s profit-maximizing level

of output is below the level that
maximizes the sum of consumer and
producer surplus.
 A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.
 Summary

 Policymakers can respond to the

inefficiencies of monopoly behavior with
antitrust laws, regulation of prices, or by
turning the monopoly into a
government-run enterprise.
 If the market failure is deemed small,
policymakers may decide to do nothing
at all.
 Summary

 Monopolists can raise their profits by

charging different prices to different
buyers based on their willingness to
pay.
 Price discrimination can raise
economic welfare and lessen
deadweight losses.
Graphical
Review
 Economies of Scale as a Cause of
Monopoly...
Cost

Average
total
cost

0 Quantity of Output
 Demand Curves for Competitive and
Monopoly Firms...
(a) A Competitive Firm’s (b) A Monopolist’s
Demand Curve Demand Curve
Price Price

Demand

Demand

0 Quantity of 0 Quantity of
Output Output
Demand and Marginal Revenue Curves
for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average revenue)
1 revenue
0
-1 1 2 3 4 5 6 7 8 Quantity of Water
-2
-3
-4
 Profit-Maximization for a Monopoly...
2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B the profit-maximizing
Monopoly quantity...
price

Average total cost

A

Demand
Marginal
cost

Marginal revenue
0 QMAX Quantity
 The Monopolist’s Profit...
Costs and
Revenue
Marginal cost

Monopoly E B
price
M pro

Average total cost

on f
op it
ol
y

Average
total cost D C
Demand

Marginal revenue
0 QMAX Quantity
 The Market for Drugs...
Costs and
Revenue

Price
during
patent life

Price after Marginal

patent cost
expires Marginal
revenue Demand

0 Monopoly Competitive Quantity

quantity quantity
The Efficient Level of Output...
Price
Marginal cost

Value Cost to
to monopolist
buyers

Value
Cost to to Demand
monopolist buyers (value to buyers)
0 Efficient Quantity
quantity

Value to buyers is greater Value to buyers is less

than cost to seller. than cost to seller.
 The Inefficiency of Monopoly...
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
 Marginal-Cost Pricing for a Natural
Monopoly...
Price

Average
total cost Average total cost
Loss
Regulated
price Marginal cost

Demand

0 Quantity