Chapter 10

Pure Monopoly

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Objectives
• Characteristics of pure
monopoly
• Profit-maximizing output and
price
• Economic effects of monopoly
• Charging different prices in
different markets
10-2
 Characteristics of Monopoly

• Single seller
• No close substitutes
• “Price maker”
• Blocked entry
• Nonprice competition

10-3
 Examples of Monopoly
• Regulated or natural monopolies
– electricity
• Near monopolies
– Western Union
– Frisbee
– De Beers
• Geographic monopolies
– Professional sport teams
• Dual objectives of study
10-4
 Barriers to Entry
• Economies of scale
• Legal barriers to entry
– Patents
– Licenses
• Ownership or control of
essential resources
• Pricing and other strategic
barriers to entry
10-5
 Monopoly Demand

• Assumptions:
– Monopoly status is secure
– No government regulation
– Single-price monopolist
• Face down-sloping demand
– Entire market demand

10-6
 Price and Marginal Revenue
Marginal revenue is less than price
• A monopolist is
selling 3 units at
$142
$142
• To sell 4, price must
be lowered to $132 132
• All customers 122
must pay the same 112 Loss = $30 D
price 102
• TR increases $132 Gain = $132
minus $30 (3x$10) 92
82

0 1 2 3 4 5 6

10-7
 Price and Marginal Revenue
Marginal revenue is less than price
• A monopolist is
selling 3 units at
$142
$142
• To sell 4, price must
be lowered to $132 132
• All customers 122
must pay the same 112 Loss = $30 D
price 102
• TR increases $132 Gain = $132
minus $30 (3x$10) 92
• $102 becomes a 82
point on the MR
curve MR
• Try other prices to
determine other 0 1 2 3 4 5 6
MR points
The Constructed Marginal Revenue Curve
Must Always Be Less Than the Price
10-8
 Down-Sloping Demand
• Marginal revenue < price
– To increase sales, must lower price
• Firm is a price maker
– Choose P,Q combination
• Operate in the elastic region
– Marginal revenue > 0
– Total-revenue test (recall)
10-9
 Profit Maximization
• Output-price determination
– Marginal revenue marginal cost
rule
– Same cost definitions
• No supply curve

10-10
Monopoly Revenue and Costs

Revenue Data Cost Data

(2) (3)
(1) Price Total (4) (5) (6) (7) (8)
Quantity (Average Revenue Marginal Average Total Cost Marginal Profit (+)
Of Output Revenue) (1) X (2) Revenue Total Cost (1) X (5) Cost or Loss (-)

0 $172 $0 ] $100 ] $90 $-100

$162
1 162 162 ] $190.00 190 ] 80 -28
142
2 152 304 ] 135.00 270 ] 70 +34
122
3 142 426 ] 113.33 340 ] 60 +86
102
4 132 528 ] 100.00 400 ] 70 +128
82
5 122 610 ] 94.00 470 ] 80 +140
62
6 112 672 ] 91.67 550 ] 90 +122
42
7 102 714 ] 91.43 640 ] 110 +74
22
8 92 736 ] 93.75 750 ] 130 -14
2
9 82 738 ] 97.78 880 ] 150 -142
-18
10 72 720 103.00 1030 -310

Can you See Profit Maximization?

10-11
Monopoly Revenue and Costs
Demand and Marginal-Revenue Curves
$200
Elastic Inelastic

150
Price
100

50
D
MR
0 2 4 6 8 10 12 14 16 18
Total-Revenue Curve
$750
Total Revenue

500

250
TR

0 2 4 6 8 10 12 14 16 18
10-12
 Profit Maximization
$200

Price, Costs, and Revenue 175

MC
150
Pm=$122
125
Economic
Profit ATC
100

75
A=$94 D
50
MR=MC

25
MR

0 1 2 3 4 5 6 7 8 9 10
Quantity
10-13
 Misconceptions

• Not the highest price

• Total, not unit, profit
• Possibility of losses

10-14
 Loss Minimization

Price, Costs, and Revenue

MC

ATC
A Loss
Pm
AVC

V
D

MR=MC

MR

0 Qm
Quantity
10-15
 Economic Effects

Purely Pure
Competitive Monopoly
Market

S=MC MC
Pm b
P=MC=
Pc Minimum Pc c
ATC
a

D D
MR
Qc Qm Qc

Pure competition is efficient

Monopoly is inefficient
10-16
 Economic Effects

• Pure competition is efficient

– Productive efficiency
– Allocative efficiency
– CS+PS maximized
• Monopoly is inefficient
– Charge P>MC
– Deadweight loss
• Income transfer
10-17
 Cost Complications
• Economies of scale
– Simultaneous consumption
– Network effects
• X-inefficiency
– Lowest ATC not achieved
• Rent seeking behavior
• Technological advance
– More likely with monopoly?
10-18
 Policy Options

• Use antitrust laws

– Divide the firm
• Natural monopoly
– Regulate price
• Ignore
– Unstable in long run

10-19
 Price Discrimination
• Three forms
– Charge each customer max
willingness to pay
– Charge one price for first unit
and a lower price for subsequent
units
– Charge different customers
different prices

10-20
 Price Discrimination

• Conditions
– Monopoly power
– Market segregation
– No resale
• Examples
– Airfares
– Electric utilities
– Theaters & golf courses

10-21
 Regulated Monopoly

• Natural monopolies
• Rate regulation
• Socially optimum price
P = MC
• Fair return price
P = ATC
10-22
 Regulated Monopoly
Dilemma of Regulation
Monopoly
Price
Price and Costs (Dollars)

Pm
Fair-Return
Price
Socially
f Optimal
Pf a Price
ATC

Pr
r MC

MR D
b
0 Qm Qf Qr
Quantity

10-23
 De Beers Diamonds
• 66 years of monopoly pricing
– Independent producers went along
• Mid-2000 abandoned monopoly
– New discoveries
– Independent producers withdrew
– Political considerations
• New strategy
– “The diamond supplier of choice”

10-24
 Key Terms
• pure monopoly
• barriers to entry
• simultaneous consumption
• network effects
• X-inefficiency
• rent-seeking behavior
• price discrimination
• socially optimal price
• fair-return price
10-25
Next Chapter Preview…

Monopolistic
Competition
and Oligopoly

10-26