Ragan: Economics

Fifteenth Canadian Edition

Chapter 10
Monopoly, Cartels, and Price
Discrimination

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 Course Schedule
Unit Chapter / Topic
1 Chapter 1: Economic Issues and Concepts
Chapter 2: Economic Theories, Data and Graph
2 Chapter 3: Demand, Supply, and Price
3 Chapter 4: Elasticity
Chapter 5: Markets in Action
4 Chapter 6: Consumer Behavior
5 Chapter 7: Productions in the Short Run
Chapter 8: Productions in the Long Run
6 Chapter 9: Competitive Markets
Mid Exam (1:30 hours)
7 Chapter 10: Monopoly, Cartels, and Price Discrimination
Chapter 11: Imperfect Competition and Strategic Behavior
8 Chapter 12: Economic Efficiency and Public Policy
9 Chapter 13: How Factor Markets Work
10 Chapter 16: Market Failures and Government Intervention
11 Final Exam (2:30 hours)

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Chapter Outline/Learning Objectives
Section Learning Objectives
Blank After studying this chapter, you will be able to
10.1 A Single-Price Monopolist 1. explain why marginal revenue is less than
price for a profit-maximizing monopolist.
2. understand how entry barriers can allow
monopolists to maintain positive profits in the
long run.
10.2 Cartels and Monopoly 3. describe why firms would form a cartel to
Power restrict industry output and how this would
increase their profits.
10.3 Price Discrimination 4. explain how some firms can increase their
profits through price discrimination.

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10.1 A Single-Price Monopolist
Revenue Concepts for a Monopolist
Demand Curve: Unlike a perfectly competitive firm, a
monopolist faces a negatively sloped demand curve.
So a monopolist faces a tradeoff between the price it
charges and the quantity it sells.
Total Revenue: If the monopolist charges the same price for
all units sold, total revenue (TR) is:
TR = p × Q

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Revenue Concepts for a Monopolist (1 of 3)
Average revenue (AR) is total revenue divided by quantity:
AR = TR/Q
AR = (p × Q)/Q
AR = p
Since the demand curve shows the price of the product, it
follows that the demand curve is also the monopolist’s
average revenue curve.

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Revenue Concepts for a Monopolist (2 of 3)
Marginal revenue (MR) is the revenue resulting from the
sale of one more unit of the product:
MR = TR/Q
Because of the downward sloping demand curve, the
monopolist must reduce the price that it charges on all units
to sell an extra unit.
So the price received for the extra unit sold is not the firm’s
marginal revenue because by reducing the price on all
previous units, the firm loses some revenue.

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Revenue Concepts for a Monopolist (3 of 3)
Marginal revenue is equal to the price minus this lost
revenue.
So the marginal revenue resulting from the sale of an extra
unit is less than the price that the monopolist receives for
that unit.
The monopolist’s MR curve lies below its demand curve.

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Figure 10-1 A Monopolist’s Average and
Marginal Revenue
Average and Marginal Revenue Curves
Computing Average and Marginal Revenue
Price Quantity Total Change Marginal
(Average Sold Q Revenue in Total Revenue
Revenue) (2) (p × Q) Revenue (ΔTR/ΔQ)
(1) (3) (ΔTR) (4) (5)
10 0 0 90 9
9 10 90 70 7
8 20 160 50 5
7 30 210 30 3
6 40 240 10 1
5 50 250 –10 –1
4 60 240 –30 –3
3 70 210 –50 –5
2 80 160 –70 –7
1 90 90 –90 –9
0 100 0 Blank Blank

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Short-Run Profit Maximization (1 of 4)
Figure 10-2 Short-Run Profit Maximization for a Monopolist

The profit-maximizing output

is Q* where MC = MR.
The price is determined by
the demand curve.
Because price exceeds
average total cost, this
monopolist is making an
economic profit, shown by
the red rectangle.

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Short-Run Profit Maximization (2 of 4)
• A monopolist does not have a supply curve because it is
not a price taker.
• A monopolist chooses its profit-maximizing price-quantity
combination from among the possible combinations on the
market demand curve.
• Can we compare the monopoly outcome to the competitive
outcome?

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 Short-Run Profit Maximization (3 of 4)
Competition and Monopoly Compared
Out put
• The level of output in a monopolized industry is less than
the level of output that would be produced if the industry
were perfectly competitive.
Price
• For a perfectly competitive market, price equals marginal
cost.
• For a monopoly, price is greater than marginal cost.

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 Short-Run Profit Maximization (4 of 4)
Competition and Monopoly Compared
Economic Surplus
• More economic surplus in perfect completion as compared
to monopoly
Deadweight loss
• More Deadweight loss in monopoly as compared to perfect
completion.
• A monopoly leads to market inefficiency.

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 The Inefficiency of Monopoly
Competition and Monopoly Compared

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 Entry Barriers
• For monopoly profits to persist, the entry of new firms must
be prevented.
• Entry Barrier are two types: Natural or Created
• A natural monopoly is an industry characterized by
economies of scale sufficiently large that only one firm can
cover its costs while producing at its minimum efficient scale.
• Many entry barriers are created by conscious government
actions. Examples are patent law, or the granting of a charter
or franchise that prohibits competition by law.

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The Very Long Run and Creative Destruction
(1 of 2)
• In the very long run, technological changes and innovations
can avoid effective entry barriers.
• Joseph Schumpeter (1883–1950) defended monopoly on the
basis that the pursuit of monopoly profits provides incentives
to innovate.
• Schumpeter called the replacement of one monopolist by
another through innovation the process of creative
destruction.

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10.2 Cartels and Monopoly Power

A cartel is an organization The Effect of Cartelizing a

of producers who agree to Competitive Industry
act as a single seller to
maximize joint profits.
The profit-maximizing
cartelization of a
competitive industry
reduces output and raises
price from the perfectly
competitive level.

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Problems That Cartels Face (1 of 2)
Cartels tend to be unstable because members have an
incentive to cheat.

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Problems That Cartels Face (2 of 2)
• Any one firm within the cartel has an incentive to cheat.
• But if all firms cheat, the price falls back toward the
competitive level, and joint profits will not be maximized.
• A successful cartel must also be able to prevent the entry
of new producers.
• Successful cartels are often able to license the firms in the
industry and to control entry by restricting the number of
licenses.

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10.3 Price Discrimination
Price discrimination is the sale by one firm of different units
of a product at two or more different prices for reasons not
associated with differences in cost.
If price differences reflect cost differences, they are not
discriminatory.
When price differences are based on different buyers’
valuations of the same product, they are discriminatory.

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When Is Price Discrimination Possible?
1. Market Power: Any firm that is a price taker cannot
discriminate. Price discrimination applies only to firms with
some amount of market power.
2. Different Valuations of the Product: Price discrimination
is possible if the firm is able to determine the willingness to
pay of its various consumers.
3. Prevent Arbitrage: Arbitrage occurs when buyers
purchase the product at a lower price and re-sell it at a
higher price, making a profit on the transaction. A price-
discriminating firm must be able to prevent people from
conducting these transactions.

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Different Forms of Price Discrimination
Price Discrimination Among
Units of Output
A firm captures consumer
surplus by charging different
prices for different units sold.

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Different Forms of Price Discrimination
Price Discrimination Among Market Segments
It is usually easier for firms to distinguish between different
groups of consumers of a product—different market
segments—than it is to detect an individual consumer’s
willingness to pay for different units of that product.
So price discrimination among market segments is more
common than price discrimination among units.

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Price Discrimination Among Market Segments

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Different Forms of Price Discrimination (2 of 2)

Hurdle Pricing
Hurdle pricing exists when firms create an obstacle that
consumers must overcome to get a lower price.
Consumers then assign themselves to the various market
segments—those who don’t want to jump the hurdle and are
willing to pay the high price, and those who choose to jump
the hurdle to benefit from the low price.
A familiar example is coupons for discounts at grocery
stores.

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The Consequences of Price Discrimination
• Higher Profit: For any given level of output, the most
profitable system of discriminatory prices will always
provide higher profits to the firm than the profit-maximizing
single price.
• More Output: A monopolist that price discriminates among
units will produce more output than will a single-price
monopolist.
• More Efficient: If price discrimination leads the firm to
increase total output, the total economic surplus generated
in the market will increase, and the outcome will be more
efficient.

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 Unit 7 Activity

To what extent do you agree with the common

allegation that when all firms in an industry are
charging the same price, it indicates the absence of
competition and the presence of some form of
price-setting agreement? Based on your answer,
which types of industries tend to represent this
scenario and what key characteristics permit them
to charge the same price?

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