Chapter 10 M&B

Chapter 6 Lipsey

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
INTRODUCTION TO MONOPOLY
 Characteristics of Monopoly

• Single seller – single firm

producing the product
 Characteristics of Monopoly

• No close substitutes (produce

unique products)
 Characteristics of Monopoly

• “Price maker”
– One firm so have full control over
the P
– Downward sloping demand curve
– Use this to their advantage
 Characteristics of Monopoly

• Blocked entry
– No immediate competitor
– Barriers in terms of economic,
technological or legal
 Characteristics of Monopoly

• Nonprice competition
– Standardized (natural gas,
electricity )- public relation
advertising
– Differentiated – (windows or
Frisbee) – Advertise attributes
 Examples of Monopoly
• Regulated or natural monopolies
– electricity
• Near monopolies
– Western Union
– Intel
• Geographic monopolies
– Professional sport teams
 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
 Entry Barriers
• Barriers determined by technology
– Natural monopoly – given the industry’s current
technology, the demand conditions allow no more
than one firm to cover its costs while producing at
the minimum point of its LRAC.
• Policy created barriers
– Many entry barriers are created by conscious
government actions and are, therefore, officially
condoned

Significance of entry barriers:

 Profits attract entry, and entry erodes profits
 They frustrate the adjustment mechanism that
would otherwise push profits towards zero in the
long run
• Natural Monopoly:
– A monopoly firm is referred to as a natural
monopoly if the market demand cuts the ATC
at any point where ATC is diminishing
– If they set the price, it will be lower than the
competitive price
– Government regulate the price
– Example: electricity, water supply
 Monopoly Demand

• Assumptions:
– Monopoly status is secure
– No government regulation
– Single-price monopolist
• Face down-sloping demand
– Entire market demand
– MR < P
The figure shows
the effect on
revenue of an
increase in
quantity sold:
Because the
demand curve has
a negative slope,
marginal revenue
is less than price
 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
 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
 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)
Total, Average, &
Marginal Revenue
Curves AND Elasticity of
Demand

Price Quantity Total Marginal

p=AR q Revenue Revenue
TR=p*q MR= TR/ q
£9.1 9 £81.9
£9 10 £90.0 £8.1
£8.1 11 £97.9 £7.9

When TR is rising, MR is
positive & demand is
elastic. When TR is
falling, MR is negative &
demand is inelastic
A Single-Price Monopolist
 Profit Maximization
• Output-price determination
– Marginal revenue marginal cost
rule
– Same cost definitions
• No supply curve
When a monopoly firm is in profit-maximizing
equilibrium, its marginal cost is always less
than the price it charges for its output.

The equilibrium of
a monopoly:
The Monopoly
maximizes its
profits by producing
where marginal
cost equals
marginal revenue
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?

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
 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
 Monopoly Profits

Alternative Profit
Possibilities for a
Monopolist
Profit maximization
means that the
monopoly is doing
as well as it can do,
given the cost and
the demand curves
that it faces; it does
not mean that profits
are being earned.
 Misconceptions

• Not the highest price

• Total, not unit, profit
• Possibility of losses
 Loss Minimization

Price, Costs, and Revenue

MC

ATC
A Loss
Pm
AVC

V
D

MR=MC

MR

0 Qm
Quantity
No Supply Curve under a Monopoly
When a firm faces
a negatively sloped
demand curve,
there is no unique
relation between
the price that it
charges and the
quantity that it
sells.
For a monopoly
firm, there is no
unique relationship
between market
price and quantity
supplied
Under Perfect Competition:
Firms face perfectly elastic curves so that
P=MR.
In equilibrium MR=MC hence P=MC.

Under Monopoly:
Firm faces negatively sloped demand curve for
which MR<P and hence MC < P in equilibrium.

A profit maximizing monopoly will never sell

in the range where the demand curve is
inelastic.
 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
 Economic Effects

• Pure competition is efficient

– Productive efficiency
– Allocative efficiency
– CS+PS maximized
• Monopoly is inefficient
– Charge P>MC
– Deadweight loss
• Income transfer
 A Multi Plant Monopoly
•A multi-plant profit maximizing
monopolist will always operate its plants
so that their marginal costs are equal.

•The monopoly firm’s marginal cost curve

is the horizontal sum of the marginal cost
curves of its individual plants.
 MCA

MCB
12

50 50

• The Equimarginal principle

– Assume plants use different technologies and were
built at different time periods
– A: Old plant and B: New plant
– Question: 100 units should be produced at least cost;
how should the production be divided?
– Reallocate resources: reduce units allocated to A and
increase the allocation to B until MCA = MCB
Long Run Monopoly Equilibrium
• In both monopolized& perfectly
competitive industries, profits & losses
provide incentives for exit and entry.

• If a monopoly firm’s profits are to persist in

the long run, the entry of new firms into
the industry must be prevented by
effective entry barriers
 Cost Complications
• Economies of scale
– Simultaneous consumption
– Network effects
• X-inefficiency
– Lowest ATC not achieved
• Rent seeking behavior
• Technological advance
– More likely with monopoly?
 Policy Options

• Use antitrust laws

– Divide the firm
• Natural monopoly
– Regulate price
• Ignore
– Unstable in long run
 Cartels as Monopolies
CARTEL: A monopoly can arise if many firms in an
industry agree to cooperate with one another, to
behave as a single seller, in order to maximize joint
profits.

Cartelization of a
perfectly competitive
industry can always
increase that
industry’s profits
 Problems Facing Cartels
Cartels encounter two characteristic
problems.
1.Enforcement of output restrictions
Cartels tend to be unstable because of the
incentives for individual firms to violate the
output quotas needed to enforce the monopoly
price.
2. Restricting Entry
Successful cartels are often able to license
the firm in the industry and by controlling the
number of licenses.
 Conflicting forces affecting cartels
Cooperating leads to the monopoly price, but individual self-
interest leads to production in excess of the monopoly output
 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
 Price Discrimination

• Conditions
– Monopoly power
– Market segregation
– No resale
• Examples
– Airfares
– Electric utilities
– Theaters & golf courses
• When is Price Discrimination
Possible
Price discrimination is possible if the seller can
either distinguish individual units bought by a
single buyer or separate buyers into classes
such that resale among classes is
impossible.
• Consequences of Price
Discrimination
Proposition 1: For any given level of output,
the most profitable system of discriminatory
prices will provide higher total revenue to the
firm than the profit-maximizing single price.
Proposition 2: Output under price
discrimination will generally be larger than
under a single-price monopoly.
 Why Price Discrimination is Profitable
• Discrimination among units of output
– Perfect price discrimination
• Discrimination among buyers in one market
• Discrimination among markets
• Price discrimination more generally: the
ability to charge multiple prices gives a seller the
opportunity to capture some (or all) of the
consumers surplus.
 Regulated Monopoly

• Natural monopolies
• Rate regulation
• Socially optimum price
P/MB = MC
• Fair return price
P = ATC
 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
 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”
 Key Terms
• pure monopoly
• barriers to entry
• simultaneous consumption
• network effects
• X-inefficiency
• rent-seeking behavior
• price discrimination
• socially optimal price
• fair-return price
Next Chapter Preview…

Monopolistic
Competition
and Oligopoly

10-48
 End Term Presentation
• End Term Presentation is based on the
analysis of competition in Pakistani Industry.
• Each group will have to choose an industry of
their own choice to research on their sales,
the number of firms in that industry, the
nature of the product, the barriers to entry,
the prices and the promotion strategies.
• Sales data of each individual firm in the
industry will be collected for a minimum time
period of 5 years in order to calculated the
 TWO INDICATORS OF
MARKET CONCENTRATION
INTERPRETATION
INTERPRETATION