Monopoly

Monopoly
 A firm is considered a monopoly if . . .
 it is the sole seller of its product.
 its product does not have close substitutes.
 While a competitive firm is a price taker, a
monopoly firm is a price maker.
 The monopolist is the supply-side of the
market and has complete control over the
amount offered for sale
Characteristics of Monopoly
 Single seller
 Unique product
 High degree of control over price that is held by the monopolist
 Individual supply of the monopolist coincides with the market
supply
 Market demand equals the demand for the product/service
 Monopolist is a “price maker”
 Impossible entry into the market
What does it mean to have a unique
product?

There are no close

substitutes for the
monopolists product
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.
 Patent and copyright laws are two
important examples of how government
creates a monopoly to serve the public
interest.
Government-Created
Sources of Monopoly: Monopolies
 Economies of Scale
 In capital intensive industries, the economies of large scale production may lead to a
small number of firms producing the product
 Natural Monopolies
 Public Utilities
 Government regulation of these monopolies
 Control of Raw Materials
 May be an effective way of blocking competition for many years
 Patents
 Exclusive right to use, keep, or sell an invention for a period of years
 Competitive tactics
 Aggressive production and merchandising techniques
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.
 A natural monopoly arises when there are
economies of scale over the relevant range of
output.
Figure 1 Economies of Scale as a Cause of
Monopoly

Cost

Average
total
cost

0 Quantity of Output

Copyright © 2004 South-Western

HOW MONOPOLIES MAKE PRODUCTION AND
PRICING DECISIONS
 Monopoly versus Competition
 Monopoly
 Is the sole producer
 Faces a downward-sloping demand curve

 Is a price maker

 Reduces price to increase sales

 Competitive Firm
 Is one of many producers
 Faces a horizontal demand curve

 Is a price taker

 Sells as much or as little at same price

What is the difference between
monopoly and perfect competition?

The D and MR curves of the

monopolist are downward
sloping; in perfect competition
they are horizontal
 Determining Monopoly Price
 Monopolist’s demand curve slopes downward to the
right because it is the market demand curve of all
consumers
 The first question the monopolist asks is, “How many
units of my good can I expect to sell at various prices?”
 A monopolist can either decide the price it wants to
charge or the output level but not both.
Monopolist’s Demand Curve
Price

TR =10,800
12

10 TR = 10,000

8 TR = 8,800

0 900 1,000 1,100 Units

 Figure 2 Demand Curves for Competitive and
Monopoly Firms

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

Price Price

Demand

Demand

0 Quantity of Output 0 Quantity of Output

Copyright © 2004 South-Western

A Monopoly’s Revenue
 Total Revenue
P × Q = TR
 Average Revenue

TR/Q = AR = P
 Marginal Revenue

∆ TR/∆ Q = MR
Table 1 A Monopoly’s Total, Average,
and Marginal Revenue

Copyright©2004 South-Western
A Monopoly’s Revenue

 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 Revenue

 A Monopoly’s Marginal Revenue

 When a monopoly increases the amount it
sells, it has two effects on total revenue (P ×
Q).
 The output effect—more output is sold, so Q is
higher.
 The price effect—price falls, so P is lower.
Monopoly
 The monopolist's demand curve
downward sloping
the greater the market power,

the less elastic the demand curve

MR below AR
 Figure 3 Demand and Marginal-Revenue Curves
for a Monopoly

Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average
1 revenue revenue)
0
–1 1 2 3 4 5 6 7 8 Quantity of Water
–2
–3
–4

Copyright © 2004 South-Western

Monopolist’s Cost Curves
 Monopolist’s cost curves reflect the law
of diminishing returns
 Thus, the cost curves have the same
general shape and characteristics as the
cost curves in a competitive industry
Cost & Revenue Curves for a Monopoly
$20
19 Profits maximized where MR = MC
18
17
16
15 If ATC is higher
Price and Cost

14 ATC (lies above the AR

13
MC
curve) the
12
11
monopolist would
B P incur a loss
10
9 Pure
8 B′ Profit C
7 MR will be less
6 than AR or demand
5 AR because the
4 A
3
monopolist must
2 lower price to
Q MR
1 increase sales
0
1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity
Profit Maximization

 A monopoly maximizes profit by producing

the quantity at which marginal revenue
equals marginal cost & MC curve cuts MR
curve from below.
 It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
 Maximizing Profit When Marginal Revenue
Equals Marginal Cost

The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

 At output levels below MR = MC the

decrease in revenue is greater than the
decrease in cost (MR > MC).
 At output levels above MR = MC the
increase in cost is greater than the
decrease in revenue (MR < MC)
 Figure 4 Profit Maximization for a Monopoly

Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity
Copyright © 2004 South-Western
Profit Maximization

 Comparing Monopoly and Competition

 Fora competitive firm, price equals marginal
cost.
P = MR = MC
 Fora monopoly firm, price exceeds marginal
cost.
P > MR = MC
Where does a monopolist produce to
maximize profit or minimize losses?

MR = MC
MC cuts MR from below
Profit
£
maximising under
MC monopoly

MR
O Qm Q
What is unique about the demand
curve for a monopolist?

The monopolist demand

curve and the industry
demand curve are one in
the same
What determines price for a
monopolist?

Demand
Why is MR < P?

To sell additional units, the price

has to be lowered; this price-cut
applies to all units
Can a monopolist make a profit in
the long-run?

If the positions of a monopolist’s

demand and cost curves give it a profit
and nothing disturbs these curves, it
can make a profit in the long-run
 P
200 MR=MC
175 MC
150
125 ATC
100
75 Profit
50 AVC
25
MR D
1 2 3 4 5 6 7 8 9 Q
 P
200 MC ATC
175
150
MR=MC
125 Loss
100
75 AVC
50
25 MR D
1 2 3 4 5 6 7 8 9 Q
Monopoly
 The monopolist's demand curve
 downward sloping
 the greater the market power,

the less elastic the demand curve

 MR below AR
 Equilibrium price and output
 Equilibrium output, where MC = MR
 And MC cuts MR from below
 Equilibrium price, found from D curve
 Profit
 Measuring profit
 Supernormal profit can persist in long run
HOW MONOPOLIES MAKE PRODUCTION AND
PRICING DECISIONS
 Monopoly versus Competition
 Monopoly
 Is the sole producer
 Faces a downward-sloping demand curve

 Is a price maker

 Reduces price to increase sales

 Competitive Firm
 Is one of many producers
 Faces a horizontal demand curve

 Is a price taker

 Sells as much or as little at same price

Monopoly
 Monopoly versus perfect competition
 lower short-run output at a higher price
 supernormal profit not competed away
 costs under monopoly
 lack of competition to drive down costs
 BUT possibility of substantial economies of scale

 innovation and new products

 less incentive to innovate
 BUT greater possibility of innovation through investing

ploughed-back profit
 competition for corporate control
Monopoly
 Monopoly pricing compared to perfect
competition pricing:
 Monopoly

P > MC
 Perfect Competition
P = MC
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£ MC

Monopoly
P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and monopoly: with the sam
MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1 Perfect competition

P2

AR = D

MR
O Q1 Q2 Q
Is monopoly efficient?
A monopolist is inefficient because
resources are underallocated to the
production of its product
Is perfect
competition efficient?

A perfectly competitive firm that

produces where P = MC achieves an
efficient allocation of resources
P Perfect Competition
MR=MC MC

MR, D
Pc

Qc
Q
P MR=MC
Monopolist
MC

Pm

MR D
Qm Q
How does monopoly harm
consumers?

It charges a higher price

and produces a lower
quantity than would be the
case in a perfectly
competitive situation
 What is the case against
monopoly?
 Higher price
 Charges a Price > MC
 Long-run economic profit
 Alters the distribution of income to
favor monopolist
Perfect Competition
 Review of Perfect Competition
P = LMC = LRAC
 Normal profits or zero economic profits in the
long run
 Large number of buyers and sellers
 Homogenous product
 Perfect information
 Firm is a price taker
Perfect Competition
P Market P Individual Firm
D S
LMC LRAC

P0 P0
D = MR = P

Q0 Q q0 Q