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Chapter 9

Monopoly
The Monopoly Market Structure
 What is a monopoly exactly?
 A monopoly is a market structure characterized by:
 A single seller
 A unique product
 Impossible entry into the market
 Under a monopoly, the consumer has only one choice.
Thus, they can either buy from the producer or not
consume
 There are no close substitutes.
A Single Seller
 One single firm IS the industry.

 Local monopolies are more commonly observed in the


real-world than national monopolies.
 Examples
Unique Products
 Why do Monopolists have unique products?
 Absence of close substitutes
Impossible Entry
 Barriers to Entry are high
 It is different or impossible for a new firm to enter an industry
due to:
 Ownership of Vital Resources
 Legal Barriers
 Economies of Scale
Ownership of Vital Resources

 A seller can create its own barrier to entry if it owns a


significant portion of a key resource required for the
production of the good or service.

 In practice, monopolies rarely arise for this reason. The


market for most resources is national or even
international, and ownership of most resources is
dispersed among a large number of people and nations.
 Example
Legal Barriers
 Legal barriers to entry are the source of most present-
day monopolies.

 Entry into the market or competition within the market


are restricted by the granting of a public franchise,
government license, patent, or copyright.
 Examples:
Economies of Scale
 Monopolies can emerge in time naturally because of the
relationship between average cost and the scale of the
operation.
 This is called “natural monopolies”
 Def: A natural monopoly is an industry in which the LRAC of
production declines throughout the entire market.
 Natural monopoly provides an economic argument for
regulated public utilities.
Economies of Scale
 When this happens a single firm can supply the entire
market demand at a lower cost than two or more
smaller firms.

 Markets characterized by economies of scale often


become competitive over time because of technological
advances or because of natural growth in the size of the
market.
SOURCES OF MONOPOLY
Economies of Scale

The cost to distribute 4 million


kilowatt hours of electric power is

5 cents a kilowatt-hour with one


seller in the market, or . . .
10 cents a kilowatt-hour with two
sellers, or . . .
15 cents a kilowatt-hour with four
sellers.
Because of economies of scale, one
seller can meet the market demand
at a lower average cost than two or
more sellers.
Price and Output Decisions for a Monopolist
 The demand curve for a monopolist differs from the
competitive firm because the monopolist is a price maker
not taker.
 Def: A price maker is a firm that faces a downward sloping
demand curve.
More Demand and some Marginal Revenue
 Demand and Marginal Revenue
 They are both negatively-sloped

 Demand
 Market demand is negatively-sloped. The monopolist faces
a tradeoff between price and quantity sold.
 To obtain a higher price, the monopolist must lower
quantity. Or, if it wants to sell a larger quantity, it must
lower price.
MONOPOLY EQUILIBRIUM
 Demand and Marginal Revenue

 Marginal revenue is less than price

 The marginal revenue curve is negatively-sloped but lies below the


demand curve at each quantity: MR<P at all Q.
MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

Calculate the marginal revenue generated along the demand curve.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

If the price is $16, quantity demanded is 2 haircuts per hour.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

If the price is $14, quantity demanded is 3 haircuts per hour.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

Total revenue from two haircuts per hour decreases by $4.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

Total revenue from the additional haircut is $14.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

Marginal revenue from the additional haircut is $10.


MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

The marginal revenue curve is negatively-sloped and lies below the


demand curve. Marginal revenue is less than price at each quantity.
MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist

The diagram shows the


monopolist’s
• average total cost (ATC),
• marginal cost (MC),
• demand (D),
• and marginal revenue (MR).

The monopolist maximizes profits


or minimizes losses by producing
the quantity at which marginal
revenue equals marginal cost.
MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist

The equilibrium quantity is 3


haircuts per hour where MR=MC,
and
the equilibrium price is $14, shown
by the demand at the quantity 3.

The ATC of 3 haircuts is $10.

Because P>ATC at the equilibrium


quantity, the monopolist earns a
profit of $4 per haircut or $12 per
hour.

23 Monopoly
MONOPOLY EQUILIBRIUM
Profit Maximization by a Monopolist: Numerical Example

The data in the table below verify that 3 haircuts per hour maximizes the
monopolist’s profit.
MONOPOLY EQUILIBRIUM
 Short-Run and Long-Run Equilibrium

 When a monopolist incurs short-run losses

 However, if a monopolist incurs economic losses in the short-


run, it exits the market in the long-run. The long-run equilibrium
quantity is zero.
MONOPOLY EQUILIBRIUM
 Short-Run and Long-Run Equilibrium

 When a monopolist earns short-run profits


Price Discrimination
 The monopolist may charge different prices to
consumers to maximize profits.
 Def: Price discrimination occurs when a seller charges
different prices for the same product that are not justified by
cost differences.
 Selling a good or service at a number of different prices where
the price differences do not reflect differences in cost but instead
reflect differences in consumers’ price elasticities of demand.

 However, specific conditions must be met before the


seller can act in this way.
Conditions for Price Discrimination
 The seller must be a price maker and therefore face a
downward-sloping demand curve
 The seller must be able to segment the market
distinguishing between consumers willing to pay different
prices
 It must be impossible or too costly for customers to
engage in arbitrage
How can a producer price discriminate
 Discriminating among groups of consumers

 Different prices for consumers with different elasticities. The market is


segmented based on some easily distinguished characteristic of
consumers—age, for example.
 Discriminating among units of a good

 The seller charges the same prices to all consumers but offers
each consumer a lower price for a larger number of units
bought—volume discounts, for example.
Price Discrimination with Two Groups of Consumers
(a) (b)
per unit
Dollars

Dollars per unit


$3.00

LRAC, MC $1.50
LRAC, MC
1.00 1.00
MR D MR’ D’

0 400 Quantity per period 0 500 Quantity per period


A monopolist facing two groups of consumers with different demand elasticities may be
able to practice price discrimination to increase profit or reduce loss. With marginal cost
the same in both markets, the firm charges a higher price to the group in panel (a), which
has a less elastic demand than group in panel (b).
Is Price Discrimination Unfair

 There is nothing evil or illegal about economic price


discrimination. It simply means charging different
prices for the same good or service unrelated to
differences in cost.

 Price discrimination is common in all markets other


than perfectly competitive markets.
Is Price Discrimination Unfair

 What are its effects:


 Increase seller’s profit, at least in the short run
 Enhance economic efficiency
 Conserve on scarce resources.
 Many buyers benefit because they are now paying a lower
price
 Example: Movie Theatres- senior citizen and college students
discounts
How does it increase the sellers profits

 Increases seller’s profits


 By observing different elasticities for the consumers the
following can happen
 Reduce the price for buyers with elastic demand will increase TR
 Increase the price for buyers with inelastic demand will increase
TR
 When the total quantity is not changing, then costs are not
changing, but revenues are profits are HIGHER
What about efficiency
 Enhances economic efficiency
 We know that under a monopoly the output is under-
produced. But price discrimination can fix this
underproduction of the good
 A price-discriminating monopolist is able to sell a larger
quantity than a single-price monopolist by reducing price
only on the additional units sold, not on all units sold.
 Because the problem with monopoly is underproduction,
increasing quantity enhances efficiency. The sum of
producer and consumer surplus is higher in a monopoly
market with price discrimination than in a market with a
single-price monopolist.
MONOPOLY AND COMPETITION
Competitive Equilibrium

The market demand curve is D.

The market supply curve is S.

The competitive market


equilibrium is where quantity
demanded equals quantity supplied.

The competitive equilibrium


quantity is QC and the equilibrium
price is PC.
MONOPOLY AND COMPETITION
Monopoly Equilibrium

The competitive market supply


curve, S, is the monopolist’s
marginal cost curve, MC.

The monopolist’s marginal revenue


curve is MR.

The monopolist’s equilibrium


quantity is QM where marginal
revenue equals marginal cost. The
equilibrium price is PM , shown by
the demand at QM.
MONOPOLY AND COMPETITION
 Competitive and Monopolistic Equilibrium

Monopoly quantity is lower and price is higher

Amonopolist supplies a smaller quantity than a competitive market


would supply at a higher price.

The higher price allows a monopolist to earn positive long-run


economic profits.
MONOPOLY AND COMPETITION
 Economic Consequences of Monopoly

The absence of competition results in

• Inefficiency and deadweight loss


• Redistribution of wealth
MONOPOLY AND COMPETITION
Efficiency of Competitive
Equilibrium

The competitive equilibrium price,


PC, brings consumers’ marginal
benefit into equality with
producers’ marginal cost.

Therefore, the competitive


equilibrium quantity, QC, is
efficient. The sum of consumer
surplus and producer surplus is
maximized.
MONOPOLY AND COMPETITION
Inefficiency of Monopoly

Marginal benefit in the monopoly


equilibrium (equals to the
monopoly equilibrium price, PM)
exceeds marginal cost.

Therefore, the monopoly


equilibrium quantity, QM, is
inefficient because of
underproduction. Monopoly results
in a deadweight loss.
MONOPOLY AND COMPETITION
 Economic Consequences of Monopoly

Redistribution of wealth
MONOPOLY AND COMPETITION
Monopoly Redistributes Wealth

The deadweight loss of monopoly


arises from a net loss in both
consumer and producer surplus
compared with the competitive
equilibrium.

In addition to the net loss in the


total surplus, monopoly also
redistributes some of the remaining
surplus from consumers to the
monopolist.