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Class 7 Monopoly & Monopsony

MONOPOLY
1. Monopolist produces at the point A, where MC>MR. What does he have to do? Find
the amount of profit at the optimum point.

MC
PM
AC
A
PC
MR D
QM QA Q
Equilibrium is obtained when MC = MR, and the quantity is QM. This quantity can be sold at
price PM, and company pays PC per unit. (where the vertical line intercepts AC). Profit is
dashed square: П = (PM – PC) ×QM

If MC>MR, company might be at the A point (any point where MC>MR). The area between
the equilibrium point, A point, point where MR equals 0 and QA is accumulated loss. The
company has to decrease its production in order to increase the profits.

2. Find the monopolist’s margin!

μ = (P-MC)/P

3. Find how margin depends on the elasticity of supply!

(1) Let demand be: P = -aQ + b
The slope of demand curve is actually a derivation of the demand function:
dP
(2) P ' = dQ = −a
(3) TR = P×Q = (-aQ + b)×Q
(4) TR' = MR = -2aQ + b
Now we split MR in two parts:
(5) MR = -aQ –aQ +b
We substitute for the last two items: (from (1)):
(6) MR = -aQ + P
Slope a is actually a derivation of demand function: (from (2))
dP
(7) MR = dQ × Q + P but since we don't deal with infinitesimaly small units, instead of d we
put Δ.
∆P
(8) MR = P + Q × ∆Q where the slope of demand curve is negative, so the MR decreases as
the quantity increases.
Q × ∆P  1 
(9) MR = P + P × = P1 + 
P × ∆Q  Ed 
Since MC = MR, instead of MC we put MR in the formula for margin:
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 1 
P − P1 + 
(10)  E D  1 1
MR = = 1 −1 − =−
P ED ED
P − MC 1 MC
=− ⇒P=
(11) P ED 1
1+
ED

4. Why is this measure used as the measure of monopoly power?

The greater is the difference between MC and P, the greater the profit of monopolist. The
spread increases as the elasticity grows smaller. Hence, if demand is very elastic, monopolist
will earn little. If Ed = ∞, then D = MR, and there’s no profit for monopolist.
5. Why is it impossible to construct a supply curve for monopolist?
Because supply depends on demand.

MC
S

MR MR' D D'
Q
Figure shows that production changes as demand changes. Connecting the points of
equilibrium production and consumption as demand changes, one gets supply curve.

6. Can certain company have monopoly power although it’s not the only on the market?
Yes, it can. As long as ED < ∞, there exists monopolist margin (profits can be made), and it’s
a sign of an imperfectly competitive market.

7. What are the sources of monopoly power?

These are restrictions for newcomers on the market: a.) exclusive rights (licences, copyright,
etc.) and b.) economies of scale (natural monopolies), e.g. transport of electricity, aluminium
industry, etc.

8. Which factors determine the size of monopoly power?

Elasticity of market demand, number of companies, (more companies mean more substitutes
on the market, which decreases prices and revenues). Mere existence of substitutes decreases
elasticity of demand. Reaction of other companies on the changes in price affect monopoly
power too.
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9. How changes in demand affect monopoly power?

If demand is P = -aQ + b, then TR = (P×Q) = (-aQ + b) Q = -aQ2 + bQ. Hence MR = -2aQ +
b. MC = MR holds in monopoly. Thus obtained quantity is put in demand, and the price is
obtained. The steeper is demand, the higher monopoly power.

10. Average revenue function of a monopolist is P = 100 – 0.01Q, and costs are C = 50Q
+ 30000.
a.) Find optimal quantity, price and quantity.
AR is demand curve. TR = P×Q = 100Q – 0.01Q2. Hence, MR = 100 – 0.02Q. MC = C' = 50.
MR = MC
100 – 0.02Q = 50
Q = 2500
P = 100 – 0.01×2500 = 75
П = P×Q – TC = 75×2500 – 30 000 -50×2500 = 32 500

100

75
62
50 AC
MC

MR D

2500 5000 10000 Q

Green rectangle represents profit.

11. Marginal cost is 10, fixed costs are 0, and this is the average revenue table:

AR 27 24 21 18 15 12 9 6 3 0
Q 0 2 4 6 8 10 12 14 16 18
a.) Find demand function equation and draw demand and marginal revenue curve.
AR is P, i.e. demand curve. We take any 2 points, and put it in the formula for line equation
when 2 points are known:
P2 − P1
P − P1 = ( Q − Q1 )
Q2 − Q1
21 − 24
P − 24 = ( Q − 2)
4 −2 Demand
P = −1.5Q + 27
TP = ( −1.5Q + 27 )Q = −1.5Q 2 + 27 Q
MR = −3Q + 27
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27

MR D

9 18 Q

b.) Find the optimal quantity, price and profit of monopolist.

MR = MC
27 – 3Q = 10
3Q = 17
Q = 5.67
P = 27 – 1.5×5.67 = 18.5
TR = 18.5×5.67 = 104.83
When MC are constant, and FC = 0, AC = MC holds.
П = P×Q – MC×Q = 104.83 – 56.7 = 48.17

c.) Find the price in perfect competition.

In perfect competition MC curve above its intercept with AVC represents a short-run supply
curve. Equilibrium is obtained when demand equals supply, i.e. AR = MC (P = MC = MR)
10 = −1.5Q + 27
Q =11 .33
P =10
Price is 10 because MC = 10.
This quantity is significantly higher than in monopoly case.

d.) What would happen if monopolist were forced to produce and sell at P = 10?
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P P

27 27

18.5

10 10
MR D MR D

5,67 9 18 5,67 9 11,33 18

Q Q
Before After
If the price equals 10, monopolist will loose all the profit and will produce the quantity
produced in perfect equilibrium. However, he might reconsider further staying in the industry.
The solution would be lowering marginal cost (it would form a spread between price and
average cost, and thus positive profits.

12. In a town exist 10 households, which demand electricity: Q = 50 – P (each

household). Power plant has total cost 500 + Q.
a.) Find the optimal power production (from the monopolist point of view), price and
profit.
First we have to find market demand. Individual demands sum up horizontally:

50

50 100 150 200 250 300 350 400 450 500 Q

At price P = 0, there is demand for 500 units (10 households×50/1) where 1 is a slope of an
individual demand. Market demand is: P = 50 – (50/500) ×Q = P = 50 – 0.1Q

MC = TC' = 1
TR = 50Q – 0.1Q2
MR = 50 – 0.2Q
MR = MC
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50 – 0.2Q = 1
2Q = 490
Q = 245
Q per household = Q/10 = 24.5
P = 50 – 24.5 = 25.5
П = 245×25.5 – 500 – 245 = 5502.5

50

25.5
3.04
AC=500/Q+1
1

245 250 490 500 Q

Figure: There’s a difference between AC and P, and it’s a profit area (green).

b.) If the Government interferes in order to eliminate dead weight loss, what would be
the price and the quantity?
Dead weight loss is formed when supplied quantity decreases (nobody gets that part, i.e. it’s a
fall in total welfare compared to perfect competition).
Dead weight loss doesn’t exist in perfect competition, where P = MC. Hence, if the
Government wants to minimize DWL, the price has to be set where P = MC:
MC = 1 = P
1 = 50 – 0.1Q
Q = 490
Profit of the monopolist:
П = 490×1 – 500 – 490 = -500 (monopolist accumulates losses)
Consumer surplus is:
CS = (50-1) ×490/2 =12005

50

2,02
AC=500/Q+1
1

250 490 500 Q

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Figure: In perfect competition, price equals 1, and quantity 490. Monopolist has losses (blue
rectangle) because AC is above the price, but there’s no DWL.

c.) If price regulators doesn’t want the power plant to have losses, what would be the
price?
In monopoly, profit is a difference between price and average cost, multiplied by quantity:
П = TR – TC = P×Q – AC×Q = Q× (P-AC). Hence profits will be 0 (nonnegative profit)
when price equals average cost (MC doesn’t contain fixed cost, that’s why power plant has
losses equal to FC. AC contains both VC and FC.):

AC = P
50
+1 = 50 + 0.1Q
Q
0.1Q 2 − 49 Q + 500 = 0
There are 2 solutions, Q = 10.4 and Q = 479.6
Since when Q = 10.4 MC are decreasing, we ignore that solution, and take only the other one:
Q = 479.6
Solving demand for Q we get: P = 2.04
At this price П = 0, and DWL is a triangle: the difference between this and perfectly
competitive price, and this and perfectly competitive quantity:
DWL = (2.04 – 1) × (490 – 479.6)/2 = 5.4
Find consumer surplus
CS = (50 – 2.04)×479.6/2 = 11500$, or 1150$ per household.

50

2,04
AC=500/Q+1
1

479.6 490 500 Q

Figure: Fixing losses at 0, where D = S, there’s no profit since P = AC. However, there exist a
small DWL (orange triangle).

Note: In this exercise, perfectly competitive point and point of 0 profit is not the same point,
since MC is not equal to AC (since FC are not 0)

d.) Find the fixed amount that should be paid like a right for having electricity at all (which
would cover fixed cost), so as to keep the price at the level which makes DWL = 0.
FC = 500
Per household: 500/10 = 50
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We have already found that CS = 12005 in perfect competition. It is 1200,50$ per household.
If we deduct 50$ of the fixed amount, there’s still 1150,50$ left, which is better than the case
with small DWL (look at c).

MONOPSON

13. How monopsonist decides how much to buy, and what is his profit (compare it with
perfect competition). Is he going to buy more or less than the competitive buyer?
In monopsony there exists 1 buyer and several sellers.
P

P*
ME AE = S
Pc
Pm

D = MV

Qm Qc Q
P* is the price that monopsonist might pay, and Pm is the price paid to seller. The spread is
monopsonist’s profit. In perfect competition the quantity is greater, and producers get more
(therefore, the answer is: monopsonist buys less and pays less).

Equilibrium in monopsony is obtained in the intercept of MV (marginal value, or

monopsonist’s demand) curve and ME (marginal expenditure or cost, sometimes noted with
MC). Solve AE (Average expenditure) for thus obtained quantity, and this is the price paid by
monopsonist.

ME is the change in total expenditure as the quantity (inputs, or products) change. A company
that buys inputs that are bought by other companies too, have ME = MV (both in monopoly
and perfect competition). For monopsonist, however, ME is above AE.

14. Draw graphs of partial equilibrium for perfectly competitive market for inputs and
products:
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P P
S

S
D

Q Q
Perfectly competitive input market Perfectly competitive product market

15. What is monopsony power? Can a company have monopsony power even when it’s
not the only on the market?
Monopsony power is the ability of a buyer to control the input market. If there are few buyers,
they will have a bit of monopsony power too, but less then when they are alone.

16. What are the sources of monopsony power?

They depend on the purchasing side of the market:
a) Elasticity of supply (The greater E, the smaller power, and vice versa)
b) The number of buyers
c) The way how buyers cooperate

17. What are the social cost of a monopsony? If the profit of monopsonist is distributed
among
P the buyers, would it eliminate these costs?
G

B F ME AE = S
C K E

H D = MV

Qm Qc Q
In perfect competition consumer surplus is triangle GBE. Producer surplus is all between
supply and the line BE. In monopsony, monopsonist takes the rectangle BCKH from the
sellers. Now consumer surplus (or monopsonist surplus) is the area GCHF. However, triangle
FEH is the loss for society, DWL. If the green-coloured rectangle is given to the sellers, if
would not eliminate DWL, but only redistribute the actual surplus among these two groups.
Social cost remains the same.
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18. Monopsonist demand is 600 – 2Q. Average cost is Q, and marginal is 2Q.
a.) What’s the price paid by monopsonist? How many products does he buy? Draw a
graph!

S =AE = Q
ME = 2Q
D = MV = P = 600 – 2Q

ME = MV (we get the quantity that monopsonist buys)

600 – 2Q = 2Q
Q = 150

Quantity is put in the supply equation (ME), in order to get the price:
P P= Q = 150
600

300 2Q Q

200

150
H D = MV

150 200 300 Q

b.) Find the profit of monopsonist!
П = Q×MV(Q) – Q×AE(Q) = 300×150 – 150×150 = 22500

c.) What would be the price and quantity in perfect competition?

S=D
Or
MV = AE
600 – 2Q = Q
Q = 200
P = Q = 200

d.) Find total surplus in perfect competition.?

TS = 600×200/2 = 60000
DWL = (300-150)×(200-150)/2 = 7500

e.) Find consumer surplus in monopsony case.

CS in monopsony is consisted of the triangle above the profit, and the profit itself.:
CS = (600-300)×150 + 22500 = 67500

f.) If the Government wants to cancel detrimental effect of monopsony and to make him
distribute his profit to the sellers, would it erase DWL?
No, since DWL disappears only when quantity increases.