Chapter 15 Monopolies

Look for the answers to these questions:

 Why do monopolies arise?
 Why is MR < P for a monopolist?
 How do monopolies choose their P and Q?
 How do monopolies affect society’s well-being?
 What can the government do about monopolies?
 What is price discrimination?

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 Introduction
 A monopoly is a firm that is the sole seller of a
product without close substitutes.
 In this chapter, we study monopoly and contrast
it with perfect competition.
 The key difference:
A monopoly firm has market power, the ability to
influence the market price of the product it sells.
A competitive firm has no market power.

MONOPOLY 1
 Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive
right to produce the good. (patents, copyright
laws)

MONOPOLY 2
 Why Monopolies Arise
3. Natural monopoly: a single firm can produce
the entire market Q at lower cost than could
several firms.
Example: 1000 homes
need electricity Cost Electricity
ATC slopes
ATC is lower if downward due
one firm services to huge FC and
all 1000 homes Dhs 80 small MC
than if two firms Dhs 50 ATC
each service
Q
500 homes. 500 1000
MONOPOLY 3
 Monopoly vs. Competition: Demand Curves
In a competitive market, the market demand curve slopes
downward. But the demand curve for any individual firm’s
product is horizontal at the market price. The firm can
increase Q without lowering P, so MR = P for the
competitive firm.
P P A competitive firm’s
A competitive market’s
demand curve
demand curve
D

Q Q
MONOPOLY 4
 Ch 14 MC & the Firm’s Supply Decision
Rule: MR = MC at the profit-maximizing Q.
At Qa, MC < MR. Costs
So, increase Q
MC
to raise profit.
At Qb, MC > MR.
So, reduce Q
to raise profit. P1 MR
At Q1, MC = MR.
Changing Q
would lower profit. Q
Q a Q1 Q b

1 FIRM IN A COMPETITIVE MARKET 5

Monopoly vs. Competition: Demand Curves

A monopolist is the only

seller, so it faces the
market demand curve.
A monopolist’s
To sell a larger Q, demand curve
P
the firm must reduce P.
Thus, MR ≠ P.

D
Q

MONOPOLY 6
ACTIVE LEARNING 1
A monopoly’s revenue
Common Grounds
is the only seller of Q P TR AR MR
cappuccinos in town. 0 4.50 n.a.
The table shows the 1 4.00
market demand for
2 3.50
cappuccinos.
Fill in the missing 3 3.00
spaces of the table. 4 2.50
What is the relation 5 2.00
between P and AR?
6 1.50
Between P and MR?
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 Common Grounds’ D and MR Curves
P, MR
$5
Q P MR
4
0 $4.50 Demand curve (P)
3
1 4.00 2
2 3.50 1
3 3.00 0
-1 MR
4 2.50
-2
5 2.00 -3
0 1 2 3 4 5 6 7 Q
6 1.50
MONOPOLY 8
 Profit-Maximization
 Increasing Q has two effects on revenue:
 Output effect: higher output raises revenue
 Price effect: lower price reduces revenue
 To sell a larger Q, the monopolist must reduce
the price on all the units it sells. So, MR < P
 Like a competitive firm, a monopolist maximizes
profit by producing the quantity where MR = MC.
 Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to
pay for that quantity. It finds this price from the D
curve.
MONOPOLY 9
 Profit-Maximization

Costs and
1. The profit- Revenue MC
maximizing Q
is where P
MR = MC.
2. Find P from
the demand D
curve at this Q. MR

Q Quantity

Profit-maximizing output
MONOPOLY 10
 The Monopolist’s Profit

Costs and
Revenue MC

As with a P
ATC
competitive firm, ATC
the monopolist’s
profit equals D
(P – ATC) x Q MR

Q Quantity

MONOPOLY 11
 The Welfare Cost of Monopoly
Competitive eq’m:
Price Deadweight
quantity = QC loss MC
P = MC
total surplus is P
maximized P = MC
MC
Monopoly eq’m:
quantity = QM D
P > MC MR
deadweight loss
Q M QC Quantity

MONOPOLY 12
 Price Discrimination
 Discrimination: treating people differently based
on some characteristic, e.g. race or gender.
 Price discrimination: selling the same good
at different prices to different buyers.
 The characteristic used in price discrimination
is willingness to pay (WTP):
 A firm can increase profit by charging a higher
price to buyers with higher WTP.

MONOPOLY 13
 Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist Consumer
charges the same Price
surplus
price (PM) to all
Deadweight
buyers. PM loss
A deadweight loss
results. MC
Monopoly
profit D
MR

QM Quantity

MONOPOLY 14
 Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
produces the Price
competitive quantity, Monopoly
profit
but charges each
buyer his or her WTP.
This is called perfect
MC
price discrimination.
D
The monopolist
captures all CS MR
as profit.
Quantity
But there’s no Q
deadweight loss..
MONOPOLY 15
 Price Discrimination in the Real World
 In the real world, perfect price discrimination is
not possible:
 No firm knows every buyer’s WTP
 Buyers do not announce it to sellers
 So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.

MONOPOLY 16
 Examples of Price Discrimination
Tickets to events: Discounts for seniors, students,
children.They are all more likely to have lower
WTP
Airline prices: Discounts for Saturday-night
stayovers help distinguish business travelers,
who usually have higher WTP, from more price-
sensitive leisure travelers.
Quantity discounts: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s
twice as big.

MONOPOLY 17
CONCLUSION: The Prevalence of Monopoly
 In the real world, pure monopoly is rare.
 Yet, many firms have market power, due to:
 selling a unique variety of a product
 having a large market share and few significant
competitors
 In many such cases, most of the results from this
chapter apply, including:
 markup of price over marginal cost
 deadweight loss

MONOPOLY 18
How does government react?

 Policymakers may respond by

 1) regulating monopolies,
 2) using antitrust laws to promote competition,
 3) or by taking over the monopoly and running it.
 4) Due to problems with each of these options, the
best option may be to take no action.

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