Chapter 8

Monopoly
Chapter summary
The characteristics of a monopoly are that it is a single seller, the product produced is unique
and there are barriers to entry. Barriers to entry may include ownership of a vital resource, legal
barriers, or economies of scale. The latter barrier also leads to what is known as a natural
monopoly.
Being a single seller indicates that the monopoly is a price maker – that is, it sets the
price in the market by producing that output level, which maximises its profits, thereby
effectively determining market supply, which in turn sets the market price. The monopolist
faces the market demand curve. Therefore, the monopolist’s marginal revenue curve lies below
the market demand curve it faces. The profit-maximising output is still where MR=MC. Long-
run economic profits are expected for a monopolist because of the strong barriers to entry,
which limit others from entering and competing in the market.
Monopolies may price discriminate in order to increase their profits if they are able to do
so. Price discrimination means the firm is charging different prices to different people where
those price differences are not a reflection of cost differences. A comparison with perfect
competition is also made in order to look at the disadvantages of a monopoly and advantages of
perfect competition.
The chapter concludes with an analysis of the pros and cons of monopoly.

New concepts introduced

• monopoly • price discrimination
• price maker • natural monopoly
• arbitrage • the ethics of price discrimination

Instructional objectives
After completing this chapter, students should be able to:
• describe the characteristics of a monopoly
• graphically express the monopolist’s demand curve and understand that this curve is really
the market demand curve
• graphically find the profit maximising output to produce and explain why this output is the
profit maximising level
• graphically determine the area representing any economic profits or losses
• explain why short-run economic profits may persist in the long run
• explain what is meant by price discrimination, what must be accomplished in order to do so,
and why a monopolist may price discriminate
• discuss the ethical dilemmas involved in some forms of price discrimination
• compare and contrast the competitive market environment and the monopoly market
• list the monopoly disadvantages from society’s perspective.

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58 Economics for Today Instructor’s Manual

Chapter 8 outline
Introduction
The monopoly market structure
Single seller
Unique product
Barriers to entry
Ownership of a vital resource
Legal barriers
Economies of scale
Exhibit 8.1 Minimising costs in a natural monopoly
Price and output decisions for a monopolist
Marginal revenue, total revenue and price elasticity of demand
Exhibit 8.2 Demand, marginal revenue and total revenue
Monopoly in the short run
Exhibit 8.3 Profit maximisation and loss minimisation for a monopolist
International focus: Monopolies around the world
Monopoly in the long run
Price discrimination
Conditions for price discrimination
Exhibit 8.4 Price discrimination
The ethics of price discrimination
You make the call: Why don’t adults pay more for popcorn at the movies?
Comparing monopoly and perfect competition
The monopolist as a resource misallocator
Exhibit 8.5 Comparing a perfectly competitive firm and a monopolist
Perfect competition means more output for less
Exhibit 8.6 The impact of monopolising an industry
The case against and for monopoly
Analyse the issue: Does size matter?
Key concepts
Summary
Study questions and problems
Online exercises
Answers to ‘You make the call’
Multiple-choice solutions

Hints for effective teaching

1 It is essential that students know how to identify and draw the curves AR, MR, AC and
MC and show when the monopoly is making an economic profit and making losses.
Once again, it would be helpful to use the steps outlined in the previous chapter, point
(4) of ‘Hints for effective teaching’.
2 Get the students to give some examples of monopoly markets. In the past, some
examples included local telephone services, local cable TV and the utilities companies.
But note that times have changed and that competition is the main driving force towards

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 Chapter 8: Monopoly 59

efficiency and productivity. Note also that monopolies can be found at the local level
(e.g. the only service station or hotel in small town).
3 Point out that many real-world monopolies are natural monopolies, which are
government owned or government regulated.
4 Stress the negative social outcomes associated with monopolised markets. It would also
be useful to compare the negativity in light of perfect competitive markets.
5 Point out that the ACCC is charged with combating the growth of monopoly power.
Moreover, this is a most effective way to combat monopoly power. In the text, the
discussion on ‘Analyse the issue: Does size matter?’ would be a good one.
6 Have students think of some examples of price discrimination. For example: golf
courses, doctors, movie theatres, university fees.

Solutions to text problems

Answers to ‘Analyse the issue’
Does size matter? (pp 226–7)
1 In order to become competitive internationally, firms must do more than just reduce
their input cost levels. This is possible with economies of scale, which can be achieved
through mergers with other firms producing similar products/services.
2 Mergers were approved because the ACCC determined that these mergers did not
significantly reduce competition in the Australian market. These mergers it is believed
will improve the welfare of the public.

Study questions and problems solutions

(pp 230–31)
1 a Telstra owns and charges other telephone companies for using their lines. Hence,
the product/service is unique, with only one supplier/seller.
b The fact that there is only one pharmacy indicates that it has monopoly power
within the town as it is the only seller and the product is unique. Pharmacies are
licensed, so there is also a barrier to entry.
c The supplier of electricity to your home operates a natural monopoly, in which
average costs decline continuously as output increases in the long run. This is
why electricity is supplied by one firm for the area/region.
2 A perfectly competitive firm must accept the going market price because it is only one
of a large number of firms producing a similar product in an industry. The monopolist is
the industry because it is the only firm in the industry. As a result, the monopolist faces
the entire downward-sloping demand curve for its product.
3 The hospital charges for pharmaceuticals at a higher price because patients can purchase
these items more easily and conveniently, whereas to purchase pharmaceuticals from
pharmacies in suburbs will mean that time will be spent travelling to the pharmacies.
There is also a ‘captive’ element in a hospital – it has a locational monopoly.
4 All three statements are false.
a A monopoly can exist by owning an essential resource or achieving economies
of scale. It need not be owned by the government (e.g. Microsoft)
b A monopolist maximises profit and not price
c Demand conditions in the short run can cause a monopolist to incur a loss when
the MR = MC price is below the ATC curve. See Exhibit 8.3b, p. 216

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60 Economics for Today Instructor’s Manual

5 A single seller is likely to emerge because the firm with the higher cost will leave the
market since it cannot compete with the firm with the lower cost. Alternatively, the
higher cost firm might merge with the lower cost firm.
6 See the following table and graph.
Price Quantity Total Marginal Price
$ demanded revenue revenue elasticity of
$ $ demand
5.00 0 0 – elastic
4.50 1 4.50 4.50 elastic
4.00 2 8.00 3.50 elastic
3.50 3 10.50 2.50 elastic
3.00 4 12.00 1.50 elastic
2.50 5 12.50 .50 unit elastic
2.00 6 12.00 -.50 inelastic
1.50 7 10.50 -1.50 inelastic
1.00 8 8.00 -2.50 inelastic
0.50 9 4.50 -3.50 inelastic
0.00 10 0 -4.50 inelastic

Figure 9A-1

This is similar to what was shown in Exhibit 5.5, p.124.

7 P = $2.50; Q = 5; Profit = $12.50. The price elasticity of demand is unit elastic

If MC >0, the price will be above $2.50 and output will be less than 5 (See Table
above).
8 In the inelastic range of the demand curve, MR is negative while MC is positive.
Because the monopolist will profit maximise by setting MR equal to MC, and since MC
is always positive then MR must be positive. That is, it will always operate where
demand is elastic (See Table and Figure above).
9 a The monopolist will increase output
b The monopolist will decrease output

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 Chapter 8: Monopoly 61

10 There will be no price or output. The monopolist shown in the graph would shut down,
because the price is below AVC at the point where MR = MC output (The demand curve
is everywhere below the AVC curve).
11 A case of price discrimination is b. Give reasons for selecting b and not selecting a, c or
d.

Figure 9A-2

12 See Figure 9A-2. Before the takeover, the price of lawn mowing is Pc and the output is
Qc. Since Pc = MC, the allocation of resources to the perfectly competitive mowing
industry is efficient. After the takeover, the price rises to Pm, and the quantity supplied
falls to Qm. To profit maximise, the monopolist equates MR and MC, with P > MC. As a
result, resources are under allocated to a monopolistic lawn mowing industry. As there
are no barriers to entry, the monopoly would not survive.

Multiple-choice solutions
(pp 231–2)
1d the same as the market demand curve
2d price at which marginal revenue equals marginal cost
3d would do none of the above
4d all of the above are true
5b 200 units per day
6d earns positive economic profit
7b $25 per unit
8c (hint: TR = PxQ; TFC = (ATC–AVC) x Q) five.
9b differences in the price elasticity of demand among different groups of buyers
10d arbitrage
11e sets marginal cost equal to marginal revenue.

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