Chapter 5: MONOPOLY

Monopoly
• Windows: the operating system sold by the Microsoft Corporation.
• When Microsoft first designed Windows, it applied for and received a
copyright from the government.
• The copyright gives Microsoft the exclusive right to make and sell copies of the
Windows operating system.
• If a person wants to buy a copy of Windows, she has little choice but to give
Microsoft the approximately $100 that the firm has decided to charge for its
product. Microsoft is said to have a monopoly in the market for Windows.
• Microsoft’s business decisions are not well described by the model of firm
behavior we developed in the previous chapter.
 Monopoly
• Monopoly: a firm that is the sole seller of a product without any close
substitutes

• Characteristics:
• There is only one producer and many consumers.
• Separate products, no substitutes.
• Barriers to entry into the industry.
• Prices and output are determined by the monopolist.
• There is no supply curve, no one-to-one relationship between price and
supply
 Monopoly
• Barriers to entry: A monopoly remains the only seller in its market because
other firms cannot enter the market and compete with it .
• Barriers to entry, have three main sources:
• Monopoly resources: A key resource required for production is owned by a
single firm.
• Government regulation: The government gives a single firm the exclusive right
to produce some good or service.
• The production process: A single firm can produce output at a lower cost than
can a larger number of firms.
 Natural Monopoly
• Natural monopoly: a type of monopoly that arises because a single firm can
supply a good or service to an entire market at a lower cost than could two or
more firms.
Ex: The distribution of water.
• To provide water to residents of a town, a firm must build a network of pipes
throughout the town.
• If two or more firms were to compete in the provision of this service, each
firm would have to pay the fixed cost of building a network.
• Thus, the average total cost of water is lowest if a single firm serves the entire
market.
How Monopolies Make Production and Pricing Decisions
 A Monopoly’s Revenue

Consider a town with a single producer of water

 Profit Maximization
• Demand and Marginal – Revenue Curves for a Monopoly

• The demand curve shows how the quantity sold affects the
price of the good.
• The marginal – revenue curve shows how the firm’s revenue
changes when the quantity increases by 1 unit.
• The price on all units sold must fall if the monopoly increases
production, marginal revenue is less than the price.
 Demand curve - Marginal revenue curve
• Demand curve of a monopoly firm:
- Market demand
- The demand curve slopes down to the right, AR = P

• Marginal revenue curve

• (D): P = a + bQ
TR = P.Q à TR = (a + bQ).Q = a.Q + b.Q2
MR = a + 2b.Q
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Profit Maximization
The monopolist’s profit-maximizing quantity of output is determined by
the intersection of the marginal-revenue curve and the marginal-cost
curve
 Profit Maximization

•In competitive markets, price equals marginal cost.

•In monopolized markets, price exceeds marginal cost.

• For a competitive firm: P = MR = MC.

• For a monopoly firm: P > MR = MC.
A Monopoly’s Profit

•Profit = TR - TC.
We can rewrite this as:
•Profit = (TR/Q - TC/Q) x Q.
•Profit = (P - ATC) x Q.
 Decide the output of a firm
• Firm’s target:
• Maximize Profit (Prmax)

• Maximize Total Revenue (Trmax)

• Maximize output without loss (P = AC & Qmax)

• Achieve normalized profit over average cost (a.AC)

16
Decide the output of a firm
• Maximize Profit (Prmax)
MR, MC, AC
MC

AC

AC

D
Q
Q 17
MR
Decide the output of a firm
• Maximize Profit (Prmax)

▫ Firm in m monopoly market

– MR = MC < P

▫ Firm in perfectly compmarket e market

– MR = MC = P

18
Decide the output of a firm
• Maximize Total Revenue (Trmax)
MR, MC, AC

TR

D
Q
Q 19
MR
 Decide the output of a firm
• Maximize output without loss (P = AC & Qmax)
MR, MC, AC

A AC
P1

B
P2

D
Q
Q1 Q2 20
 Decide the output of a firm
• Achieve normalized profit over average cost (a.AC)
MR, MC, AC P = (1 + a) AC

A (1 + a)AC
P1 AC

E
P2

D
Q
Q1 Q2 21
Monopoly - The Analytics of Price

P = a + b.Q
TR = P.Q

MR =
TR
=
(P.Q ) = P
.Q + P.
Q
Q Q Q Q
P Q 1
MR = P. . + 1 = P. 1 +
Q P ED
MR MC
P= =
1 1
1+ 1+
ED ED
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 Measure the degree of monopoly
MC 1 P MC
P= =
1 ED P
1+
ED
• Lerner coefficient
L = (P – MC) / P
The bigger the L, the higher the level of monopoly
L = 1: Monopoly
L = 0: Perfect Competition

• Bsin coefficient

B = (P – AC) / P
In longterm: P = LAC and B = 0 23
Monopoly and The Inefficiency of Monopoly

MR, MC, AC
MC
A

B
P
P* E*
C
E
D
Q
Q Q*
MR
24
Summary