Monopoly 15

CHAPTER 15

Monopoly

Monopoly is business at the end

of its journey.

— Henry Demarest Lloyd

McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
 Monopoly 15

Chapter Goals

• Summarize how and why the decisions facing a

monopolist differ from the collective decisions of
competing firms

• Explain why MR = MC maximizes total profit for a

monopolist
• Determine a monopolist’s price, output, and profit
graphically and numerically

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 Monopoly 15

Chapter Goals

• Show graphically the welfare loss from monopoly

• Explain why a price-discriminating monopolist will

earn more profit than a normal monopolist

• Explain why there would be no monopoly without barriers

to entry
• Discuss three normative arguments against monopoly

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 Monopoly 15

A Monopolistic Market
• Monopoly is a market structure in which one firm makes up
the entire market
• Barriers to entry into the market prevent competition
• Barriers to entry can be:
• Legal
• Sociological
• Natural
• Technological
• There are no close substitutes for the monopolist’s product

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 Monopoly 15

The Key Difference

Between a Monopolist and a Perfect Competitor

• A monopolistic firm’s marginal revenue is not its price

• Marginal revenue is always below its price
• Marginal revenue changes as output changes and
is not equal to the price
• A monopolistic firm’s output decision can affect price
• There is no competition in monopolistic markets so
monopolists see to it that monopolists, not consumers,
benefit

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 Monopoly 15

Profit Maximizing Level of Output

• The goal of the monopolistic firm is to maximize profits,

the difference between total revenue and total cost
• The monopoly maximizes profit when marginal revenue
equals marginal cost
• Marginal revenue (MR) is the change in total revenue
associated with a change in quantity
• Marginal cost (MC) is the change in total cost associated
with a change in quantity

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 Monopoly 15

Profit Maximizing Level of Output

• The profit-maximizing condition of a monopolistic firm is:

MR = MC
• For a monopolistic firm, MR < P
• A monopolistic firm maximizes total profit, not profit per unit

If MR > MC,
• The monopoly can increase profit by increasing output
If MR < MC,
• The monopoly can increase profit by decreasing its output

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 Monopoly 15

Monopolistic Profit Maximization Table The profit-

maximizing
condition is:
Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($) MR = MR
0 36 0 47 --- -47
33 1
1 33 33 48 48.00 -15 If MC < MR,
27 2
2 30 60 50 25.00 10 increase
21 4 production
3 27 81 54 18.00 27
15 8
4 24 96 62 15.50 34 Profit maximizing
9 16
5 21 105 78 15.60 27 quantity is where
3 54 MC = MR
6 18 108 102 17.00 6
-3 40
7 15 105 142 20.29 -37 If MC > MR,
-9 56
8 12 96 198 24.75 -102 decrease
-15 80 production
9 9 81 278 30.89 -197

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 Monopoly 15

Monopolistic Profit Maximization Graph

Marginal revenue is not constant
P as Q increases because:
• revenue increases as the
MC
monopolist sells more
• revenue decreases because the
D at Qprofit max
monopolist must lower the price
to sell more
P= Find output where
$24
MC = MR, this is the profit
maximizing Q
MC = MR
D Find how much consumers
MR will pay where the profit
Q max Q intersects demand,
4 = Qprofit max
this is the monopolist price

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 Monopoly 15

Monopoly Compared to Perfect Competition Graph

• In a monopoly, P>MR,
P • In perfect competition, P=MR=D
MC • MR=MC is the profit max rule for
both

First find the monopoly

PM Q and P
PPC
Then find the perfectly
DPC= MRPC competitive Q and P
DM
Outcome: Monopoly output
MRM is lower and price is higher
Q
QM QPC than perfect competition

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 Monopoly 15
Find output where Determining Profits Graphically:
MC = MR, this is the profit
A Firm with Profit
maximizing Q
P
Find how much consumers MC
will pay where the profit
max Q intersects demand, D at Qprofit max
this is the monopolist price ATC

P
Find profit per unit where Profits
the profit max Q ATC ATC at Qprofit max
intersects ATC
MC = MR
D
Since P>ATC at the MR
profit maximizing quantity, Q
Qprofit max
this firm is earning profits

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 Monopoly 15
Determining Profits Graphically: Find output where
A Firm with Zero Profit or Losses MC = MR, this is the profit
maximizing Q
P
MC Find how much consumers
will pay where the profit
ATC
D at Qprofit max max Q intersects demand,
this is the monopolist price

P
ATC at Qprofit max Find profit per unit where
=ATC
the profit max Q
intersects ATC
MC = MR
D Since P=ATC at the
MR profit maximizing quantity,
Q this firm is earning
Qprofit max
zero profit or loss

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 Monopoly 15

Find output where

Determining Profits
MC = MR, this is the profit Graphically: A Firm with Losses
maximizing Q
P
Find how much consumers ATC at Qprofit max MC
will pay where the profit ATC
max Q intersects demand,
this is the monopolist price
ATC D at Qprofit max
Losses
P
Find profit per unit where
the profit max Q
intersects ATC
MC = MR
D
Since P<ATC at the MR
profit maximizing quantity, Q
Qprofit max
this firm is earning losses

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 Monopoly 15

The Welfare Loss from a Monopoly

P • The welfare loss from a

MC monopoly is represented by
the triangles B and D
• The rectangle C is a transfer
of surplus from the consumer
PM
PPC C D to the monopolist
B
• The area A represents the
opportunity cost of diverted
D resources, which is not a loss
A MR to society
QM QPC Q

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 Monopoly 15

The Price-Discriminating Monopolist

• When a monopolist price discriminates, it charges

different prices to different individuals or groups of
individuals
• Consumers with less elastic demands are charged
higher prices.
• Consumers with more elastic demands are
charged lower prices

• Price discrimination increases output and profits

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 Monopoly 15

The Price-Discriminating Monopolist

• Examples of price discrimination

• Movie discounts to senior citizens and children
• Airline discounts for Saturday-night stay overs
• Cars are seldom sold at list price
• Tracking consumer information and pricing
accordingly
• These markets are highly susceptible to price
discrimination because the market demand is made
up of distinguishable individuals who have different
demand elasticites

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 Monopoly 15

Barriers to Entry
• Natural Ability
• A firm is better at producing the good than anyone
else
• Economies of Scale
• Natural monopoly is when a single firm can
produce at a lower cost than can two or more firms
• Government-Created Monopolies
• Patents, licenses, and franchises
• If there were no barriers to entry, profit-maximizing firms
would always compete away monopoly profits

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 Monopoly 15

A Natural Monopoly Graph

Average • One firm producing Q1 has average cost C1
Cost
• If two firms share the market, each produces
Q0.5 and has average cost C0.5

• If three firms share the market, each

produces Q0.33 has average cost C0.33
C0.33

C0.5

C1
ATC
Q0.33 Q0.5 Q1 Q

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 Monopoly 15

A Natural Monopoly Graph, Profit and Regulation

• A natural monopolist produces QM and
Average
Cost charges PM, therefore earning a profit
• If there is government regulation and a
competitive solution where P = MC is
required, the monopolist produces QC
PM and charges PC, therefore earning a loss
Profits
CM

CC
Losses ATC
PC
MR MC
D
Q
QM QC

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 Monopoly 15

Normative Views of Monopoly

• Monopolies are unjust because they restrict freedom to

enter business
• Monopolies transfer income from “deserving” consumers
to “undeserving” monopolists
• Monopolies cause potential monopolists to waste
resources trying to get monopolies
• Rent-seeking activities

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 Monopoly 15

Government Policy and Monopoly: AIDS Drugs

• A few companies have patents for AIDS drugs that enable

them to charge high prices because demand is inelastic

Policy Options
• Government regulation where price = marginal cost
benefits society, but discourages research
• Government purchase of the patents and allowing
anyone to produce the drugs so their price = marginal
cost. This is expensive for taxpayers.

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 Monopoly 15

Chapter Summary
• Monopoly is a market structure, protected by barriers to
entry, in which a single firm produces a product for which
there are no close substitutes
• A monopolist maximizes profit or minimizes losses where
MR=MC
• To determine a monopolist’s profit or loss:
• Find output where MR=MC
• Determine price and ATC at that output
• Profit or loss = (P – ATC) * Q

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 Monopoly 15

Chapter Summary

• Monopoly output is lower and price is higher than in

competitive markets
• Because monopolies reduce output and charge P > MC,
monopolies create a welfare loss for society
• A price-discriminating monopolist earns more profit than
a normal monopolist by charging a higher price to those
with less elastic demand and a lower price to those with
more elastic demand

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 Monopoly 15

Chapter Summary
• Natural monopolies exist in industries with strong
economies of scale, so it is more efficient for one firm to
produce the entire output
• In a natural monopoly the competitive outcome where
P=MC results in losses
• Normative arguments against monopoly are:
• Monopolies are inconsistent with freedom
• Distributional effects of monopoly are unfair
• Monopolies encourage people to waste time and
money trying to get monopolies
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 Monopoly 15

Preview of Chapter 16:

Monopolistic Competition and Oligopoly

• List the four distinguishing characteristics of monopolistic competition

• Demonstrate graphically the equilibrium of a monopolistic competitor

• State the central element of oligopoly

• Explain why decisions in the cartel model depend on market share and
decisions in the contestable market model depend on barriers to entry

• Describe two empirical methods of determining market structure

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