Chapter 9

Monopoly

ECONOMICS: Principles and Applications, 4e

HALL & LIEBERMAN, © 2008 Thomson South-Western
 Monopoly
• Monopoly firm - The only seller of a good or service
with no close substitutes
• Monopoly market
– The market in which the monopoly firm operates
• Barriers to entry
– Economies of scale
– Legal barriers
– Network externalities

2
 Barriers to Entry
• Economies of scale
– One firm can operate at lower average cost than other
firms
– Natural monopoly - arises when one firm
• can produce for the entire market
• at lower cost per unit

3
 Figure 1: A Natural Monopoly
• Figure 1 A Natural Monopoly

Three firms –each produce 100 units

Dollars
Each operate at C on LRATC curve
Cost per unit = $15
Two firms- each produce 150 units
Each firm operate at B on LRATC
$15 C Cost per unit = $12 (higher)
B
12 One firm – produce 300 units
Operate at A on LRATC curve
A Cost per unit=$5
5
LRATC

100 150 300 Articles of

Clothing
per Day
4
 Barriers to Entry
• Legal barriers
– Protection of intellectual property
• Patents - temporary grant of monopoly
• Copyrights - grant of exclusive rights to sell a literary, musical,
or artistic work
– Government franchise
• Grant of exclusive rights over a product

5
 Barriers to Entry
• Network Externalities
– The added benefits for all users of a good or
service that arise because other people are using
it too
– Joining a large network is more beneficial than
joining a small network

6
 Monopoly Behavior
• Goal
– Earn highest profit possible
• Economic constraints
– Cost – to produce any level of output
• Input prices
• Technology
– Given market demand curve
• the highest price it can charge

7
 Monopoly Price or Output Decision
• The output level
– And the maximum price it can charge and still sell that
output level
• The price
– And the maximum output the firm can sell at that price
• The MR curve lies below the demand curve
– Downward-sloping demand curve
– MR<P

8
Figure 2: Demand and Marginal Revenue
• Figure 2 Demand and Marginal Revenue for Patty’s Pool
Dollars
$13

A
10
9 B

Demand

0
-1 3 4
MR 9
 The Profit-Maximizing Output Level
• To maximize profit
– Produce the quantity where MC = MR
– MC curve crosses the MR curve from below
• Price and output are not independent decisions, but
different ways of expressing the same decision

10
 The Profit-Maximizing Output Level
• Figure 3 Monopoly Price and Output Determination

Monthly $60 MC
Price per
Subscriber

40 E

10,000 30,000
MR
Number of Subscribers
11
 Monopoly and Market Power
• Market power
– The ability of a seller to raise price without losing all
demand for the product being sold
• Price setter
– A firm with market power that selects its price, rather
than accepting the market price as a given

12
 Profit and Loss
• Profit
– When P > ATC
– Total profit = Profit per unit * Q
– Profit per Unit = P – ATC
• Loss
– When P < ATC
– Total loss = Loss per unit * Q
– Loss per unit = ATC - P
13
 Profit and Loss
• Figure 4 Monopoly Profit and Loss
(a) (b)
Dollars MC ATC Dollars ATC
MC AVC
$50
E E
$40 40
32 Total Loss

Total
Profit

D D
10,000 Number of 10,000 Number of
MR Subscribers MR Subscribers
14
 Equilibrium in Monopoly Markets
• Monopoly market – equilibrium
– The monopoly is maximizing profit
• Short run
– Produce where MR=MC
– Profit if P>ATC
– Loss if P<ATC
• If P>AVC – produce
• If P<AVC – shut down

15
 Equilibrium in Monopoly Markets
• Long run
– Monopolies may earn economic profit
– Monopoly suffering an economic loss - should always
exit the industry
• If regulated - the government may decide to subsidize it
• If privately owned – exit the industry

16
 Monopoly vs. Perfect Competition
• Economic profit
– Reduced to zero by entry of other firms – in perfect
competition
– Continue indefinitely – in monopoly
• For a given technology, monopoly market
– Higher price
– Lower output
• than a perfectly competitive market

17
 Monopoly and Perfect Competition
• Figure 5 Comparing Monopoly and Perfect Competition
(a) Competitive Market (b) Competitive Firm
Price Dollars 2. and each firm produces
per per Unit 1,000 units, where P = MC.
Unit S
MC ATC

E
$10 $10 d=MR

D
Quantity of Quantity of
100,000 1,000
Output Output
1. In this competitive market 3. When monopoly takes
of 100 firms, equilibrium over, the old market
price is $10… supply curve . . .
18
 Monopoly and Perfect Competition
• Figure 5 Comparing Monopoly and Perfect Competition
(c) Monopoly
Price 4. becomes the monopoly's MC curve.
per
Unit S = MC

F
$15
5. The monopoly produces where MR = MC,
E
10

MR D
Quantity of
100,000 Output
60,000 6. with a higher price and lower market
output than under perfect competition.
19