Lecture 10

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Economics
6th edition, Global Edition
Chapter 15 &
Chapter 16
Monopoly and Antitrust
Policy
Copyright © 2017 Pearson Education, Ltd. All rights reserved.

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Chapter Outline
15.1 Is Any Firm Ever Really a Monopoly?
15.2 Where Do Monopolies Come From?
15.3 How Does a Monopoly Choose Price and Output?
15.4 Does Monopoly Reduce Economic Efficiency?
15.5 Government Policy Toward Monopoly
16.1 Price Discrimination

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15.1 Is Any Firm Ever Really a Monopoly?
Monopoly is a market structure consisting of a firm that is the only

seller of a unique good or service that does not have a
close/perfect substitute (relatively inelastic demand curve).
Monopoly exists at the opposite end of the competition spectrum
to perfect competition.
We study monopolies for two reasons:
1. Some firms truly are monopolists, so it is important to
understand how they behave.
2. Firms might collude in order to act like a monopolist; knowing
how monopolies act helps us to identify these firms.

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Do monopolies really exist?
Suppose you live in a small town with only one pizzeria. Is that
pizzeria a monopoly?
1. It has competition from other fast-food restaurants
2. It has competition from grocery stores that provide pizzas for
you to cook at home
If you consider these alternatives to be close substitutes for
pizzeria pizza, then the pizza restaurant is not a monopoly.
If you do not consider these alternatives to be close substitutes for
pizzeria pizza, then the pizza restaurant is a monopoly.
Regardless, the pizzeria’s unique position may afford it some
monopoly power to raise prices, and obtain economic profit.

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15.2 Where Do Monopolies Come From?
For a firm to exist as a monopoly, there must be barriers to entry

preventing other firms coming in and competing with it.
The four main barriers to entry are:

1. Government restrictions on entry
2. Control of a key resource
3. Network externalities
4. Natural monopoly

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1. Government Restrictions on Entry
In the U.S., governments block entry in two main ways:
a. Patents and copyrights

Newly developed products like drugs are frequently granted
patents, the exclusive right to produce a product for a period of 20
years from the date the patent is filed with the government.
Similarly, copyrights provide the exclusive right to produce and
sell creative works like books and films.
Patents and copyrights encourage innovation and creativity, since
without them, firms would not be able to substantially profit from
their endeavors.

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1. Government Restrictions on Entry
In the U.S., governments block entry in two main ways:
b. Public franchises
A government designation that a firm is the only legal provider of a
good or service is known as a public franchise. These might
exist, for example, in electricity or water markets.
Sometimes (more commonly in Europe than the U.S.)
governments even operate these firms as a public enterprise.
• A U.S. example of this is the U.S. Postal Service.

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2. Control of a Key Resource
For many years, the Aluminum Company of America (Alcoa) either

owned or had long-term contracts for almost all the world’s supply
of bauxite, the mineral from which we obtain aluminum.
• Such control over a key resource served as a substantial

barrier to entry for additional firms.
The National Football League (NFL) acts as a monopoly in this

manner too: it ensures that the majority of the world’s best football
players are under contract to the NFL, and unable to be used for
another potential league.

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3. Network externalities
Economists refer to network externalities as a product

characteristic whereby the usefulness of a product increases with
the number of consumers who use it.
Examples: Auction sites (like eBay)

Computer operating systems (like Windows)
Social networking sites (like Facebook)
These network externalities can set off a virtuous cycle for a firm,
allowing the value of its product to continue to increase, along with
the price it can charge.
But consumers may be locked into an inferior product.

Figure 15.1 Average total cost curve for a natural monopoly
A natural monopoly 10
occurs when economies of
scale are so large that one
firm can supply the entire
market at a lower average
total cost than can two or
more firms.
In the market for electricity
delivery, a single firm (point
A) can deliver electricity at
a lower cost than can two
firms (point B).
Natural monopolies are
most likely when fixed
costs are high.
Other Types of Barriers to Entry
Product differentiation and brand loyalty

If a firm produces a clearly differentiated product,
where the consumer associates the product with
the brand, it will be very difficult for a new firm to
break into the market.
Economies of scope
A firm that produces a range of products can use
use shared research, marketing, storage, transport
facilities, etc…. The lower costs make it difficult for
a new single-product entrant to the market.

Lower costs for an established firm

An established monopoly is more likely to have developed
specialised production and marketing skills and to be more
aware of the most efficient techniques, to have access to
cheapest finance as well as the most reliable and/or
cheapest suppliers. Thus, it is operating on a lowest cost
curve. New firms would find it hard to compete and would be
likely to lose any price war.

Ownership of, or control over, wholesale or

retail outlets
If a firm control the outlets through which the product must be
sold, it can prevent potential rivals from gaining access to
consumers.
Mergers and takeovers

The monopolist can put in a takeover bid for any new
entrant and this may discourage new entrants.

Aggressive tactics
An established monopolist can probably sustain losses for
longer than a new entrant. Thus, it could start a price war,
mount massive advertising campaigns, offer attractive after-
sales service, introduce new brands to compete with new
entrants, etc.
Intimidation
The monopolist may resort to various forms of harassment,
legal or illegal, to drive a new entrant out of business.

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15.3 How Does a Monopoly Choose

Price and Output?
Monopolists have no competitors, and hence no concern about

strategic interactions.
• They seek to maximize profit by choosing a quantity to

produce, just like perfect competitors.
In fact, monopolists face a downward sloping demand curve.
• The barriers to entry will prevent other firms from competing

away their economic profit.

Monopoly Price-Setting Strategies
There are two types of monopoly price-setting

strategies:
A single-price monopoly is a firm that must sell

each unit of its output for the same price to all its
customers.
Price discrimination is the practice of selling

different units of a good or service for different
prices. Many firms price discriminate, but not all of
them are monopoly firms.

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Figure 15.2 Calculating a monopoly’s revenue television

Time Warner Cable is
a monopolist in a local
market for cable
services.
The first two columns
show the market
demand curve, which
is also Comcast’s
demand curve.
The price (P) equals
average revenue (AR).
The firm’s demand
curve (a downward
sloping line) is also its
AR and P.
P = D = AR
Price and MR for the Monopolist
Price and Marginal Revenue
– A monopoly is a price setter, not a price taker like a firm in

perfect competition.
– The reason is that the demand curve for the monopoly’s output
is the market demand curve.
– To sell a larger output, a monopoly must set a lower price.

Hence, marginal revenue is less than price at each level of
output (refer to Table 15.2). That is,
MR < P
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Figure 15.2 Calculating a monopoly’s revenue
As the monopolist
decreases price to expand
output, two effects occur:
1. Revenue increases
from selling an extra
unit of output.
2. Revenue decreases,
because the price
reduction is shared
with existing
customers.

A Single-Price Monopoly’s Output and Price
Decision
Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the

elasticity of demand for its good:
If demand is elastic, a fall in price brings an increase in total

revenue. MR is positive.
If demand is inelastic, a fall in price brings a decrease in total

revenue. MR is negative.
If demand is unit elastic, a fall in price does not change total

revenue. MR = 0, where total revenue is maximized.

A Single-Price Monopoly’s Output and
Price Decision
Price and Output Decision
– The monopoly selects the profit-maximizing level of

output in the same manner as a competitive firm,
where MR = MC.
– The monopoly sets its price at the highest level (P >

MC – the P is determined at a point on the demand
curve) at which it can sell the profit-maximizing
quantity.
– Profit is the difference between these (P - AC),

times quantity (Q).
A Single-Price Monopoly’s Output and Price
Decision
In the short run, a monopoly may make a positive

economic profit, zero economic profit or even a negative
economic profit.
The monopoly might make a positive economic profit,

even in the long run, because the barriers to entry protect
the firm from market entry by competitor firms (almost if
not completely blocked).
But a monopoly that incurs an economic loss might shut

down temporarily in the short run or exit the market in the
long run.
Positive Economic Profit/Supernormal Profit
Price,
revenue,
cost ($) P MC AC
AC
D = P = AR
Qe MR Quantity (unit)

Zero Economic Profit/Normal Profit
Price,
revenue, MC
cost ($) AC
AC = P
D = P = AR
MR Quantity (unit)

Negative Economic Profit/Subnormal Profit
Price, cost,
revenue ($) AC
AC MC
P AVC
AVC
D = P = AR
Qe MR Quantity (unit)

Long-run profits for a monopoly
If the monopoly is earning supernormal profit, this

can lead to entry of new firms.
But in a monopoly, entry of new firms is restricted or

almost completely blocked.
So a monopoly earns supernormal profit in the long

run.
15.4 Single-Price Monopoly and Competition
Efficiency Compared
Comparing Price and Output
The next figure compares the price and quantity in perfect

competition and monopoly.
The market demand curve, D, in perfect competition is the

demand curve that the firm in monopoly faces.
The market supply curve in perfect competition is the horizontal

sum of the individual firm’s marginal cost curves, S = MC.
This curve is the monopoly’s marginal cost curve.

Perfect Competition
Equilibrium occurs where the

quantity demanded equals the
quantity supplied at quantity Qc
and price PC. Profit –maximizing
output, Qc occurs where MR =
MC.
Monopoly
Equilibrium output, QM, occurs

where marginal revenue equals
marginal cost, MR = MC.
Equilibrium price, PM, occurs on
the demand curve at the profit-
maximizing quantity.

Efficiency Comparison – PC and Monopoly
The efficiency of perfect

competition.
The market demand curve is the
marginal benefit curve, MB.
The market supply curve the
marginal cost curve, MC.
So competitive equilibrium is
efficient: MB = MC.
Total surplus, the sum of
consumer surplus and producer
surplus, is maximized.
The quantity produced is efficient.

The inefficiency of
monopoly.
Because price exceeds
marginal cost (P > MC),
marginal benefit exceeds
marginal social cost (MB >
MC), and a deadweight loss
arises (quantity produced is
below socially optimum
level).
Redistribution of Surpluses -
Some of the lost consumer
surplus goes to the
monopoly as producer
surplus.
Price
Monopoly is inefficient
because:
MC AC - It does not achieve
Pm
productive efficiency. The
Pc firm always produces at

the decreasing part of AC
(P ≠ min AC). There is a

problem of excess
D = P = AR capacity.
MR
- It does not achieve
Qm Qc Quantity allocative efficiency.
Consumers have to pay
Excess capacity higher price (P > MC).
Consumer welfare
Copyright © 2017 Pearson Education, Ltd. All rights reserved. (surplus) is not maximized
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15.5 Government Policy Toward Monopoly
Because monopolies reduce consumer surplus and economic

efficiency, governments regulate their behavior.
• Many governments try to stop firms colluding, and seek to
prevent mergers and acquisitions creating large firms, through
antitrust laws.
Collusion: An agreement among firms to charge the same price
or otherwise not to compete.
Antitrust laws: Laws aimed at eliminating collusion and
promoting competition among firms (refer to Table 15.1).

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Table 15.1 Important U.S. antitrust laws (optional)
In the 1870s and

1880s, several
“trusts” had formed:
boards of trustees
that oversaw the
operation of several
firms in an industry,
and enforced
collusive agreements.
The federal
government
responded with
antitrust laws to limit
anti-competitive
behavior.
16.1 Price Discrimination
Price discrimination is the practice of selling different units

of a good or service for different prices.
There are 3 major types:
1. First degree price discrimination: The consumer is charged the

maximum price he or she is prepared to pay for each unit due to
consumer surplus - stallholders.
2. Second degree price discrimination: A firm charges a consumer

so much for the first so many units purchased, a different price
for the next so many units purchased, and so on - utilities. In
terms of quantity - one for $4, three for $10.

Price Discrimination
3. Third degree price discrimination: Charging different

prices in different markets/groups - product in local
market and international market; bus fares for adults
and children; student and non-student haircut.
To be able to price discriminate, a monopoly must:

– Have market power.
– Identify and separate different markets where product must
not be able to be resold from low-priced to high-priced
markets.
– Different demand elasticity for each market – higher price in
inelastic market & lower price in elastic market.
Advantages & Disadvantages of
Monopoly
Disadvantages of monopoly
– high prices / low output: short run & long run

– lack of incentive to innovate
– poor quality output
– greater income inequality
– productively inefficient (P > min LRAC)
– allocatively inefficient (P > MC)
Advantages of monopoly
– higher productivity & lower ATC (economies of scale)

– product innovation & improvement (investment)
– social benefits/responsibilities
– provision of infrastructures
–

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1

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

15.1 Is Any Firm Ever Really a Monopoly?

Monopoly is a market structure consisting of a firm that is the only

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Do monopolies really exist?

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

15.2 Where Do Monopolies Come From?

For a firm to exist as a monopoly, there must be barriers to entry

The four main barriers to entry are:

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

1. Government Restrictions on Entry

In the U.S., governments block entry in two main ways:

a. Patents and copyrights

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

1. Government Restrictions on Entry

In the U.S., governments block entry in two main ways:

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

2. Control of a Key Resource

For many years, the Aluminum Company of America (Alcoa) either

• Such control over a key resource served as a substantial

The National Football League (NFL) acts as a monopoly in this

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Economists refer to network externalities as a product

Examples: Auction sites (like eBay)

But consumers may be locked into an inferior product.

Product differentiation and brand loyalty

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Lower costs for an established firm

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Ownership of, or control over, wholesale or

Mergers and takeovers

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

15.3 How Does a Monopoly Choose

Monopolists have no competitors, and hence no concern about

• They seek to maximize profit by choosing a quantity to

In fact, monopolists face a downward sloping demand curve.

• The barriers to entry will prevent other firms from competing

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

There are two types of monopoly price-setting

A single-price monopoly is a firm that must sell

Price discrimination is the practice of selling

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Figure 15.2 Calculating a monopoly’s revenue television

Price and Marginal Revenue

– A monopoly is a price setter, not a price taker like a firm in

– To sell a larger output, a monopoly must set a lower price.

Figure 15.2 Calculating a monopoly’s revenue

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Marginal Revenue and Elasticity

A single-price monopoly’s marginal revenue is related to the

If demand is elastic, a fall in price brings an increase in total

If demand is inelastic, a fall in price brings a decrease in total

If demand is unit elastic, a fall in price does not change total

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Price and Output Decision

– The monopoly selects the profit-maximizing level of

– The monopoly sets its price at the highest level (P >

– Profit is the difference between these (P - AC),

In the short run, a monopoly may make a positive

The monopoly might make a positive economic profit,

But a monopoly that incurs an economic loss might shut