Microeconomics Monopoly

Chapter 1: Pure Monopoly
•Chapter Outline
• Introduction
•Characteristics of Monopoly Firm
•Demand and Revenue functions
• Short-run equilibrium
• Long run equilibrium
• Multi-plant Monopoly
• Price Discrimination
• Comparison with Perfect competition
• The social cost of monopoly ..the deadweight loss
02/21/2024 Micro II Slides Monopoly Guta AAU
1
1.1.What is a Pure Monopoly?
• A pure monopoly exists when a single firm is the sole
producer of a product for which there are no close
substitutes.
• Monopoly is a market structure in which there is a single
seller of goods and services which has no close substitutes in
the market
• A monopoly is a market that has only one seller, but many buyers.
• Monopsony is the opposite of monopoly: a market with
many sellers but only one buyer
• In a monopolised market structure, the industry is a single-
firm industry.
– Examples: local telephone company, Hydro electric company,
Ethiopian airlines, etc
02/21/2024 Micro II Slides Monopoly Guta AAU 2
1.2.Characteristics of Pure Monopoly
1. Single supplier – the firm and the industry
are synonymous.
2. No close substitutes – the product is unique
and unlike any others.
3. Price maker – the firm has considerable
control over price since it controls the total
quantity supplied.
4. Blocked entry – barriers to entry exist
because there is no immediate competition.

1.3. Sources or causes of monopoly power
• Barriers to entry are factors that prohibit firms from entering an
industry.
• The barriers to entry are the sources of monopoly power.
They include:
1. Size of the market.....natural monopoly
2. Economies of scale
3. Legal barriers to entry: Copy rights, patent rights,
government franchise and licensing
4. Ownership or control of essential resources
5. Exclusive knowledge of production process
6. Pricing policies of existing firms…limit pricing
7. Mergers, takeovers and acquisitions
Natural Monopoly
• A natural monopoly exists when the
technology for producing a good or service
enables one firm to meet the entire market
demand at a lower price than two or more
firms could.

Economies of Scale
• If as a firm expands average total cost falls, then economies
of scale exist.
• Where a single firm, achieves a low average total costs,
given market demand a natural monopoly created.
• A natural monopoly exists because economies of scale are
large and the firm can achieve minimum efficient scale.
• New firms face very large start up costs which result in
high average total costs. This makes it hard to compete
with a monopolist that is already well established.
• The large firm decrease price to abolish new entrants

Economies of Scale
P, Cost
AC with four
firms = 15 Economies of scale
exists when Mkt DD
is met
AC with two LAC
firms =10
AC with one
firms =6
DD
Q
4 8 12

Economies of scale …..continued
•
LAC
ACS t –
g p a r ca le
l i ni n s of s
•D ec m i e
o n o -
ec g p a r t
f s ca le
a s i n ie s o
•Incre econom
dis
ACL
QS QL

Legal Monopoly
• A legal monopoly is a market in which competition and entry
are restricted by granting of a public franchise, government
license, patent, or copyright.
• A patent right is the exclusive right of an inventor to
use, or to allow another to use, her or his invention.
– It is an exclusive right granted to the inventor of a product or
service.
• Patent rights are granted by the government to a firm
to produce a commodity of specified quality and
character or to use a specified technique of production.
• Such monopolies are called patent monopolies.
• In the United States, a patent is valid for 20 years
Legal Monopoly ……cont’d
• Copyright is an exclusive right granted to the
author or composer of a literary, musical,
dramatic, or artistic work.
• A Public Franchise is an exclusive right
granted to a firm to supply a good or service.
• Government franchise is the promise of the government to
prohibit new entrants
• A government license controls entry into
particular occupations, professions, and
industries.
Patents and Copyrights in Ethiopia
• Both patents and copyrights are issued by the
govt’t of Ethiopia
• Patent rights are given under four categories
– Patents……for invention of new thing in Ethiopia
• Given for 15 years
– Patents of introduction
– Utility Model Certificates
– Certificates of Registration of Industrial Designs

Patents and Copyrights in Ethiopia ….cont’d
• Copyrights are also given under two
categories:
1. Copyrights for authors
 Valid for the life time of the author and 50 years after
her/his death
2. Copyrights for sound performers and
producers
 Valid for 50 years

Sole Ownership Essential Resources and/or/ Exclusive
knowledge of techniques of production
• A firm that owns or controls an essential resource
can prohibit the entry or rival firms.
• Private property serves as an obstacle to potential
rivals.
• When only a single firm knows how the out put is
produced then only the firm supply it
• Because others do not know how to produce
• Note: monopoly firms can also be divided in to
two as government monopoly or market
monopoly.
1.4. Monopoly Demand, Revenue and Cost Curves
• In pure competition, a firm faces a perfectly

elastic demand since it is a price taker.
• The market supply and demand curves
determine price, which determines the
firm’s demand curve.
• In pure monopoly, the firm’s demand curve is
the market demand curve.
• The pure monopolist is the industry; therefore,
the demand curve is downward-sloping.
Demand ……cont’d
Pure Competition Pure Monopoly
Price Price
Ep>1
P
Firm’s demand Ep=1 same as Market
Demand
0<Ep<1
0 0
Quantity Quantity

Demand ……cont’d
• Mathematically down ward sloping dd curve is
represented by equation of the form
Y=a-bX and
• Thus, P=a-bQ
• a- is the y(p) axis intercept
• -b- slope of demand curve = D(Y)/d(X) =
d(Q)/ d(P)

Total Revenue
• Total revenue is the total sale received from
selling a specific amount.
• Mathematically
TR=PQ
TR=(a-bQ)Q
TR=aQ-bQ2, which is quadratic
equation and its graph is downward concave
parabola

Continued…
TR
TR
Q
– TR=maximum when its slope MR=0

Average Revenue
• AR measures the revenue received from the sale of one
unit on average
• AR= = = P
• Thus, for pure monopoly P=AR

Marginal Revenue
• MR measures the revenue received from the sale of
one additional unit
• MR= = = = a-2bQ = MR
• MR is the slope of TR function
• MR is the first order derivative of the TR function
w.r.t. Q
• MR is less than price(the demand curve)
• P=a-bQ and MR=a-2bQ
• P>MR

DD, AR, MR, TR and ep
P
Ep>1
Ep<1
P1
Ep<1 DD  P=AR
Q1 Q
TR MR
TR
Q1 Q
DD, AR, MR, TR and ep
P Q TR AR MR
$6 0 0 - -
$5 1 5 5 5
$4 2 8 4 3
$3 3 9 3 1
$2 4 8 2 -1
$1 5 5 1 -3

The relationship among AR , P, MR and price
elasticity of demand (ep)
TR P Q P
• Given TR=P*Q, MR 
Q
 P' Q  Q' P 
Q
Q  P  P(1 
P Q
)
Q P
• Note that P Q is the reciprocal of the
price elasticity of demand(ep)
1
• Therefore , MR  P (1 
ep
)
• Since P= AR, 1
MR  AR(1  )
ep

• The general relationship between AR and MR
can be summarized as follows
• When
– ep= 1, MR = 0 AR > 0 therefore, AR > MR
– ep < 1 >0 MR < 0, AR > 0 therefore, AR > MR
– ep > 1 < ∞ MR >0, AR > 0 but AR > MR
– ep = 0, MR < 0, AR = 0 therefore, AR > MR
– ep = ∞, MR > 0, AR > 0 and AR = MR

Graphically,
AR, e =∞
A
MR
e >1
e =1
e <1
AR e =0
Q
MR

Cost curves under monopoly
• In the short run, cost condition faced by a
monopoly firm are, for all practical purposes,
identical to those faced by a firm under
perfect competitions
• A monopoly firm is faced with usual U-shaped
AC and MC curves

The Monopolist Is a Price Maker/searcher/
• A pure monopolist can influence market

supply through its output decisions.
Subsequently, it can also influence the
product price.
• By increasing market supply can decrease
p or
• By decreasing market supply can
increase p
Monopoly Price-Setting Strategies
• A monopolist faces a tradeoff

between price and the quantity sold
• There are two price-setting possibilities:
– Single price(uniform price )
• 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
• A price-discriminating monopoly is a firm that is able to sell
different units of a good or service for different prices.
1.5. Short Run equilibrium
(Output and Price Determination)
• In perfect competition market profit maximizing
price is set by the DD & SS forces of the market
and the firm determine only the profit
maximizing quantity, Q
• In pure monopoly market both profit maximizing
P and Q are set by the firm…two decision variables
• There are two approaches:
– TR-TC approach and
– MR-MC approach

1.5.1.Total Revenue Total Cost approach
• P & Q are set by comparing TR and TC
• At equilibrium point:
I. The (+) gap b/n TR and TC is maximum
where TR > TC
II. The (-) gap b/n TR and TC is minimum,
where TR<TC

TC
a’
a Lines aa’ and bb’
TR
are parallel and
TC
their slopes are
• equal
 Thus slope of TR
b’
b TR (MR) and slope of
TC (MC) are equal
at the tangency
Q* points
Q
π
Q
Q*
π
1.5.2. Marginal Revenue- Marginal Cost Approach
• It is derived from total approach

• Profit maximizing Q is set where
MR=MC and MC is increasing (lope of
MC > slope of MR)
• MR curve–downward sloping (slope
negative)

Graphically,
P, MC
MC
Pe
e
DD P=a-bQ
Q
Qe
MR

SR Equilibrium ….continued
• A monopolist produces a level of output

where MR = MC. This determines the profit
maximizing output.
• Price is determined by the market demand
curve.
– A vertical line is drawn from Qe to the
demand curve.
– Pe is the profit-maximizing price.

Exercise
Price MC
ATC
P=10
Q: Find Profit for the
AC=8
firm whose graph
e
DD
20 MR Quantity of output
Short run equilibrium profit: the three possibilities
Case A: Positive profit
P MC
P > AC at
equilibrium
P B AC
Monopolist
AC Profit A
MC e
DD
MR
Q

Case B: negative profit( Loss)
P MC AC
AC Mon B
opo
list L P < AC at
os s
equilibrium
P A
MC
e
DD
MR
Q

Case C: zero economic profit (Normal Profit)
P MC
P = AC at
AC equilibrium
P= AC
MC
DD
MR
Q

Mathematically
• An Equation reach its maximum where its

slope is Zero and
• Slope of the first equation slope is less than zero
or
• First order derivation is = 0 (necessary)
• Second order derivation < 0 (sufficient)

Continued…
• π = TR – TC
• F.O.C
d d dTR dTC
0   0
dQ dQ dQ dQ
MR  MC  0
MR  MC
Continued…
• S.O.C
d  2
d  d (TR  TC )
2 2
2
 0  2
 2
 0
dQ dQ dQ
d ( MR  MC ) dMR dMC
0 
dQ dQ dQ
slope...of ( MR )  slope...of ( MC )
Numerical example #1
• Assume a pure monopoly firm with Demand,

p=40-Q, TFC=50, and TVC=Q2
• Required:
a) the profit maximizing unit of output and price
b) the maximum profit
• Answer
a) Q=10, P=30
b) π= 150

• Suppose the monopolist faces the market demand
function given by 144
Q 
P2
• The AVC of the firm is given as AVC = Q ½ and
the firm has a fixed cost of $ 5
• Required:
a) determine equilibrium P&Q
b) determine the maximum profit
• Answer: a)_____________ b) __________________

Numerical Example #3
• Given: TC and DD as:
• and
• Required:
a) determine equilibrium P&Q
b) determine the maximum profit
• Answer: a Qe= 6.7 b) Pe=13.3

1.6. Markup pricing: the relationship b/n
MC and P
• At equilibrium, price is set where MR=MC
• But managers know MC and do not know MR before
P is set
• They use a Rule of Thumb for Pricing
• So the easy and practical way of setting P is markup
pricing using the formula that can be derived from
MR=MC MC
P 
1 ep  1.elastic.or
1
ep
unitary.elastic
Markup …….continued…
• Mark up is the amount added on MC to get P
• P-MC=mark up
• Example
• Monopolist TC=10+1.5Q
Estimated ep=-4
a) Find profit maximizing P (answer=2)
b) What is the markup (answer 0.5)

Markup …….continued…
• Derivation of Mark up pricing formula from MR=MC
• TR=PQ
dTR d ( PQ) dQ dP
MR   P Q
dQ dQ dQ dQ
QdP
MR  P 
dQ

Continued…
dQ
• But dQ P solving for
ep  dP
dP Q
• dQ epQ find its reciprocal and insert in

dP P the MR equation
dP P

dQ epQ
• Since, MR=P+Q(dP/dQ)
QP
MR  P 
epQ
Continued…
P 1 1
MR  P   MR  P (1  )  MR  P (1  )
ep ep ep
Solving , for , P...and ..knowing .that.ep..is..negative

MR
p , but  MR  MC , at...equlibrium
1
1
ep
MC
Thus,  p 
1
1
ep

Markup pricing …cont’d
• Where, the markup value is given by
•

Monopoly Power
• Market power is the ability of a single economic
actor (or small group of actors) to have a substantial
influence on market prices
• Pure monopoly is rare
• Several firms compete with one another in any market
• In perfect competition, many sellers are there no
monopoly power  P=MC
• In pure monopoly, one seller  monopolize the
market  P>MC
• Measuring monopoly power is simply measuring the
extent to which P>MC
The Lerner Index
• It is measured by Lerner index that is derived
from mark up pricing formula
• The index was developed by Abba Lerner,
P  MC 1
1934 L  L 
P ed
• Thus, and
• The Lerner index lies between zero and one
– L=0 implies, absence of monopoly power
– L=1 implies, maximum monopoly power
• The larger the value of L, the greater the degree of
monopoly power
Numerical Example:
• Given demand curve as Q= 20-2P
a. Measure monopoly power of the
firm using the Lerner index(L) if the
market price of the product at
equilibrium is 6.

1.7. Supply Curve under Monopoly
• For a perfect competitive firm
– its supply curve is the segment of MC curve above the minimum
of AVC and
– there is one to one correspondence b/n P&Q
• For pure monopoly firm
• There is no unique supply curve due to the fact that,
I. The same Q can be sold at different P
II. Different Q can be sold at the same P based on the elasticity
of the DD curve
• A monopolistic market has no supply curve
• There is no one-to-one relationship between price
arid the quantity produced.
Supply Curve …cont’d
• The reason is that the monopolist's output

decision depends not only on marginal cost, but
also on the shape of the demand curve.
• Shifts in demand can lead to changes in price
with no change in output, changes in output
with no change in price, or changes in both.
• Shifts in demand usually cause changes in both
price and quantity
• Note: A competitive industry supplies a specific
quantity at every price and no such relationship
exists for a monopolist
Graphically,
P, MR, MC
P, MR, MC
P2 MC
P1=P2
MC
P1
DD2
DD1
DD1
Q Q
Q1=Q2 Q1 Q2
DD2 MR2
MR1
MR2 MR1
1.8. Long – run Equilibrium under Monopoly
• In perfect competition, there is free entry and
exit of firms– thus, normal profit in the LR
• In monopoly, there are barriers to entry
and thus, in the LR the firm can get:
– (+) profit
– (0)profit
• It can also build a plant which is:
– Less than optimal plant(small)
– Optimal plant
– Greater than optimal plant(large)
Long – run Equilibrium…… cont’d
• Monopoly firm in the LR:
• May not build optimum plant (which operates
at minimum LAC)
• May not use the existing plant at full capacity
(production at the minimum point on the
SRAC)
• No loss in the LR
• The size of the plant depends on the market
size
Sub-optimal Plant size in the LR
P, MR, MC, AC
P SRMC
LAC
LMC
SRAC
DD
MR
Qe Q Opt Q

Optimal Plant size in the LR
P, MR, MC, AC
LMC
SRMC LAC
SRAC
DD
e
MR
Qe Q
• The case of greater than optimal plant size in the LR shall be

done by students
• Note: any of these could exist and there are no external forces
to push the firm to optimal plant as such.
LR Equilibrium …..cont’d
• At what output level the monopolist
maximizes its profit?
• A monopolist maximizes its long run profit
where
LMC = MR ,
slope of LMC > the slope of MR at the point of
intersection, and
SAC curve is tangent to the LAC at the point
corresponding to long run equilibrium output.

1.8. The multi- plant monopolist
• It is a monopoly which operates in more than
one plant
• The cost conditions may differ from one plant
to another.
• Firms produce the same product in different
plants which sold in the same market
• Reasons – to minimize cost of transportation
- to make the product accessible quickly etc

Assumptions of Multi-plant monopoly
• Two plants
• Homogeneous product
• Different Marginal cost of production in
the two plants
• The firm knows its average and marginal
revenue functions ( single AR=DD)

The firm decision
• Equilibrium quantity( Qe)
• Equilibrium price(Pe)
• Allocation of the output between
the two plants(q1 and q2)

The new Equilibrium
MC=MC1+MC2
P, MC P, MC
P, MC
MC1
MC2
AC1 AC2
P
AC2
AC1
DD
e
MR
0 Qe=q1+q2
0 q1 0 q2
Firm level Plant 1 Plant 2
Note that the MC of the firm is not horizontal summation of the MC of the plants
Construction of MC of the Multi-plant….hypothetical data
Output and Price Marginal Marginal cost Marginal cost Multi plant
sales revenue Plant -1 Plant-2 Marginal cost
1 5.0 - 1.92 2.04 1.92
2 4.5 4 2.00 2.14 2.00
3 4.1 3.30 2.08 2.24 2.04
4 3.8 2.9 2.16 2.34 2.08
5 3.55 2.55 2.24 2.44 2.14
6 3.35 2.35 2.32 2.54 2.16
7 3.2 2.30 2.40 2.64 2.24
8 3.08 2.24 2.48 2.74 2.24
9 2.98 2.18 2.56 2.84 2.32
10 2.98 2.08 2.64 2.94 2.34

Equilibrium ……. Cont’d
• How can the monopolist decide the total
production and how much of that output each
plant should produce?
• Total Q produced where MR=MC, but there
are two different MC (MC1 & MC2)
 MR=MC1=MC2
 If their MC are equal, the firm produces in
both plants equal units.

Algebraically
• TR=PQ where Q=Q1+Q2
• TC=TC1 + TC2
TC1 =f(Q1)
TC2=f(Q2)
π= TR-TC
π= TR-(TC1+TC2)
π= TR- TC1-TC2
Continued…
• Profit is maximum where first derivation is equal to zero
d d  
0    0  or
dQ dQ Q1 Q 2
 dTR dTC 1 dTC 2
    0  MR1  MC 1  0
Q1 dQ1 dQ1 dQ1
 dTR dTC 1 dTC 2

    0  MR 2  MC 2  0
Q 2 dQ 2 dQ 2 dQ 2

Continued…
Thus, MR1  MC 1  MR 2  MC 2
But , MR1...and .. MR 2 , are...equal
thus, MR1  MR 2  MR  MC 1  MC 2
• Then the above equilibrium condition can be

written as:
MR = MC1 and MR = MC2

• Given of the cost functions in the two plants and demand
curve as follows answer questions that follow.
Answer Key:
a)________
b)________
C)________
• Required: d)_______
– Equilibrium output (Q)

– Equilibrium price(P)
– Corresponding output at each plant(q1, q2)
– Profit generated from each plant and total profit .

• Given of the cost functions in the two plants and demand
curve as follows answer questions that follow.
Answer Key:
a)________
b)________
• Required: C)________
d)_______
– Equilibrium output (Q)
– Equilibrium price(P)
– Corresponding output at each plant(q1, q2)
– Profit generated from each plant and total profit .

• Suppose Ethiopian Electric Light and

Power Corporation (EELPC) is a multi
plant monopolist having two plants,
Tekeze plant (plant1) and Fincha plant
(Plant2).
• The operating costs of the two plants are
given as follows:

Continued…
• Tekeze Plant: TC1 = 10 Q12
• Fincha plant: TC2 = 20 Q22 where
– Q1 - Amount of electric power produced in Tekeze and
– Q2 – amount of electric power produced in Fincha
• EELPC estimates the demand for electric power by
the following function
• P= 700 – 5Q where
– P - is price (total in million birr) per Giga watt and
– Q – is the total amount of Giga watt sold and Q = Q1 + Q2
• Note that a Giga watt of electric power, whether it
comes from Fincha or Tekeze plant worth equal price
Required
a) What level of output (electric power) should EELPC produce
and what price per Kilowatt should it charge to maximize its
profit?
b) How much of the total output should be produced in each
plant?
c) Suppose that recently the Tekeze plant is suffering from
siltation problem (which leads to additional cost of cleaning
the dum), but Fincha plant is not. How should EELPC adjust
Q1, Q2 and QT and P to maximize its profit?
Answer Key:
a)________
b)________
C)________

1.9. Price Discrimination
• Price discrimination is the business practice of selling
the same good at different prices to different or same
consumers
• It is selling same or slightly differentiated products at
different prices
• The price differences are not justified by differences in
costs.
• The characteristic used in price discrimination
is willingness to pay (WTP)
• A firm can increase profit by charging a higher price to
buyers with higher WTP.
Examples of price discrimination
• Firms use common variables for price discrimination
( discriminating variables) such as:
– Age, sex, location of consumer, quantity bought, income,
time of purchase etc.
• Examples of price discrimination in reality:
– Movie tickets: Discounts for seniors, students, and people
who can attend during weekday afternoons.
• Example: Olyad Cinema: different P at 8:00, 10:00 and 12:00
– Transportation fee: for students, for children,
– Night club entrance fee: for female
– Price of Books: hard/soft cover, EEE, low price edition
– Unit price of pipe water consumed
– Unit price of electricity consumed, etc
– Quantity discounts
1.9.1. Goal and types of Price Discrimination
• What do you think is the aim of applying PD?
• The major goal of price discrimination is to
raise profit of the firm
• There are three types/ degrees/ of price
discrimination
1. Degree I
2. Degree II
3. Degree II

First degree (Perfect) price discrimination
• The firm charges each consumer the maximum price it
is willing to pay for each unit of output
• Reservation price= willingness to pay = maximum
price the consumer is willing to pay = actual price
• Reservation price varies with the amount
bought due to the law of diminishing MU
• Seller negotiate with each buyer on each unit bought
• Seller charges the maximum price on the demand curve
e.g. A doctor who charges poor and rich different prices
according to their willingness to pay

Degree I ….Continued
• Consumers are willing to pay less and less as
the amount bought increase due to LDMU
• This is shown by down ward sloping DD curve.
p
7
Price for different consumer
6 and different unit is different
5
4
3
1 2 3 4 5 Q

Effects
• The producer captures the whole consumer
surplus
• It is more or less ideal and less common

Second degree price discrimination
• It is sometimes called block pricing or quantity
discrimination
• The seller charges different prices for different
category of quantities purchased
• If the consumer buys less, price will be high but if the
consumer buy high amount there will be a discount
• For public utilities such as telephone , electricity,
water consumption, prices increase with quantity
consumed
• The goal is to discourage increased consumption

Graphically
• In second degree price discrimination price for the consumers
buying in the same block is equal and price of different blocks
are different
• For example consumer who buy between 10 and 20 units will
pay birr 5 for each.
p
7
6
5
4
3
10 20 30 40 50 Q

Effects
• Only part of consumer surplus is taken
away
• It may encourage efficient utilization of
resources for public utilities such as
telephone , electricity, water.
• For these services, higher prices are used
to discourage further consumption

Examples of Degree II price Discrimination
Adama Water Supply and Adama Ethiopian Electric
Sewerage Service Enterprise Power Corporation(EEPCo)
Block No Consumption Rate
per m3 Block No Consumption Rent Rate
per KWH
Block 1 0-5 4.05
Block 2 6 - 10 5.05 Block 1 1 - 25 1.40
Block 3 11 - 30 6.30 Block 2 26 - 50 3.40
Block 4 > 30 7.90 Block 3 51 - 100 6.82
Block 4 101-150 10.23
Exercise: Calculate the total Bill price
for a household which consumed 40 M3
of water for a given month
Answer: _________
Third Degree (multi-market) price discrimination
• Sometimes called multi-market price
discrimination
• The seller group the market (potential consumers)
into different groups according to the ability to pay
and charge different prices
• The market group with high price elastic are
charged lower price and with less elastic charged
higher price
• To maximize profit the seller sell more in the market
with high MR and redistribute until MR in all market
segment are equal
Necessary conditions for price Discrimination
( Degree III)
• There are three necessary conditons for this type of
price discrimination to be successful
1. There should be effective division of the market in to
sub markets
 buyers of low price market should not resale the
commodity in high price market.
• Effective division could be possible through
 Geographical variation with high transport cost
 Exclusive use of the commodity..non transferable
 Lack of distribution channels

Conditions …..continued
2. The price elasticity of demand should be different in each
sub market.
– If the price elasticity of demand is the same in the submarkets,
it is not possible to apply price discrimination
– The consumer with high price elasticity is charged less price
– The consumer with high price elasticity is charged less price
3- Lastly, the market should be imperfectly competitive
– Price discrimination is the extent to which firms extract
consumer surplus and this is not possible in perfect competition
• Example : movie & theatre halls charge college
students and other people different prices

Decisions of the firm
• Equilibrium output to be produced
• The corresponding amount of the good or service to be sold
in each market
• Equilibrium price charged in each market
• Profit generated from each marker
• Total equilibrium profit generated due to discrimination
• Equilibrium condition:
• The goods produced in the same plant  So MC is the same

Graphical Analysis
MC
P2
P P
P1
e1 e2 e DD
DD1 DD2
MR1 MR2 MR
q1 Q q2 Q Qe=q1+q2 Q
Market I Market II Firm Level

Price Elasticity and Price Discrimination
Note:
• If ep1=ep2, P1 will be the same as P2.i.e.no price discrimination
• If ep1 >Ep2, P1 should be smaller than P2, for the equality to hold
• If ep1 < Ep2, P1 should be grater than P2, for the equality to hold
• Elastic demand curve has smaller price

Numerical Example #1
• Suppose a monopolist sells its product in two

markets (A and B) and total out put is 55
• Demand for market A PA=100-QA
• Demand for market B PB=80-2QB
a) How many units should be sold in each markets?
b) In which market higher price should be charged?
– Hint:
» at equilibrium MR1=MR2=MC
» High ep implies less price

• Suppose Ethiopian Air lines (EAL) flies only one route: from
Addis Ababa to Dubai. EAL knows that two different types
of people fly to Dubai.
– Type A consists of rich merchants flying to Dubai for
business purposes with demand for flight of QA = 260-
0.4PA.
– Type B consists of poor ladies flying to Dubai in search of
jobs ( such as house maid) whose total demand is QB =
240-0.6PB.
• Assume that EAL has a running cost of $30,000 plus $100
per passenger and it has decided to charge different prices
for the two groups of passengers.

• Required:
a. How many tickets should EAL sell to each group?
b. How much price should EAL charge each group?
c. Suppose now that EAL is prohibited by the
Ethiopian government to exercise such
discrimination. How many tickets should the EAL
sell to maximize its profit and at what price?
Answer Key:
a) QA = 110 and QB = 90
b) PA=375, PB=250
Q=200, P=300

Numerical example #3,
• Given: demand and cost functions faced by a price

discriminating monopoly, answer questions that follows
Required:
A. Output sold in each market and total equilibrium output
B. Price charged in each market
C. Profit generated in each market
D. Proof that price discrimination increases profit of the firm
E. Show that the firm charges relatively high price in the
inelastic market

Comparison of Monopoly with Perfect
Competition
• In general, monopoly firm, compared to
a competitive firm,
1. Charges higher price at equilibrium
2. Produces smaller output

1.10. The Social Cost of Monopoly:
The Deadweight Loss
• It measures the net loss in consumer surplus when the
market is monopolized
• Consumer surplus= willingness to pay – actual payment
• Producer surplus=actual receipt – willingness to receive
• Total welfare of the society = consumer surplus +
producers producer surplus
• To see the efficiency of pure monopoly, we compare the
welfare of the society in perfect competition against
that of monopoly

Continued…
• Assume there a perfect competition
firm
• In the LR  P=MC
• Thus area a is consumer surplus and
area b is producer surplus in the
following graph.

Continued….
Equilibrium of perfect
competition is where
P MC=MR
a MC
DD P=MR=AR
Pc
b
DD
Qc Q

Continued…
• Assume due to a certain reason if the firm

is monopolized
• Its DD curve become market demand
curve DD
• MR become less than DD
• P > Mc
• Both producer and consumer surpluses
decrease
Continued….
Equilibrium of perfect
competition is where
MC=MR
P
a MC
Pm f
c i d g dd P=MR=AR
Pc e
b
h DDm Equilibrium of
pure monopoly is where
MC=MR
0 Qm Qc Q
MR

Comparison …cont’d
• PC features Monopoly Features
• Q = Qc • QQm=Qm
• P =Pc • P =Pm
• TR= 0QcgPC • TR =0QmfPm
• CS=PcgP • CS = PmPf
= PmPf +PcPmfi+gif
• PS = 0hgiPc
= 0hiPc+hgi

The deadweight Loss ( loss in CS)
• Area PmPf remains as consumer surplus
– No change in welfare
• Area PcPmfi has been captured as
revenue by the monopoly firm
• Area gif is lost due to change in market
structure
– There is change(loss) in welfare

The deadweight Loss ( loss in PS)
• PS= 0hgiPc
= 0hiPc+hgi
• Area ohiPc is now part of the TR of the monopolist

• Area hgi has been lost due to the change in the
market structure
– There is loss in welfare
• Total welfare Loss is the sum of the loses in CS & PS
• Deadweight loss= area (gfi)+area (hgi)
= area(e)+area(d)
Is monopoly Good or Bad?
•What Do
YOU Think?
Monopoly is Good
• Because:
1. It may lead to innovation and new
product development
2. It may lead to efficiency: large firms
can be efficient than small firms
3. Naturally created

Monopoly is Bad
• Because:
1. The effect on price
– Firms with monopoly power are likely to charge higher prices
than would be the case if there was greater competition
2. The effect on choice
– The fewer firms there are in a market, the less
choice the consumer has
3. The effect on new entering firms
– Monopoly firms make it difficult for new firms to
enter the industry

Public Policy Toward Monopolies
• Increasing competition with antitrust laws (US)
– Ban some anticompetitive practices, allow government to
break up monopolies.
• Regulation
– Govt agencies set the monopolist’s price.
• Public ownership
– Problem: Public ownership is usually less efficient since
no profit motive to minimize costs
• Doing nothing
– The foregoing policies all have drawbacks, so the best
policy may be no policy.
Challenges that Business firms face
1. Changes in Demand
2. Changes in Technology
3. Failure to control cost
4. Cash-flow problems
5. Poor management and administration
6. Growth of competition

Microeconomics Monopoly

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Microeconomics Monopoly

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Chapter 1: Pure Monopoly

02/21/2024 Micro II Slides Monopoly Guta AAU 3

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• In pure competition, a firm faces a perfectly

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– TR=maximum when its slope MR=0

• Thus, for pure monopoly P=AR

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• A pure monopolist can influence market

• A monopolist faces a tradeoff

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• It is derived from total approach

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• A monopolist produces a level of output

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Case A: Positive profit

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• An Equation reach its maximum where its

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• Assume a pure monopoly firm with Demand,

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Solving , for , P...and ..knowing .that.ep..is..negative

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• The reason is that the monopolist's output

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• The case of greater than optimal plant size in the LR shall be

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1 5.0 - 1.92 2.04 1.92

2 4.5 4 2.00 2.14 2.00

3 4.1 3.30 2.08 2.24 2.04

4 3.8 2.9 2.16 2.34 2.08

5 3.55 2.55 2.24 2.44 2.14

6 3.35 2.35 2.32 2.54 2.16

7 3.2 2.30 2.40 2.64 2.24

8 3.08 2.24 2.48 2.74 2.24

9 2.98 2.18 2.56 2.84 2.32