Monopoly_Chapter 15_Macroeconomics_ Mankew power point slides

Chapter 15Chapter 15
MonopolyMonopoly
©© 2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi
• Learn why some markets have only one
seller.
• Analyze how monopoly determines the
quantity to produce and the price to
charge.
• See how monopoly’s decisions affect
economic well-being.
• Consider the various public policies aimed
at solving the monopoly problem.
• See why monopolies try to charge
different prices to different customers.
• Learn why some markets have only one
seller.
• Analyze how monopoly determines the
quantity to produce and the price to
charge.
• See how monopoly’s decisions affect
economic well-being.
• Consider the various public policies aimed
at solving the monopoly problem.
• See why monopolies try to charge
different prices to different customers.
In this chapter you will…In this chapter you will…

• While a competitive firm is a
price taker, a monopoly firm is a
price maker.
• A firm is considered a monopolymonopoly
if . . .
–it is the sole seller of its product.
–its product does not have close
substitutes.
• While a competitive firm is a
price taker, a monopoly firm is a
price maker.
• A firm is considered a monopolymonopoly
if . . .
–it is the sole seller of its product.
–its product does not have close
substitutes.
MONOPOLYMONOPOLY

• The fundamental cause of
monopoly is barriers to entry.
• Barriers to entry have three sources:
– Ownership of a key resource.
– The government gives a single firm the
exclusive right to produce some good.
– Costs of production make a single
producer more efficient than a large
number of producers.
• The fundamental cause of
monopoly is barriers to entry.
• Barriers to entry have three sources:
– Ownership of a key resource.
– The government gives a single firm the
exclusive right to produce some good.
– Costs of production make a single
producer more efficient than a large
number of producers.
Why Monopolies AriseWhy Monopolies Arise

• Monopoly resources
– Although exclusive ownership of a key
resource is a potential source of
monopoly, in practice monopolies rarely
arise for this reason.
• Government created monopolies
– Governments may restrict entry by giving a
single firm the exclusive right to sell a
particular good in certain markets.
– Patent and copyright laws are two important
examples of how government creates a
monopoly to serve the public interest.
• Monopoly resources
– Although exclusive ownership of a key
resource is a potential source of
monopoly, in practice monopolies rarely
arise for this reason.
• Government created monopolies
– Governments may restrict entry by giving a
single firm the exclusive right to sell a
particular good in certain markets.
– Patent and copyright laws are two important
examples of how government creates a
monopoly to serve the public interest.

• Natural Monopolies
– An industry is a natural monopoly when
a single firm can supply a good or
service to an entire market at a smaller
cost than could two or more firms.
– A natural monopoly arises when there
are economies of scale over the
relevant range of output.
• Natural Monopolies
– An industry is a natural monopoly when
a single firm can supply a good or
service to an entire market at a smaller
cost than could two or more firms.
– A natural monopoly arises when there
are economies of scale over the
relevant range of output.

Cost
Quantity of Output
0
Average
total
cost
Figure 15-1: Economies of Scale as a CauseFigure 15-1: Economies of Scale as a Cause
of Monopolyof Monopoly

• Monopoly versus Competition
– Monopoly
• Is the sole producer
• Faces a downward-sloping demand curve
• Is a price maker
• Reduces price to increase sales
– Competitive Firm
• Is one of many producers
• Faces a horizontal demand curve
• Is a price taker
• Sells as much or as little at same price
• Monopoly versus Competition
– Monopoly
• Is the sole producer
• Faces a downward-sloping demand curve
• Is a price maker
• Reduces price to increase sales
– Competitive Firm
• Is one of many producers
• Faces a horizontal demand curve
• Is a price taker
• Sells as much or as little at same price
Pricing and Production DecisionsPricing and Production Decisions

(a) Competitive Firm (b) Monopoly
Price
0 0
Price
Demand
Demand
Quantity of OutputQuantity of Output
Figure 15-2: Demand Curves for CompetitiveFigure 15-2: Demand Curves for Competitive
and Monopoly Firmsand Monopoly Firms

• Total Revenue
P × Q = TR
• Average Revenue
TR/Q = AR = P
• Marginal Revenue
∆TR/∆Q = MR
• Total Revenue
P × Q = TR
• Average Revenue
TR/Q = AR = P
• Marginal Revenue
∆TR/∆Q = MR
A Monopoly’s RevenueA Monopoly’s Revenue

Table 15-1: A Monopoly’s Total, Average,Table 15-1: A Monopoly’s Total, Average,
and Marginal Revenue.and Marginal Revenue.
- 4
32438
- 2
42847
0
53056
2
63065
4
72874
6
82483
8
91892
$ 10
$ 1010101
------$ 0$ 110
(MR = ∆TR/∆Q)(AR = P x Q)(TR = P x Q)(P)(Q)
Marginal
Revenue
Average
Revenue
Total
RevenuePrice
Quantity of
Water

• A Monopoly’s Marginal Revenue
–A monopolist’s marginal revenue
is always less than the price of its
good.
• The demand curve is downward
sloping.
• When a monopoly drops the price to
sell one more unit, the revenue
received from previously sold units
also decreases.
–A monopolist’s marginal revenue
is always less than the price of its
good.
• The demand curve is downward
sloping.
• When a monopoly drops the price to
sell one more unit, the revenue
received from previously sold units
also decreases.

–When a monopoly increases the
amount it sells, it has two effects
on total revenue (P × Q).
• The output effect—more output is
sold, so Q is higher.
• The price effect—price falls, so P is
lower.
–When a monopoly increases the
amount it sells, it has two effects
on total revenue (P × Q).
• The output effect—more output is
sold, so Q is higher.
• The price effect—price falls, so P is
lower.

Price
Quantity of Water
1 2 3 4 5 6 7 8
11
10
9
8
7
6
5
4
3
2
1
0
–1
–2
–3
–4
Marginal
revenue
Demand
(average
revenue)
Figure 15-3: The Demand and MarginalFigure 15-3: The Demand and Marginal
Revenue Curves for a MonopolyRevenue Curves for a Monopoly

• A monopoly maximizes profit by
producing the quantity at which marginal
revenue equals marginal cost.
• It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
• A monopoly maximizes profit by
producing the quantity at which marginal
revenue equals marginal cost.
• It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
Profit MaximizationProfit Maximization

Costs and
Revenue
Quantity0
Marginal cost
Marginal revenue
Demand
Average total cost
Q1 Q2
2. … and then the demand
curve shows the price
consistent with this quantity.
Monopoly
price
B
A
1. The intersection of the
MR curve and the MC curve
determines the profit
maximizing quantity…
QMAX
Figure 15-4: Profit Maximization for aFigure 15-4: Profit Maximization for a
MonopolyMonopoly

• Comparing Monopoly and Competition
– For a competitive firm, price equals
marginal cost.
P = MR = MC
– For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
• Comparing Monopoly and Competition
– For a competitive firm, price equals
marginal cost.
P = MR = MC
– For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
Profit MaximizationProfit Maximization

• Profit equals total revenue minus
total costs.
–Profit = TR - TC
–Profit = (TR/Q - TC/Q) × Q
–Profit = (P - ATC) × Q
• The monopolist will receive
economic profits as long as price is
greater than average total cost.
• Profit equals total revenue minus
total costs.
–Profit = TR - TC
–Profit = (TR/Q - TC/Q) × Q
–Profit = (P - ATC) × Q
• The monopolist will receive
economic profits as long as price is
greater than average total cost.
A Monopoly’s ProfitA Monopoly’s Profit

Costs and
Revenue
Quantity0
Monopoly
price
QMAX
Monopoly
profit
Marginal cost
Marginal revenue
Demand
Average total cost
D
BE
C
Average
total cost
Figure 15-5: The Monopoly’s ProfitFigure 15-5: The Monopoly’s Profit

• A new drug discovery gives rise to a
patent and gives the firm a monopoly on
the sale of that drug.
• When the patent expires and any company
can make or sell the drug.
• The market switches from being
monopolistic to being competitive.
• A new drug discovery gives rise to a
patent and gives the firm a monopoly on
the sale of that drug.
• When the patent expires and any company
can make or sell the drug.
• The market switches from being
monopolistic to being competitive.
CASE STUDY:CASE STUDY: The Market for DrugsThe Market for Drugs

Costs and
Revenue
Quantity0
Marginal revenue
Demand
Price
during
patent life
Marginal costPrice after
patent
expires
Monopoly
quantity
Competitive
quantity
Figure 15-6: The Market for DrugsFigure 15-6: The Market for Drugs

• In contrast to a competitive firm, the
monopoly charges a price above the
marginal cost.
• From the standpoint of consumers,
this high price makes monopoly
undesirable.
• However, from the standpoint of the
owners of the firm, the high price
makes monopoly very desirable.
• In contrast to a competitive firm, the
monopoly charges a price above the
marginal cost.
• From the standpoint of consumers,
this high price makes monopoly
undesirable.
• However, from the standpoint of the
owners of the firm, the high price
makes monopoly very desirable.
THE WELFARE COST OFTHE WELFARE COST OF
MONOPOLYMONOPOLY

Demand (Value
to buyers)
Marginal cost
Quantity
Price
0 Efficient
quantity
Value to buyers is greater
than cost to sellers
Value to buyers is less
than cost to sellers
Cost to
monopolist
Value to
buyers
Value to
buyers
Cost to
monopolist
Figure 15-7: The Efficiency Level of OutputFigure 15-7: The Efficiency Level of Output

• Because a monopoly sets its price above
marginal cost, it places a wedge between
the consumer’s willingness to pay and the
producer’s cost.
– This wedge causes the quantity sold to
fall short of the social optimum.
• The Inefficiency of Monopoly
– The monopolist produces less than the
socially efficient quantity of output.
– The “economic pie” shrinks.
• Because a monopoly sets its price above
marginal cost, it places a wedge between
the consumer’s willingness to pay and the
producer’s cost.
– This wedge causes the quantity sold to
fall short of the social optimum.
• The Inefficiency of Monopoly
– The monopolist produces less than the
socially efficient quantity of output.
– The “economic pie” shrinks.
Deadweight LossDeadweight Loss

Price
Quantity0
Marginal revenue
Demand
Marginal cost
Monopoly
price
Monopoly
quantity
Efficiency
quantity
Deadweight
loss
Figure 15-8: The Inefficiency of MonopolyFigure 15-8: The Inefficiency of Monopoly

• The deadweight loss caused by a
monopoly is similar to the
deadweight loss caused by a tax.
• The difference between the two
cases is that the government gets
the revenue from a tax, whereas a
private firm gets the monopoly profit.
• The deadweight loss caused by a
monopoly is similar to the
deadweight loss caused by a tax.
• The difference between the two
cases is that the government gets
the revenue from a tax, whereas a
private firm gets the monopoly profit.
Deadweight LossDeadweight Loss

• Government responds to the
problem of monopoly in one of four
ways.
–Making monopolized industries
more competitive.
–Regulating the behaviour of
monopolies.
–Turning some private monopolies
into public enterprises.
–Doing nothing at all.
• Government responds to the
problem of monopoly in one of four
ways.
–Making monopolized industries
more competitive.
–Regulating the behaviour of
monopolies.
–Turning some private monopolies
into public enterprises.
–Doing nothing at all.
PUBLIC POLICY TOWARDPUBLIC POLICY TOWARD
MONOPOLIESMONOPOLIES

• Legislation designed to encourage competition
and discourage the use of monopoly practices
can curb the inefficiencies resulting from market
power in general and monopoly in particular.
• Competition law has a long history in Canada:
– 1889: The Act for the Prevention and
Suppression of Combinations Formed in
Restraint of Trade.
– 1910: Combines Investigation Act
– 1986: Competition Act and the Competition
Tribunal Act
• Legislation designed to encourage competition
and discourage the use of monopoly practices
can curb the inefficiencies resulting from market
power in general and monopoly in particular.
• Competition law has a long history in Canada:
– 1889: The Act for the Prevention and
Suppression of Combinations Formed in
Restraint of Trade.
– 1910: Combines Investigation Act
– 1986: Competition Act and the Competition
Tribunal Act
Competition LawCompetition Law

• The Competition Act:
• “… maintain and encourage competition in
Canada in order to promote the efficiency
and adaptability of the Canadian
economy… …. and in order to provide
consumers with competitive prices and
product choices.”
• Competition law in Canada is enforced by
the Commissioner of Competition of the
Competition Bureau, a unit within the
Federal government’s Industry Canada.
• The Competition Act:
• “… maintain and encourage competition in
Canada in order to promote the efficiency
and adaptability of the Canadian
economy… …. and in order to provide
consumers with competitive prices and
product choices.”
• Competition law in Canada is enforced by
the Commissioner of Competition of the
Competition Bureau, a unit within the
Federal government’s Industry Canada.

• Competition laws have costs and benefits.
– Sometimes companies merge not to
reduce competition but to lower costs
through joint production.
– The benefits of greater efficiencies
through mergers are called synergies.
• If the competition laws are to raise social
welfare, the government must determine
which mergers are desirable and which
are not.
• Competition laws have costs and benefits.
– Sometimes companies merge not to
reduce competition but to lower costs
through joint production.
– The benefits of greater efficiencies
through mergers are called synergies.
• If the competition laws are to raise social
welfare, the government must determine
which mergers are desirable and which
are not.

• Government may regulate the prices that
the monopoly charges. This is often the
case with natural monopolies where
governments regulate the price.
– The allocation of resources will be
efficient and total surplus maximized if
price is set to equal marginal cost.
• Government may regulate the prices that
the monopoly charges. This is often the
case with natural monopolies where
governments regulate the price.
– The allocation of resources will be
efficient and total surplus maximized if
price is set to equal marginal cost.
RegulationRegulation

• Two practical problems associated with
marginal-cost pricing.
1. Natural monopolies often have declining
average total cost. (See Figure 15-9)
– The price is less than ATC thus creating
losses.
1. No incentive for monopolist to reduce costs.
– Reducing costs will reduce prices.
– In practice, regulators will allow
monopolists to keep some of the benefits
from lower costs in the form of higher
profit, a practice that requires some
departure from marginal-cost pricing.
• Two practical problems associated with
marginal-cost pricing.
1. Natural monopolies often have declining
average total cost. (See Figure 15-9)
– The price is less than ATC thus creating
losses.
1. No incentive for monopolist to reduce costs.
– Reducing costs will reduce prices.
– In practice, regulators will allow
monopolists to keep some of the benefits
from lower costs in the form of higher
profit, a practice that requires some
departure from marginal-cost pricing.
RegulationRegulation

Price
Quantity0
Loss
Demand
Average total cost
Average
total cost
Marginal cost
Regulated
price
Figure 15-9: Marginal Cost PricingFigure 15-9: Marginal Cost Pricing

• Rather than regulating a natural
monopoly that is run by a private
firm, the government can run the
monopoly itself.
– Crown Corporations
• Canada Post
• CBC
• Hydro-Québec
• Saskatchewan Tel and B.C. Tel.
• Ontario Hydro.
• Rather than regulating a natural
monopoly that is run by a private
firm, the government can run the
monopoly itself.
– Crown Corporations
• Canada Post
• CBC
• Hydro-Québec
• Saskatchewan Tel and B.C. Tel.
• Ontario Hydro.
Public OwnershipPublic Ownership

• Government can do nothing at all if the
market failure is deemed small compared
to the imperfections of public policies.
• Government intervention such as
regulation can cause average costs to
inflate (Political failure), increasing the
deadweight loss above its “do nothing”
level. (See Figure 15-10)
• Government can do nothing at all if the
market failure is deemed small compared
to the imperfections of public policies.
• Government intervention such as
regulation can cause average costs to
inflate (Political failure), increasing the
deadweight loss above its “do nothing”
level. (See Figure 15-10)
Doing NothingDoing Nothing

Price
Quantity0
Marginal revenue
ATCtrue
ATCinflated
Demand
Marginal cost
C
E
Ptrue
D
Qtrue
G
F
Pinflated
Qinflated
AP0
B
Q0
Figure 15-10: Political Failure and AverageFigure 15-10: Political Failure and Average
Costs CurvesCosts Curves

• Price discrimination is the business
practice of selling the same good at
different prices to different customers,
even though the costs for producing for
the two customers are the same.
• Price discrimination is not possible when
a good is sold in a competitive market
since there are many firms all selling at
the market price. In order to price
discriminate, the firm must have some
market power.
• Price discrimination is the business
practice of selling the same good at
different prices to different customers,
even though the costs for producing for
the two customers are the same.
• Price discrimination is not possible when
a good is sold in a competitive market
since there are many firms all selling at
the market price. In order to price
discriminate, the firm must have some
market power.
PRICE DISCRIMINATIONPRICE DISCRIMINATION

• Perfect Price Discrimination refers to the
situation when the monopolist knows exactly
the willingness to pay of each customer and can
charge each customer a different price.
• Three important effects of price discrimination:
– It can increase the monopolist’s profits.
– Need to separate customers according to
their ability to pay.
• No arbitrage, the process of buying a good in one
market at a low price and selling it in another
market at a higher price.
– It can reduce deadweight loss.
• Perfect Price Discrimination refers to the
situation when the monopolist knows exactly
the willingness to pay of each customer and can
charge each customer a different price.
• Three important effects of price discrimination:
– It can increase the monopolist’s profits.
– Need to separate customers according to
their ability to pay.
• No arbitrage, the process of buying a good in one
market at a low price and selling it in another
market at a higher price.
– It can reduce deadweight loss.

(a) Single price monopolist
Price
Quantity
0 0
Price
(b) Perfectly discriminating monopolist
MR
D
MC
Profit
Deadweight
loss
Consumer
surplus
Monopoly
price
Quantity
sold
Quantity
0
Profit
D
MC
Quantity
sold
Figure 15-11: Welfare with and without PriceFigure 15-11: Welfare with and without Price
DiscriminationDiscrimination

• Examples of Price Discrimination
– Movie tickets
– Airline prices
– Discount coupons
– Financial aid
– Quantity discounts
• Examples of Price Discrimination
– Movie tickets
– Airline prices
– Discount coupons
– Financial aid
– Quantity discounts

ConclusionConclusion
• How prevalent are the problems of
monopolies?
– Monopolies are common.
– Most firms have some control over their
prices because of differentiated
products.
– Firms with substantial monopoly power
are rare.
– Few goods are truly unique.
• How prevalent are the problems of
monopolies?
– Monopolies are common.
– Most firms have some control over their
prices because of differentiated
products.
– Firms with substantial monopoly power
are rare.
– Few goods are truly unique.

SummarySummary
• A monopoly is a firm that is the sole seller
in its market.
• It faces a downward-sloping demand
curve for its product.
• A monopoly’s marginal revenue is always
below the price of its good.
• Like a competitive firm, a monopoly
maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.
• A monopoly is a firm that is the sole seller
in its market.
• It faces a downward-sloping demand
curve for its product.
• A monopoly’s marginal revenue is always
below the price of its good.
• Like a competitive firm, a monopoly
maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.

SummarySummary
• Unlike a competitive firm, its price
exceeds its marginal revenue, so its price
exceeds marginal cost.
• A monopolist’s profit-maximizing level of
output is below the level that maximizes
the sum of consumer and producer
surplus.
• A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.
• Unlike a competitive firm, its price
exceeds its marginal revenue, so its price
exceeds marginal cost.
• A monopolist’s profit-maximizing level of
output is below the level that maximizes
the sum of consumer and producer
surplus.
• A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.

SummarySummary
• Policymakers can respond to the
inefficiencies of monopoly behaviour with
competition laws, regulation of prices, or
by turning the monopoly into a
government-run enterprise.
• If the market failure is deemed small,
policymakers may decide to do nothing at
all.
• Policymakers can respond to the
inefficiencies of monopoly behaviour with
competition laws, regulation of prices, or
by turning the monopoly into a
government-run enterprise.
• If the market failure is deemed small,
policymakers may decide to do nothing at
all.

SummarySummary
• Monopolists can raise their profits by
charging different prices to different
buyers based on their willingness to pay.
• Price discrimination can raise economic
welfare and lessen deadweight losses.
• Monopolists can raise their profits by
charging different prices to different
buyers based on their willingness to pay.
• Price discrimination can raise economic
welfare and lessen deadweight losses.

The EndThe End

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