9MONOPOLY for basic microeconomics

1. Chapter 9
Monopoly

2. -Adam Smith
"The price of monopoly is
upon every occasion the
higher which can be get"

3. What is Pure Monopoly
A pure monopoly is an industry in
which there is only one supplier of a
product for which there are no close
substitutes and in which it is very
difficult or impossible for another firm
to coexist.

4. The Monopoly Market Structure
▶ What is a monopoly exactly?
▶ A monopoly is a market structure characterized by:
▶ A single seller
▶ A unique product
▶ Impossible entry into the market
▶ Under a monopoly, the consumer has only one
choice.
Thus, they can either buy from the producer
or not consume
▶ There are no close substitutes.

5. A Single Seller
▶ One single firm IS the industry.
▶ Local monopolies are more
commonly observed in the real-world
than national monopolies.

6. Unique Products
▶ Why do Monopolists have unique
products?
▶ Absence of close substitutes

7. Impossible Entry
▶ Barriers to Entry are high
▶ Barriers to entry are attributes of a market that make it
more difficult or expensive for a new firm to open for
business than it was for the firms already present in that
market.

8. Barriers
1. Legal restrictions:
The U.S. Postal Service
has a monopoly position
for some of its services
because Congress has
given to it one.
2. Patents: Some firms
benefit from a special,
but important, class of
legal impediments to
entry called patents.
4. Deliberately Erected
Entry Barriers A firm may
deliberately attempt to
make entry into the
industry difficult for others.
3. Control of a Scarce
Resource or Input If a
certain commodity can be
produced only by using a
rare input, a company that
gains control of the source of
that input can establish a
monopoly position for itself.
6. Technical Superiority A
firm whose technological
expertise vastly exceeds
that of any potential
competitor can, for a period
of time, maintain a
monopoly position. For
example, IBM Corporation
for many years had little
competition in the computer
business mainly because of
its technological virtuosity.
5. Large Sunk Costs
Entry into an industry
will, obviously, be very
risky if it requires a large
investment, especially if
that investment is sunk-
meaning that it cannot be
recouped for a
considerable period of
time, if at all.
7. Economies of Scale If
mere size gives a large
firm a cost advantage
over a smaller rival, it is
likely to be impossible for
anyone to compete with
the largest firm in the
industry.

9. SOURCES OF MONOPOLY
Economies of Scale
The cost to distribute 4
million kilowatt hours of
electric power
5 cents a kilowatt-hour with
one seller in the market,
or . . .
10 cents a kilowatt-hour with
two sellers, or . . .
15 cents a kilowatt-hour with
four sellers.
Because of economies of scale,
one seller can meet the market
demand at a lower average cost
than two or more sellers.

10. Price and Output Decisions for a
Monopolist
▶ The demand curve for a monopolist differs from
the competitive firm because the monopolist is a
price maker not taker.
▶ Def: A price maker is a firm that faces a downward
sloping demand curve.

11. More Demand and some Marginal Revenue
▶ Demand and Marginal Revenue
▶ They are both negatively-sloped
▶ Demand
▶ Market demand is negatively-sloped. The monopolist
faces a tradeoff between price and quantity sold.
▶ To obtain a higher price, the monopolist must lower
quantity
. Or, if it wants to sell a larger quantity
, it
must lower price.

12. MONOPOLY EQUILIBRIUM
▶ Demand and Marginal Revenue
▶ Marginal revenue is less than price
☐ The marginal revenue curve is negatively-sloped
but lies below the demand curve at each
quantity: MR<P at all Q.

13. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

14. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue

15. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal
Revenue

16. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal
Revenue

17. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal
Revenue

18. MONOPOLY EQUILIBRIUM
Example: Demand and
Marginal Revenue

19. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal
Revenue

20. MONOPOLY EQUILIBRIUM
The diagram shows the monopolist’s
Average total cost (ATC), marginal cost
(MC), demand (D),
and marginal revenue (MR).
Profit Maximization by a Monopolist
The monopolist maximizes profits or
minimizes losses by producing the
quantity at which marginal revenue
equals marginal cost.

21. MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist

22. MONOPOLY EQUILIBRIUM
Profit Maximization by a Monopolist: Numerical Example

23. MONOPOLY EQUILIBRIUM
▶ Short-Run and Long-Run Equilibrium
▶ When a monopolist incurs short-run losses
▶ However, if a monopolist incurs economic
losses in the short- run, it exits the market
in the long-run. The long-run equilibrium
quantity is zero.

24. MONOPOLY EQUILIBRIUM
▶ Short-Run and Long-Run
Equilibrium
▶ When a monopolist earns
short-run profits

25. Price Discrimination
▶ The monopolist may charge different prices
to consumers to maximize profits.
▶ Def: Price discrimination occurs when a seller charges
different prices for the same product that are not justified
by cost differences.
▶ Selling a good or service at a number of different prices
where the price differences do not reflect differences in cost but
instead reflect differences in consumers’ price elasticities of
demand.
▶ However, specific conditions must be met before
the seller can act in this way.

26. Conditions for Price Discrimination
▶ The seller must be a price maker and therefore face
a downward-sloping demand curve
▶ The seller must be able to segment the market
distinguishing between consumers willing to pay
different prices
▶ It must be impossible or too costly for customers
to engage in arbitrage

27. How can a producer price discriminate
▶ Discriminating among groups of
consumers
▶ Different prices for consumers with different elasticities. The market
is segmented based on some easily distinguished characteristic of
consumers—age, for example.
▶ Discriminating among units of a good
▶ The seller charges the same prices to all consumers but
offers each consumer a lower price for a larger number of
units bought—volume discounts, for example.

28. Price Discrimination with Two Groups of Consumers
D
(a)
LRAC, MC
0 400 Quantity per period 0 500 Quantity per period
A monopolist facing two groups of consumers with different demand elasticities may
be able to practice price discrimination to increase profit or reduce loss. With marginal
cost the same in both markets, the firm charges a higher price to the group in panel (a),
which has a less elastic demand than group in panel (b).
(b)
Dollars
per
unit
$3.00
1.00
LRAC, MC
MR Dollars
per
unit
$1.50
1.00
D’
MR’

29. Is Price Discrimination Unfair
▶ There is nothing evil or illegal about economic
price discrimination. It simply means charging
different prices for the same good or service
unrelated to differences in cost.
▶ Price discrimination is common in all markets
other than perfectly competitive markets.

30. Is Price Discrimination Unfair
▶ What are its effects:
▶ Increase seller’s profit, at least in the short run
▶ Enhance economic efficiency
▶ Conserve on scarce resources.
▶ Many buyers benefit because they are now paying a
lower price
▶ Example: Movie Theatres- senior citizen and college
students discounts

31. How does it increase the sellers profits
▶ Increases seller’s profits
▶ By observing different elasticities for the
consumers the following can happen
▶ Reduce the price for buyers with elastic demand
will increase TR
▶ Increase the price for buyers with inelastic
demand will increase TR
▶ When the total quantity is not changing, then
costs are not changing, but revenues are
profits are HIGHER

32. What about efficiency
▶ Enhances economic efficiency
▶ We know that under a monopoly the output is under-
produced. But price discrimination can fix this
underproduction of the good
▶ A price-discriminating monopolist is able to sell a larger
quantity than a single-price monopolist by reducing price
only on the additional units sold, not on all units sold.
▶ Because the problem with monopoly is underproduction,
increasing quantity enhances efficiency
. The sum of
producer and consumer surplus is higher in a monopoly
market with price discrimination than in a market with a
single-price monopolist.

33. MONOPOLY AND COMPETITION
The market demand curve is D.
The market supply curve is S.
The competitive market
equilibrium is where quantity
demanded equals quantity
supplied.
The competitive equilibrium
quantity is QC and the
equilibrium price is PC.
Competitive Equilibrium

34. MONOPOLY AND COMPETITION
The competitive market
supply curve, S, is the
monopolist’s marginal cost
curve, MC.
The monopolist’s marginal
revenue curve is MR.
The monopolist’s equilibrium
quantity is QM where marginal
revenue equals marginal cost.
The
equilibrium price is PM , shown
by
the demand at QM.
Monopoly Equilibrium

35. MONOPOLY AND COMPETITION
▶ Competitive and Monopolistic Equilibrium
▶Monopoly quantity is lower and price is higher
▶A monopolist supplies a smaller quantity than a competitive
market would supply at a higher price.
▶The higher price allows a monopolist to earn positive long-
run economic profits.

36. MONOPOLY AND COMPETITION
▶ Economic Consequences of Monopoly
▶The absence of competition results in
• Inefficiency and deadweight
loss Redistribution of wealth
•

37. MONOPOLY AND COMPETITION
The competitive equilibrium
price, PC, brings consumers’
marginal benefit into equality
with producers’ marginal cost.
Therefore, the competitive
equilibrium quantity, QC, is
efficient. The sum of
consumer surplus and
producer surplus is
maximized.
Efficiency of Competitive
Equilibrium

38. MONOPOLY AND COMPETITION
Marginal benefit in the
monopoly equilibrium (equals to
the monopoly equilibrium price,
PM) exceeds marginal cost.
Therefore, the monopoly
equilibrium quantity, QM, is
inefficient because of
underproduction. Monopoly
results
in a deadweight loss.
Inefficiency of
Monopoly

39. MONOPOLY AND COMPETITION
▶ Economic
Consequences of
Monopoly
▶Redistribution of wealth

40. MONOPOLY AND COMPETITION
The deadweight loss of
monopoly arises from a net loss
in both consumer and producer
surplus compared with the
competitive equilibrium.
In addition to the net loss in the
total surplus, monopoly also
redistributes some of the
remaining surplus from consumers
to the monopolist.
Monopoly Redistributes Wealth