Mic 10

Microeconomics All Rights Reserved
© Oxford University Press Malaysia, 2008
10– 1

CHAPTER

10
Monopoly

10– 2

DEFINITION OF A MONOPOLY

Definition
A monopoly is a market structure in which
there is a single seller and large number of
buyers that sell products that have no close
subsitutes. The entry and exit barriers are
also high.

10– 3

CHARACTERISTICS OF A
MONOPOLY

Characteristics
One seller and large number of buyers.
A monopolist is a price maker since there is
only one seller and it has the power to control
the prices in the market.

10– 4

CHARACTERISTICS OF A
MONOPOLY (CON’T)

No close subsitutes: Monopolies firm
would sell products in which there are no
close substitutes.
Restriction of entry of new firms.
Advertising: Advertising in a monopoly
market depends on the products sold.

10– 5

TYPES OF MONOPOLIES

Natural Monopoly
Exist due to economies of scale.
Natural monopoly arises when one firm can
produce at a lower cost compared to two or
more firms within the market.

10– 6

TYPES OF MONOPOLIES (CON’T)
Government-Created Monopolies
Legal monopoly is also referred to as
government-created monopoly.
Government creates monopolies to prevent
firms from entering a market. This can be done
through:
Government franchise  Copyright
Government license  Control over
Patent raw material
10– 7

TOTAL REVENUE – TOTAL COST
APPROACH
(1) (2) (3) (4) 5) Using Table:
Total
Quantity Price Total Cost Profit Profit maximization is
(Q) (P) Revenue (TC) (TR-TC)
(TR) determined by
scanning through the
0 340 0 200 -200 profit at each level,
1 340 340 400 -60 and the level which
2 330 550 560 100 gives the highest profit
3 320 960 700 260 is the profit maximizing
output.
4 310 1240 800 440
5 300 1500 900 600
6 290 1740 1040 700
7 280 1960 1200 760
8 270 2160 1400 760
9 260 2340 1800 540
10 240 2400 2400 0

10– 8

TOTAL REVENUE – TOTAL COST
APPROACH (CON’T)
TR, TC

TC Using Graph:
TR TR curve is increasing and
after the profit maximizing
output, the curve starts to
decline.
Maximum profit is where
Highest vertical the vertical difference
difference between TR and TC is the
highest.

Quantity

10– 9

MARGINAL REVENUE –
MARGINAL COST APPROACH
Quantity Price Marginal Marginal
(Q) (P) Revenue Cost
(MR) (MC)

0 340 Using Table:
1 340 340 200 The profit maximizing
2 160
output level is obtained
330 320
following the
3 320 300 140 MR = MC rule.
4 310 280 100
5 300 260 100
6 290 240 140
7 280 220 160
8 270 200 200
9 260 180 400
10 240 60 600

10– 10

MARGINAL REVENUE – MARGINAL
COST APPROACH (CON’T)
MR, MC

MC

Using Graph:
MR curve under imperfect
market is downward sloping as
P*
output increases.
The profit maximization level
occurs at MR = MC, where
AR=P
the MC curve intersect with the
MR curve.

MR

Quantity
Q*

10– 11

PROFIT MAXIMIZATION USING
THE EQUATION METHOD
The demand function for a product sold by a
perfect competitor is given as Qd = 700 – 0.5P
and the marginal cost is constant at RM400
per unit.
Calculate the profit maximizing price and
quantity.

10– 12

THE EQUATION METHOD (CON’T)
Solution
For profit maximization to take place,
we use the MR = MC rule.
Firstly, we need to derive the demand curve.
Given Q = 700 − 0.5P
P = 1400 − 2Q
MR = 1400 – 4Q
MR = MC
1400 − 4Q = 400
4Q = 1000
Q = 250
10– 13

THE EQUATION METHOD (CON’T)
• Substitute Q = 250 into P = 1400 − 2Q
P = 1400 − 500
P = 900

10– 14

PROFIT MAXIMIZATION IN THE
SHORT RUN
Monopoly firm earns economic profit

The profit maximization level occurs
Price (RM) MC where MR curve and MC curve
intersect at point A.
ATC
To find the price, we use the same
vertical line with output up to the
demand curve. The profit maximizing
P*
AC PROFIT price and output are P* and Q*.

A At output, Q the firm earns economic
DD = AR
profit or supernormal profit equal to
the area shaded.
MR
Economic profit or supernormal profit
Quantity is the profit earned by a monopolist
Q* when TR>TC.

10– 15

SHORT RUN (CON’T)
Monopoly firm at breakeven

Price (RM) MC
ATC The profit maximization level occurs
where MR curve and MC curve
intersect at point A.

AC/P* The profit maximizing price and
output are P* and Q*.
A
DD = AR
At output, Q monopolist is at the
breakeven or earns normal profit.
MR
Economic profit or supernormal
profit is the profit earned by a
Q* Quantity monopolist when TR>TC.

10– 16

SHORT RUN (CON’T)
Monopoly firm suffers economic losses

Price (RM) MC ATC The profit maximization level
occurs where MR curve and
MC curve intersect at point A.

AC The profit maximizing price and
LOSSES output are P* and Q*.
P*
A At output, Q monopolist
suffers economic losses or
DD = AR subnormal profit equal to the
area shaded.

MR Economic losses or subnormal
profit is the loss incurred by a
Quantity
Q* monopolist when TR<TC.

10– 17

PROFIT MAXIMIZATION IN
THE LONG RUN
Monopoly firm earns supernormal profit in long run

Price (RM) LRMC

A monopoly firm earns
LRATC economic profit or
supernormal profit in the
long run due to barrierst of
P* entry for new firms.
AC PROFIT
A
DD = LRAR

LRMR

Quantity
Q*
10– 18

PRICE DISCRIMINATION AND
ITS CONDITIONS
Definition
Price discrimination refers to the selling or
charging of different prices by a firm to different
buyers for the same product.
Necessary Conditions
Existence of monopoly power: Price
discrimination can occur only if monopoly power
exists and there are no competitors in the
market.
10– 19

PRICE DISCRIMINATION AND
ITS CONDITIONS (CON’T)
Existence of different markets for the same
commodity: A firm should be able to separate
customers according to price elasticity of demand.
Prevent resale: Products purchased in the low-
priced market should not be resold in the high-
priced market.
Legal sanction: Government allows public utility
firms such as electricity to charge different prices
from different consumers.
10– 20

TYPES OF PRICE DISCRIMINATION
First-Degree Price Discrimination
• Occurs when a firm charges each consumer the
maximum price that the consumer is willing to pay
for each unit.
• This type of price discrimination is also known as
perfect price discrimination.
• The best example of first-degree price
discrimination is an auction.
10– 21

TYPES OF PRICE
DISCRIMINATION (CON’T)
Second-Degree Price Discrimination
• Occurs when products are grouped into blocks
and each block is charged at a different price.
• This type of price discrimination is charged by
public utilities such as electricity charges, water
charges, and telephone charges .

10– 22

TYPES OF PRICE
Third-Degree Price Discrimination
• Occurs when markets are divided into many
submarkets or subgroups.
• Each group is considered as a different market.
• The price charged on products depends on the
price elasticity of demand.

10– 23

TYPES OF PRICE
• An example of third-degree price
discrimination is the sale of movie tickets
where the adults are charged higher price and
children a charged at lower price.
• Other examples are transportation such as
air, railway, bus, medical, legal and
entertainment.
10– 24

COMPARISON BETWEEN PERFECT COMPETITION AND MONOPOLY

Perfect Competition Monopoly

 Large number of sellers selling  Only one seller who sells
homogenous products. products that have no close
substitutes.
 Price takers.  Price makers.
 Earns a normal profit in the long  Earn a supernormal profit since
run due to free entry and exit. there are barriers to entry for new
 In the long run, perfect entrants.
competitive firm produces at the  Price charged is always higher
lowest point on the minimum of than price charged in perfect
average cost and is more competitive market.
efficient.  Monopolist does not operate at
the minimum point of ATC curve.

10– 25

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