This document discusses monopolies and their characteristics. It notes that monopolies exist when there is only one producer of a good or service in a market. Monopolies may engage in behaviors like raising prices and earning economic profits due to their lack of competition. Barriers to entry like government restrictions, control of key resources, and natural monopolies can allow monopolies to persist by preventing competitors from entering the market. While monopolies are inefficient compared to competitive markets and reduce consumer and economic surplus, they may also incentivize innovation with the prospect of earning large profits.

1. MONOPOLY
ECON 201
Joshua Price, Ph.D.

2. The Four Market Structures

3. Monopolies
• One firm produces all of the output in
a market
• We study monopolies for two
reasons:
1. Some firms truly are monopolists
• Important to understand their
behavior
2. Firms might collude in order to act
like a monopolist
• Helps us to identify these firms

4. Monopolies
• Do they exist?
• Suppose you live in a town with only
one coffee shop.
• Is that coffee shop a monopoly?
• Competition from grocery stores
• (sell coffee you make at home)
• Competition from other stores that
sale coffee
• (e.g., gas stations, donut shop)
• Close substitutes?
• Yes  is not a monopoly
• No  is a monopoly
• The coffee shop may have some
monopoly power
• Raise prices
• Earn economic profit

5. Monopolies: Barriers to Entry
• Barriers to entry lead to monopolies
• Legal, technological, or market forces that discourage/prevent potential competitors
from entering a market
• Some reasons for barriers to entry
1. Government restrictions on entry
a) Patents & copyrights
b) Public franchises
2. Control of a key resource
3. Natural monopolies

6. Government Restrictions on Entry
• Exclusive production rights for a period of time
• Patents
• Newly developed products (e.g., drugs)
• 20 years from date patent filed with government
• Copyrights
• Creative works (e.g., books and films)
• Encourage innovation and creativity
• Allows firms to profit from their endeavors
• Without these rights, other producers will profit
• Greatly reduces incentive to innovate/create

7. Government Restrictions on Entry
• Public franchise
• Government designates the firm is only legal provider of a good/service
• Example: electricity or water markets
• Government may operate these firms as a public enterprise
• Example: US Postal Service

8. Control of a Key Resource
• National Football League (NFL) acts as a monopoly
• Majority of world’s best football players under contract to the NFL
• Unable to be used for another (potential) league
• Control over key resource is a substantial barrier to entry for competitors

9. Natural Monopoly
• Economies of scale large enough that 1 firm can supply market at lower ATC than
2+ firms
• Most likely when FC are high
• Examples
• Electricity
• Water

10. Monopoly Decisions
• Maximize profit
• Choose Q
• How much does a monopolist produce?
• 𝑀𝑅 = 𝑀𝐶
• What price will a monopolist charge?
• Monopolists can set the price
• Market demand constrains the price
• Charge price corresponding to market demand at profit-maximizingQ

11. Monopoly
Decisions
Subscribers
per Month
(Q)
Price
(P)
TR AR MR
0 $60 $0 --- ---
1 57 57 $57 $57
2 54 108 54 51
3 51 153 51 45
4 48 192 48 39
5 45 225 45 33
6 42 252 42 27
7 39 273 39 21
8 36 288 36 15
9 33 297 33 9
10 30 300 30 3
ConsiderTimeWarner Cable
• Monopolist in a local, cable television
market
• First two columns represent market
demand (…andTWC’s demand)
• 𝑇𝑅, 𝐴𝑅, and 𝑀𝑅 calculated as usual
Notice, 𝑃 = 𝐴𝑅 ≠ 𝑀𝑅
• Furthermore, MR is always below
demand for a monopolist

12. Monopoly Decisions
Monopolist maximizes profit by producing the quantity where 𝑀𝐶 = 𝑀𝑅

13. Monopoly Decisions
At this quantity, the demand curve determines
price
Profit = 𝑃 − 𝐴𝑇𝐶 × 𝑄

14. Monopoly: LR Profits
• Barriers to entry  additional firms cannot enter the market
• Thus, no distinction between the SR and LR for a monopoly
• Expect monopolists to continue earning profits in the LR

15. Monopoly Decisions: Practice Problem
• A monopolist has the costs and faces
the demand provided in this table.
• At what level of output will the
monopolist maximize profits?
• What is the monopolist’s profit at that
level of output?
P
($)
Q TC
($)
TR
($)
MC
($)
MR
($)
10.00 0 8.00 0.00 --- ---
9.00 1 13.00 9.00 5.00 9.00
8.00 2 16.00 16.00 3.00 7.00
7.00 3 18.00 21.00 2.00 5.00
6.00 4 19.00 24.00 1.00 3.00
5.00 5 21.00 25.00 2.00 1.00
4.00 6 24.00 24.00 3.00 -1.00
3.00 7 28.00 21.00 4.00 -3.00
2.00 8 33.00 16.00 5.00 -5.00

16. Monopoly & Efficiency
• Thought experiment
• Suppose the smartphone market is perfectly competitive
• Now, one firm buys up all of the smartphones in the country
• What would happen to:
• Price of smartphones?
• Quantity of smartphones traded?
• The net benefit of consumers? (i.e. consumer surplus)
• The net benefit of producers? (i.e. producer surplus)
• The net benefit of all of society? (i.e. economic surplus)

17. Monopoly & Efficiency

18. Monopoly & Efficiency

19. Monopoly & Efficiency
• What would happen to:
• Price of smartphones?
• Increases
• Quantity of smartphones traded?
• Decreases
• Fewer smartphones will be traded at a
higher price.
• What would happen to:
• Consumer surplus?
• Higher price  CS will fall
• Producer surplus?
• Must increase
• Economic surplus?
• Fewer trades  ES must fall
Suppose the smartphone market is
perfectly competitive. Now, one firm buys
up all of the smartphones in the country

20. Monopoly & Efficiency
• At 𝑃𝑀…
• CS decreases by the areas A+B
• PS falls by C, but rises by A; an overall
increase
• Area A is simply a transfer of surplus
• Neither inherently good nor bad
• But areas B and C are lost surpluses
• DWL  inefficiency

21. Monopoly & Efficiency
• How large are the efficiency losses?
• Relatively few monopolies
• Efficiency losses must be relatively
small
• Many firms have market power
• Ability to charge 𝑃 > 𝑀𝐶
• Only perfectly competitive firms do
not
• Estimates:
• Efficiency loss in US due to market
power likely less than 1% of total US
production
• About $500/person annual
• Why so small?
• Most firms face relatively large degree
of competition
• 𝑃 closer to 𝑀𝐶 than with monopolies
• DWL due to market power relatively
small

22. Monopoly & Efficiency
• Market power may produce some benefit for an economy
• Prospect of market power (and resulting economic profits)  innovation
• New goods/services
• Incentive affects both…
• Large firms: reinvest profits in the hope of making larger future profits
• Small firms: hope to obtain profits for themselves
• Austrian economist Joseph Schumpeter claimed…
• This drive would create “gale of creative destruction” that would eventually benefit
consumers more than increased price competition
• Helps explain governmental ambivalence regarding large firms with market power