Monopoly a. Market structures
b. Meaning of monopoly
c. Monopoly equilibrium
November 2, 2006 i. Demand curve and marginal revenue
ii. Profit maximization
Reading: Chapter 14 iii. Monopoly versus perfect competition
d. Monopoly and public policy
Start examining markets in which perfect competition i. Welfare effect of monopoly
does not prevail. We examine the case of monopoly – ii. Preventing monopoly
single seller - and explore how it results in market iii. Dealing with natural monopoly
failure and efficiency loss. Discuss appropriate policies e. Price discrimination
to address the problem. Also examine the case of
discriminating monopolist. 2
Market Structures Meaning of Monopoly
One of the assumptions we have made Four principal models of market
What a Monopolist Does
so far in examining markets is perfect structure: A monopolist is a firm that is the only producer of a good that has no close
competition: many small sellers. 1. perfect competition substitutes. An industry or market with one seller is known as a monopoly.
Implication: markets are efficient 2. monopoly
(under some conditions). But is 3. oligopoly The ability of a monopolist (or other firm) to raise its price above the
perfect competition a valid 4. monopolistic competition competitive level by reducing output is known as market power.
assumption? For many markets, no. Under perfect competition, price
Models of market structures and quantity are determined by
can be distinguished on two supply and demand. Equilibrium is
dimensions: at C, with price PC and quantity is
QC. A monopolist reduces the
The number of
producers in the market: quantity supplied to QM, and moves
one, few, or many (few is up the demand curve, raising the
not defined by numbers but price to PM. Firms in perfectly
qualitatively). competitive markets cannot do this
because they are price takers.
Whether the goods
offered are identical or A monopolist has market power and
differentiated hence charges higher price and
(considered different by produces less output than a
consumers but similar in competitive industry. Monopolist
the sense that they are
makes in the short and long runs. 4
Meaning of Monopoly Demand curve
Why Do Monopolies Exist? Profit maximizing firms produce at the level of output at which profit, or
revenue minus cost is at its maximum. This is the same as the output at which
Why does profit persist in the long MC = MR.
run? Why do other firms not enter the In a market with perfect competition, the individual firm is a price taker.
market? Monopolies can exist because Cannot charge a higher price than market price: buyers will buy from other
of barriers to entry due to: firms. Will not charge a lower price than market price: it can sell any amount
control of natural resources or at the going price – why sell for less. So the firm’s demand curve is a perfectly
inputs. Ex: De Beers and diamonds elastic, although the market demand curve is negatively sloped. The firm here
economies of scale, which create
natural monopolies. Ex: utilities like For the monopolist,
gas – large fixed costs and falling the demand curve is
average total cost the market demand
technological superiority. Ex: curve: it is therefore
Computer chips. But others can copy, downward sloping.
temporary As a firm expands output, ATC falls due The monopolist knows
to economies of scale. Other firms that if it produces
legal restrictions imposed by who are smaller will not be able to more it will obtain a
governments, giving exclusive rights, compete and exit. New firms cannot lower price for its
including patents and copyrights. enter, because of high fixed costs and product and will take
high ATC at low output levels. this into account.
Monopoly Equilibrium Monopoly Equilibrium
Demand curve and marginal revenue Profit Maximization
Increase in Monopolist’s profit maximizing equilibrium occurs at output at which MC = MR.
monopolist has Take simple case in which MC = ATC = constant, no fixed costs. MC is a
two opposing flat line. TC curve has a constant slope.
effects on MR and D (=P=PQ/Q=TR/Q=AR) curve are shown.
Quantity Profit maximizing output is where MC=MR or where Profit = TR-TC is
effect. One maximum. Price is read of from the D curve and from TR line.
more unit is sold, Profit = (P-ATC) x Q
revenue by the Profit = XY
price at which $ MC = slope of TC
the unit is sold. MR = slope of TR
Equilibrium price = XZ/0Z
Price effect. In
order to sell the
last unit, the
monopolist must X
cut the market
price on all units
revenue. Y Total cost
So MR curve is 0
Profit maximization, cont. Monopoly Equilibrium
In the general case MC curve is upward sloping and there are fixed costs,
so average total cost curve is U-shaped. Monopoly versus Perfect Competition
Monopolist maximizes profit by producing output at which MR = MC, given by To compare monopoly and perfectly competitive equilibria, return to the case
point A, implying quantity QM. Find monopoly price, PM , from the point on the of constant MC. Demand curve same for both cases.
demand curve directly above point A, point B. The average total cost for QM is
shown by point C. Profit is given by the area of the shaded rectangle. P = MC at the perfectly competitive firm’s
Profit = TR − TC Profit = XY profit-maximizing quantity of output
= (PM × QM) − (ATCM × QM) MC = slope of TC
= (PM − ATCM) × QM $ MR = slope of TR P > MR = MC at the monopolist’s profit-
Equilibrium price = XZ/0Z
maximizing quantity of output
Compared with a competitive industry, a
Total cost monopolist does the following:
Produces smaller quantity: QM < QC
Charges higher price: PM > PC
Earns a profit
The comparison suggests that the more
Y Total revenue inelastic the demand curve, the lower the
0 output and higher the price.
Monopoly and Public Policy Monopoly and Public Policy
Welfare effects of monopoly Preventing monopoly
By reducing output and raising price above marginal cost, a monopolist
captures some of the consumer surplus as profit and causes deadweight loss.
This implies inefficiency and a loss in social welfare. Income distribution and
To avoid social welfare loss, government policy
fairness implications are also likely to be negative. attempts to prevent monopoly behavior.
Show using total surplus, consumer surplus and producer surplus or profit.
When monopolies are “created” rather than
natural, governments can act to prevent them
from forming and break up existing ones.
The government policies that prevent or eliminate
monopolies are known as antitrust policy. If
firms are trying to get together and create a
monopoly, government gets involved to prevent
mergers or collusion.
Monopoly and Public Policy Monopoly and Public Policy
Dealing with natural monopoly Dealing with natural monopoly, cont.
If there is a natural policy, it cannot be broken up without raising
average costs. Also, one firm is likely to emerge as the only
seller. Three approaches:
1. Public ownership. Government ownership of utilities,
transportation. Sometimes works well, reducing welfare loss.
But publicly owned companies often create inefficiencies
because they have high costs (managers don’t try to keep
costs down) and they are open to political pressures, for
instance, to keep employment high.
2. Price regulation. Common in the US. A price ceiling
imposed on a monopolist does not create shortages as long Unregulated monopolist is allowed to Regulated monopolist which must
as it is not set too low. charge PM, it makes a profit, shown by charge a price equal to average total cost,
the green area; consumer surplus is the price PR*. Output is QR*, and consumer
3. Doing nothing: monopoly is a bad thing, but the cure may shown by blue area. If it is regulated surplus is entire blue area. The
sometimes be worse than the disease. Politicization of prices. and must charge the lower price PR, monopolist makes zero profit. This is the
greatest consumer surplus possible when
Not knowing what is the correct cost. Cost padding by output increases from QM to QR, and
the monopolist is allowed to at least break
regulated firms. But doing nothing results in welfare losses.
13 consumer surplus increases.
even, making PR* the best regulated price.
Price Discrimination Price Discrimination, cont.
So far we examine only single-price monopolist, one who It is profit-maximizing to charge higher prices to low-elasticity consumers
and lower prices to high elasticity ones.
charges all consumers the same price. Not all monopolists do this.
Discriminating monopolists can charge more than two prices to different
In fact, many monopolists find that they can increase their profits sets of customers. Example with three prices.
by charging different customers different prices for the same
good: they engage in price discrimination.
Price discrimination is possible if
there are two or more groups of
potentially customers who can be
easily distinguished and who
cannot resale what they buy to
each other. It is profitable if the
groups of customers have
different characteristics – such as
how elastic their demand is or
how much they are willing to pay.
Example: airline tickets for By increasing the number of different prices charged, the
businesses and students. monopolist captures more of the consumer surplus and makes
a large profit.
Perfect Price Discrimination
In the case of perfect price discrimination, a discrimination is
monopolist charges each consumer his or her probably impossible
willingness to pay; the monopolist’s profit is given by in practice.
the shaded triangle. There is no deadweight loss! Creates a problem for
prices as economic
true willingness to
pay can easily be
do try to move
towards perfect price
through a variety of
Two-part tariffs: fee