MONOPOLY by pengxuebo


3 Questions

 What price will the monopolist
 How much output will the
  monopolist produce?
 Are consumers better or worse
  off when only one firm controls
  an entire market?

 Monopoly is the only firm in an industry.
 Nobody else is selling anything like what
  the monopolist is producing (DeBeers
  diamonds…. used to be AT & T… cable?)
 No close substitutes- has significant
  market power
 No competition
 Is imperfect competition
 Profit maximizing MC=MR
Summary Continued

The Monopolist
 lowers price to sell more output,
 the price is lowered on ALL units of
  output, not just on the last one.
 This drives down MR faster than
 MR curve descends twice as quickly
  as the D Curve.
Market Power
• Market power: the ability to alter the
  market price of a good or service.
• A monopoly firm has total market power
  and confronts the downward-sloping
  market demand curve for its own
• This complicates the profit maximization
  – In imperfect competition (including
    monopoly), MR no longer equals price.

Summary Continued
 The perfect competitor produced at the
  most profitable output, which in the LR
  always happened to be the most efficient
  output.(i.e. at the minimum point of the
  ATC curve.

 The monopolist does NOT produce where
  output is at its most efficient level (i.e. the
  minimum point of the ATC curve.)
Summary Continued

Distinguishing characteristic:
 firm’s demand curve is no longer a
  perfectly elastic horizontal line.
 This means that the imperfect
  competitor will have to lower price to
  sell more.
 Marginal Cost is the additional cost of
  producing one more unit of output.
 Price and Marginal Revenue (MR)
• Points on the demand
  curve indicate a price
  for each output.
• However, to sell
  more the monopolist
  must lower the price,
  so MR will always be
  less than price.
• For the most part, the
  MR curve lies below
  the demand curve.
Summary Continued
 Monopolist makes a profit whereas in the
  LR the perfect competitor makes normal or
  zero profit

 Monopolist operates at less than peak
  efficiency- perfect competitor operates at
  peak efficiency.

 Perfect competitor charges a lower price
  and produces a larger output than the

   No close substitutes – examples?
   Single Seller – (Microsoft Office?)
   Price Maker – ($300 ?)
   Blocked Entry- (Patent?)
   Advertising – (Why?)
What keeps monopolies from
forming in our market economy?
 1887 Interstate Commerce Act
 Initially established to curtail abuse by
 The Interstate Commerce Act challenged the
  philosophy of laissez-faire economics by clearly
  providing the right of Congress to regulate
  private corporations engaged in interstate
  commerce. The act, with its provision for the
  ICC, remains one of America’s most important
  documents serving as a model for future
  government regulation of private business.
Progression of legislation
Sherman Act – 1890

Clayton Act – 1914

FTC – 1914
Barriers to Entry

 There are six barriers to entry.
 Patents – offers a producer 20 years of
  exclusive rights to produce a particular
  product. (drugs, inventions, items on cars,
 Monopoly franchises – governments
  also create and maintain monopolies by
  giving a single firm the exclusive right to
  supply a particular good or service.
  (lotteries, liquor stores, licensing,
Barriers to Entry Continued

 Control of key inputs – a company
  may lock out competition by
  securing exclusive access to key
  inputs.(bauxite… aluminum, Tiffany-
 Lawsuits – may be used to prevent
  new companies from successfully
  entering an industry.(threaten
  patent violation, rich vs poor
  company) (Standard Oil vs xyz oil)
Entry Barriers Continued

Acquisition – when all else fails, purchase a
  potential competitor. (AOL/Time/Warner)
  (Bank of America/Republic Bank)

 Economies of scale – a monopoly may
  persist because of cost advantages over
  smaller firms (more cost-effective) (Utility
  companies in a state – Con Edison- NY,
  SW Bell in TX, TV air waves)
OK! Let’s Take a Deeper Look
 Are Monopolies Beneficial to a Market

 It is conceivable that monopolies could
  benefit society.
 If economies of scale exist, the
  monopolist may attain much greater
  efficiency than a large number of
  competitive firms.
 Economies of scale act as a “natural”
  barrier to entry.
 Examples of natural monopolies used to
  include local telephone services, and other
  local utility services. Local cable is no
  longer an example of monopoly due to
Only Two Justifications for Monopoly

1. Natural monopoly
Local gas and electric companies… provide
   cheaper service as monopolies than could
   several competing firms. They are
   government regulated to insure against
   price gouging.
2. Economies of Scale
Justify bigness because only a firm with a
   large output can produce near the
   minimum point of its long-run ATC curve
Why are monopolies so bad?

Monopolies tend to be inefficient.
 because the production is Not at the
  minimum point of its ATC curve,
 the monopolist restricts output to some
  point to the left of that minimum and
 hence prevents resources from being
  allocated in the most efficient manner)
  (wastes resources!)
 Two terms to remember… allocative
  efficiency and productive efficiency.
Why We Don’t Like Monopolies

The idea of only one seller is not
  conducive to getting the best price
  on the market as compared to
Look at the Post Office…. Look at
  Amtrak….look at trying to get
  Microsoft to Repair Outlook
  Express…..have to pay
Profit Maximization

     13                                             Average
     12                                            total cost
     11                           D
      9   Profits
      7                            d
      5                                                 Demand
      3             Marginal
      2              cost                          Marginal
      1                                            revenue
      0      1      2     3       4     5      6    7      8     9
                        Quantity (baskets per hour)
    Monopoly Profit
•    The profit-maximizing
     output is qm.
•    The rectangle
     indicates the size of
•    Note that the
     monopolist will
     produce less (qm vs. qc
     ) and charge a higher
     price (A vs. X) than a
     competitive market.

What actually IS Market Power?

 Market power is the ability to alter the
  market price of a good or service.
 The demand curve facing the monopoly
  firm is identical to the market demand
  curve for the product.(the firm IS the
 Monopoly is a firm that produces the
  entire market supply of a particular good
  or service.
Price and Marginal Revenue
Unlike competitive firms, marginal
  revenue for a monopolist is not
  equal to price.
 So long as the demand curve is
  downward-sloping, MR will always
  be less than price.
Quantity     Price      Total    Marginal
                       Revenue   Revenue
   1        $13          $13       —
   2         12           24       $11
   3         11           33         9
   4         10           40         7
   5          9           45         5
   6          8           48         3
   7          7           49         1
Profit Maximization

                                13                                            total cost
  Price or Cost (per basket)

                                11                           D
                                 9   Profits
                                 7                            d
                                 6                                                 Demand
                                 3             Marginal
                                 2              cost                          Marginal
                                 1                                            revenue
                                 0      1      2     3       4     5      6    7      8     9
                                                   Quantity (baskets per hour)
 Marginal Revenue/Price
   12               C
   11       b               D
   10                               E
    9           c                           F
    8                                           G
    7                                                 Demand
    6                                                 (= price)
    5                           e
    3                                   f
    2                                           Marginal revenue
    1                                           g
   0    1   2   3    4     5     6     7             8    9       10
            QUANTITY (baskets per hour)
 Declining Marginal Revenue and Price
 Monopolist’s MR from each unit sold does not
  remain constant (as does Pure Competitor
 Monopolist has downward sloping demand
  curve which means the price that the
  monopolist can get for each additional output
  must fall as monopolist increases its output.
 Hence MR will fall as Monopolist increases
 If you assume NO price discrimination, then
  MR from each unit produced will not equal the
  price the monopolist charges.
 Three implications of a
  downward sloping demand curve
 1. Price exceeds marginal
A down sloping demand curve means
  that a pure monopoly can increase
  its sales ONLY by charging a
  lower unit price for its product. The
  fact that he must lower price to
  boost sales causes MR to be less
  than P for every level of output
  EXCEPT the first.
  For a Monopolist, P > MR

To sell an additional unit of its good,
a monopolist needs to lower price.
This price reduction both gains
revenue and loses revenue for the
In the exhibit, the revenue gained and
revenue lost are shaded and labeled.
Marginal revenue is equal to the
larger shaded area minus the smaller
shaded area.
Demand and Marginal Revenue
 The demand curve
  plots price and
 The marginal
  revenue curve plots
  marginal revenue
  and quantity.
 For a monopolist, P
  > MR, so the
  marginal revenue
  curve must lie
  below the demand
How does a monopolist figure profit?

Agreed……..monopolist has to lower
  unit price to sell more…for every
  level of output but the first… So,
  how does he know where to
    Maximize profit :MC= MR
    Where should monopolist produce?
Output Price TR         MR       TC    ATC    MC

1        $16    $16     $16      $20   $20    -
2        $15    $30     $14      $30   $15    $10
3        $14    $42     $12      $36   $12    $6
4        $13    $52     $10      $42   $10.50 $ 6

5        $12    $60     $8       $50   $10    $8
6        $11    $66     $6       $63   $10.50 $13

7        $10    $70     $4       $84   $12    $21
    Profit Maximization
Output   Price   TR    MR     TC    ATC     MC

1        $16     $16   $16    $20   $20     -
2        $15     $30   $14    $30   $15     $10
3        $14     $42   $12    $36   $12     $6
4        $13     $52   $10    $42   $10.5   $6
5        $12     $60   $ 8*   $50   $10     $8*
6        $11     $66   $6     $63   $10.5   $13
7        $10     $70   $4     $84   $12     $21
Implication #2
Price Maker

 This means that the imperfectly
  competitive markets in which
  demand curves are relevant, the
  firms have a price policy. Because of
  their ability to influence TOTAL
  SUPPLY, the output decisions of such
  firms necessarily affect product
 The monopolist determines price by
  deciding what volume of output to

 He chooses both price and output
Implication #3

Price Elasticity
The total revenue test for price elasticity of
   demand is the third reason for the down
   sloping demand curve.
Total revenue test tells us that when
   demand is elastic a decline in price
   will increase total revenue. P R
 When demand is inelastic decrease in
   price will decrease total revenue.) P R
Actually, inelastic demand for a product is
   not absolutely necessary… but if product
   demand is elastic, it not only has to lower
   price, but suggests substitutes. Cable
 For inelastic to be the decision, in
  order to increase revenue, monopolist
  would have to raise price.
*when MR is negative, demand is
 Because he has to lower price to sell
  more, will attempt to stay in elastic
  segment. Decline in P will increase R
Monopolist wants to avoid the
inelastic segment
Why did the Dallas Tollway Raise

Because they had a monopoly?

Because they had selected clientele?
            Very possible
Equilibrium for Monopolist

 Equilibrium output for a monopolist is
  determined where MC=MR

 The price the monopolist charges is
  determined by taking the point on the
  Demand curve directly above the
  intersection of the MC and MR curves.
Bottom Line

***The monopolist will never choose a price
   quantity combination where TR is
   decreasing (or stated another way… MR is
Stated another way… the profit-
   maximizing monopolist will always
   want to avoid the inelastic segment of
   its demand curve in favor of some
   price-quantity combination in the
   elastic segment. (in the inelastic
   segment, he loses a % of his profit)
Monopoly Curve

                       $1200                   W

                             1000                      C
                                                               Average total cost
      Price (per computer)


                              600                      B

                              400                             Demand
                                                              curve facing
                                    Marginal                  single plant
                                    cost                       Marginal revenue
                                                                 of single plant
                               0    200 400                800      1200       1600
                                       Quantity (computers per month)
                       Monopoly Profits

                                                        Marginal cost
                       $1200                W
                                                               Average total cost
Price (per computer)

                                                M                   Demand curve
                                                                    facing single plant
                        600                         B

                                                              Marginal revenue of
                                                              single plant
                          0    200       400    600    800 1000 1200          1400
                                         Quantity (computers per month)
Misconceptions Concerning Monopoly

1) Not the highest Price… Monopolist
   will charge the price where he can
   obtain maximum total profit….
   Not maximum total price.
2) Total…. Not Unit…
   Profit……….Monopolist seeks
   maximum TOTAL profit, not
   maximum UNIT profit.
Continued Misconceptions

3) Monopolist cannot lose money… While the Perfect
   competitor is destined for normal profit in the long
   run… and no barriers from everyone in the world
   entering the purely competitor’s world… which
   drives down prices….

But contrary to conventional wisdom, the
   monopolist is not immune to changes by the
   demands of the consumer… and more important
   … the monopolist is not immune from upward-
   shifting cost curves caused by escalating resource
Think about the discriminating monopolist
   and the non-discriminating monopolist.
   Or, stated another way… think about the
   various types of discrimination or not that
   a monopolist can engage in!!!!

What does this mean? How would the two
   types have a different look for their
   monopoly graph?
Selling a specific product at more than one
   price (remember price differences are not
   justified by cost differences)
          P       Economic profits with   MC
                    a single MR=MC
Price and Costs           price

Price Discrimination: Give me examples????
Examples: Electric utilities (vary prices amid
   some competition in certain areas)
               Golf courses (play 18 at prime
   time or “off-hours”
             Water usage
            Movie tickets
            Seats for Ranger World Series
Outcomes of Price Discrimination:
More Profit (if the monopolist can identify the
   buyers who will pay more… segregate
   them, charge the maximum price each
   would be willing to pay, TR and economic
   profit will increase
                  A perfectly discriminating
          P                                     MC
                   monopolist has MR=D,
                  producing more product
Price and Costs       and more profit!

                         Q1    Q2
     Economic profits
P           with            MC
    price discrimination


         Q1    Q2
Inefficiencies of                      S = MC
A pure monopoly

                                      At MR=MC
                                     A monopolist
The pure competitor
Will produce where                   will sell fewer
S & D intersect                        units at a
                                     higher price
                                         than in

                      Qm   Qc
What is Rent Seeking

Rent Seeking= transferring income or wealth
  to a particular firm or resource supplier at
  someone else’s or even society’s expense.
Best example is getting government to
  regulate something in the industry that
  has monopoly power (special licensing,
  special subsidies, anything directed to
  help that industry regardless of cost of
  resource mix or societal costs. Exxon did
  a lot of rent-seeking. What about
  pharmaceuticals today? – Solar today?
Regulated Monopolies

Rate Regulation
Socially Optimum Price
   P = MC
Fair-Return Price
   P = ATC
Dilemma of Regulation
Regulated Monopolies

                         MR = MC
 Socially optimum
 Is supposed to be
 Allocative efficiency
                                Fair-Return Price
                 Pf                             ATC
                 Pr                           MC

                           Qm      Qf   Qr          Q

 Government Power
 The AT&T Case
 The federal government dismantled AT&T in 1984.
 Prior to the break-up, AT&T supplied 96 percent of all
  long-distance service and over 80 percent of local
  telephone service.
 Remember, de-regulation of utilities .
 Still have natural gas, local phone service being
 Is it possible Health Care will eventually be here?
Government Power Continued

 Government Power Continued
 Antitrust Laws
 Sherman Act (1890) – prohibits “conspiracies in
  restraint of trade.

 Clayton Act (1914) – principally aimed at preventing
  the development of monopolies by prohibiting price
  discrimination, exclusive dealing agreements, certain
  types of mergers, and interlocking boards of directors
  among competing firms

 The Federal Trade Commission Act (1914) –
  created the FTC to study industry structures and
  behavior so as to identify anti-competitive practices.
          The monopolist’s profit-maximizing decision

            15                                               Marginal cost
And         14
Revenue     13
In          12                                                                   Average Total Cost
$           11
            7     Monopoly profits
            5                                                     Demand curve
            -1                                                                        Units of output
            -4             1
                                     2          3        3

                                                                        Marginal Revenue

                 How much profit did this monopolist make?
Should Government Regulate the
Chicken Industry
Financial Industry
Airline Industry?

Health, environment in question today (2010)
Banking,Cap and Trade, CEO salaries, securities, FAA,
FTC, Housing, etc….

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