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Chapter 24
Monopoly
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Introduction
In New York City, a taxicab requires a medallion as legal
possession of a license to operate the taxi business.
Thus, the medallion constitutes a barrier to entry to
New York City’s taxicab industry.
In this chapter, you will learn how governmentally
imposed and other types of barriers to entry give rise to
monopolies, or single-firm industries.
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Learning Objectives
• Identify situations that can give rise to monopoly
• Describe the demand and marginal revenue
conditions a monopolist faces
• Discuss how a monopolist determines how much
output to produce and what price to charge
• Evaluate the profits earned by a monopolist
• Understand price discrimination
• Explain the social cost of monopolies
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Chapter Outline
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Definition of a Monopolist
Barriers to Entry
The Demand Curve a Monopolist Face
Elasticity and Monopoly
Cost and Monopoly Profit Maximization
Calculating Monopoly Profit
On Making Higher Profits: Price
Discrimination
• The Social Cost of Monopolies
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Did You Know That ...
• Today the activities of 35 percent of U.S.
employees of private businesses are licensed,
certified, or regulated by government agencies,
up from just 3 percent five decades ago?
• In this chapter, you will learn that a consequence
of such government-established barriers to entry
can be a situation called monopoly.
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Definition of a Monopolist
• Monopolist
– A single supplier of a good or service for which
there is no close substitute
– The monopolist therefore constitutes the entire
industry
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Barriers to Entry
• Question
– How does a firm obtain monopoly power?
• Answer
– Barriers to entry that allow the firm to make
long-run economic profits
– Barriers to entry are restrictions on who can
start as well as stay in business.
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Barriers to Entry (cont'd)
• Barriers to entry include:
– Ownership of resources without close
substitutes
– Economies of scale
– Legal or governmental restrictions
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Barriers to Entry (cont'd)
• Ownership of resources without close
substitutes
– The Aluminum Company of America (ALCOA) at
one time owned most of of the world’s bauxite
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Barriers to Entry (cont'd)
• Economies of scale
– Low unit costs and prices drive out rivals
– The largest firm can produce at the lowest
average total cost
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Barriers to Entry (cont'd)
• Natural Monopoly
– A monopoly that arises from the peculiar
production characteristics in an industry
– It usually arises when there are large
economies of scale
– One firm can produce at a lower average cost
than can be achieved by multiple firms
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Figure 24-1 The Cost Curves That Might
Lead to a Natural Monopoly
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Barriers to Entry (cont'd)
• Legal or governmental restrictions
– Licenses, franchises, and certificates of
convenience
– Examples include
• Electrical utilities
• Radio and television broadcasting
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Why Not … stop erecting government barriers to
entry?
• Despite the understanding that governmentestablished entry barriers reduce competition,
vested interests often promote insincere public
safety rationales for licensing and certification
rules.
• On example is the requirement in some states for
all qualified people to arrange furniture and
accessories in office buildings to be American
Society of Interior Designers members, who must
earn a college degree in interior design, complete
a 2-year apprenticeship, and pass a licensing
exam.
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Policy Example: Congress Decides to License Tax
Preparers
• Many firms offering tax preparation services are
unlicensed and uncertified by any governmental
authorities.
• The Internal Revenue Service (IRS), however, has
convinced Congress to require all tax preparers to
reregister with the federal government and to
satisfy government-defined minimum competency
standards.
• The government-erected entry barriers essentially
make tax preparation firms public utilities.
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Barriers to Entry (cont'd)
• Legal or governmental restrictions
– Patents
• Intellectual property
– Tariffs
• Taxes on imported goods
– Regulation
• Government enforcement of safety and quality
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The Demand Curve a Monopolist
Faces
• The monopolist faces the industry demand
curve because the monopolist is the entire
industry
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The Demand Curve a Monopolist
Faces (cont'd)
• Recall that under perfect competition
– Firm faces perfectly elastic demand curve, it is
a price taker
– The forces of supply and demand establish the
price per unit
– Marginal revenue, average revenue, and price
are all the same
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The Demand Curve a Monopolist
Faces (cont'd)
• Marginal revenue equals the change in
total revenue due to a one-unit change in
the quantity produced and sold
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The Demand Curve a Monopolist
Faces (cont'd)
• Perfect competition versus monopoly
– The perfect competitor doesn’t have to worry
about lowering price to sell more
– In a purely competitive situation, the firm
accounts for a small part of the market
• It can sell its entire output, whatever that may be, at
the same price
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The Demand Curve a Monopolist
Faces (cont'd)
• Perfect competition versus monopoly
– The more the monopolist wants to sell, the
lower the price it has to charge on the last unit
sold
– To sell the last unit, the monopolist has to
lower the price because it is facing a downward
sloping demand curve
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Figure 24-2 Demand Curves for the Perfect
Competitor and the Monopolist
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The Demand Curve a Monopolist
Faces (cont'd)
Monopoly
Perfect Competition
Single seller
Many sellers
Faces entire
industry demand
Faces perfectly
elastic demand
Must lower price
to sell more
Must produce more
to sell more
Not all units sold for
same price (MR < P)
All units sold for same
price (P = MR)
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Figure 24-3 Marginal Revenue: Always
Less Than Price
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Elasticity and Monopoly
• The monopolist faces a downward-sloping
demand curve (its average revenue curve)
• That means that it cannot charge just any
price with no changes in quantity (a
common misconception) because,
depending on the price charged, a
different quantity will be demanded
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Elasticity and Monopoly (cont'd)
• Question
– If a monopoly raises price, what will happen to
quantity demanded?
• Hint
– Remember how consumers respond to a
change in price
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Elasticity and Monopoly (cont'd)
• Recall
– A monopolist is a single seller of a well-defined
good or service with no close substitute
• Think of some imperfect substitutes.
– The demand curve slopes downward because
individuals compare marginal satisfaction to
cost
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Elasticity and Monopoly (cont'd)
• After all, consumers have limited incomes
and unlimited wants
• The market demand curve, which the
monopolist alone faces in this situation,
slopes downward because individuals
compare the marginal satisfaction they will
receive to the cost of the commodity to be
purchased
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Costs and Monopoly Profit
Maximization
• We assume profit maximization is the goal
of the pure monopolist, just as it is for the
perfect competitor
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Costs and Monopoly Profit
Maximization (cont'd)
• Perfect competitor has only to decide on
the profit-maximizing output rate because
price is given
– The perfect competitor is a price taker
• For the pure monopolist, we must seek a
profit-maximizing price output combination
– The monopolist is a price searcher
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Costs and Monopoly Profit
Maximization (cont'd)
• Price Searcher
– A firm that must determine the price-output
combination that maximizes profit because it
faces a downward-sloping demand curve
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Costs and Monopoly Profit
Maximization (cont'd)
• We can determine the profit-maximizing
price-output combination with either of
two equivalent approaches:
– By looking at total revenues and total costs
or
– By looking at marginal revenues and marginal
costs
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Costs and Monopoly Profit
Maximization (cont'd)
• Total revenues-total costs approach
– Maximize the positive difference between total
revenues and total costs
• Marginal revenue-marginal cost approach
– Profit maximization will also occur where
marginal revenue equals marginal cost
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Costs and Monopoly Profit
Maximization (cont'd)
• Question
– Why produce where marginal revenue equals
marginal cost?
• Answer
– This is where the greatest positive difference
between total revenue and total cost occurs
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Figure 24-4 Monopoly Costs,
Revenues, and Profits, Panel (a)
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Figure 24-4 Monopoly Costs, Revenues, and
Profits, Panels (b) and (c)
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Costs and Monopoly Profit
Maximization (cont'd)
• Producing past where MR = MC
– Result is that incremental cost will exceed
incremental revenue
• Producing less than where MR = MC
– The monopolist is not maximizing profits
through this approach either
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Figure 24-5 Maximizing Profits
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Cost and Monopoly Profit Maximization
(cont’d)
• Real-World Informational Limitations
– Price searching by a less-than perfect
competitor is a process
– A monopolist can only estimate the actual
demand curve and make an educated guess
when it sets its profit-maximizing profit
– For the perfect competitor, price is given
already by the intersection of market demand
and supply
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Calculating Monopoly Profit
• Monopoly profit is given by the shaded
area in Figure 24-6, which is equal to total
revenues (P  Q) minus total costs (ATC 
Q)
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Figure 24-6 Monopoly Profit
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Calculating Monopoly Profit (cont'd)
• No guarantee of profits
– The term monopoly conjures up the notion of a
greedy firm ripping off the public
• If ATC is everywhere above AR, or demand
– No price-output combination allows the monopolist to
cover costs
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Figure 24-7 Monopolies: Not Always
Profitable
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International Example: A Mexican Cement
Monopoly Finds a Way to Incur Losses
• In Mexico, a single company, Cemex, accounts for
almost 80 percent of the nation’s cement
production and sales.
• Thus, Cemex sells cement to Mexican consumers
at almost twice the market price in the United
States, where a number of firms make and sell
cement.
• Recently, Cemex has been incurring losses as a
result of falling demand in 2008 and its debt costs
from short-term loans that the company had
borrowed during periods of expansion.
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On Making Higher Profits: Price
Discrimination
• Price Discrimination
– Selling a given product at more than one price,
with the difference being unrelated to
differences in cost
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On Making Higher Profits: Price
Discrimination (cont'd)
• Price Differentiation
– Establishing different prices for similar products
to reflect differences in marginal cost in
providing those commodities to different
groups of buyers
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On Making Higher Profits: Price
Discrimination (cont'd)
• Necessary conditions for price
discrimination
1. The firm must face a downward-sloping
demand curve
2. The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with
predictably different elasticities of demand
3. The firm must be able to prevent resale of the
product or service
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Example: Why Students Pay Different Prices to
Attend College
• Out-of-pocket tuition rates for any two college
students can differ by considerable amounts,
even if the students happen to major in the same
subjects and enroll in many of the same courses.
• The reason for this is that colleges offer students
diverse financial aid packages depending on their
“financial need.”
• To document their “need” for financial aid,
students must provide detailed information about
family income and wealth. This information helps
the college determine the prices that different
families are most likely to be willing and able to
pay, so that it can engage in price discrimination.
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Figure 24-8 Toward Perfect Price Discrimination in
College Tuition Rates
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The Social Cost of Monopolies
• Comparing monopoly with perfect
competition
– Let’s assume a monopolist comes in and buys
up every single perfect competitor
– Notice the monopolist produces a smaller
quantity and sells at a higher price
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The Social Cost of Monopolies
(cont'd)
• Comparing monopoly with perfect
competition
– Monopolists raise the price and restrict
production compared to a perfectly competitive
situation
– Consumers pay a price that exceeds the
marginal cost of production and resources are
misallocated in such a situation
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Figure 24-9 The Effects of
Monopolizing an Industry
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You Are There: A Texas Veterinary Board
Whittles Down Vets’ Competition
• The Texas Board of Veterinary Medical Examiners has
determined that horse-teeth floaters, who provide basic
dental services for horses, must be certified or else they
must work under the supervision of a licensed veterinarian.
• This way, many skilled horse-teeth floaters without a license
will no longer able to compete with licensed veterinarians in
the market for horse dental services.
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Issues & Applications: This Medallion Is Not
Simply a Decorative Pendant
• The number of taxi medallions issued by New
York City is controlled by the city’s Taxi and
Limousine Commission.
• The commission’s medallions serve as a barrier
to entry in the taxicab market.
• The medallions can be bought and sold, and the
market clearing prices have generally risen since
2004, now exceeding $600,000 for individual
owners and $800,000 for corporate owners.
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Figure 24-10 Market Prices of New York City
Taxi Medallions
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Summary Discussion of Learning
Objectives (cont'd)
• Why a monopoly can occur
– Barriers to entry
• Demand and marginal revenue conditions
faced by a monopolist
– Because the monopolist constitutes the entire
industry, it faces the entire market demand
curve.
– Marginal revenue is less than price.
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Summary Discussion of Learning
Objectives (cont'd)
• How a monopolist determines how much
output to produce and what price to
charge
– Seeks to maximize its economic profits
– Produces where marginal revenue equals
marginal cost
– Charges maximum price for the amount of
output where MR = MC
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Summary Discussion of Learning
Objectives (cont'd)
• A monopolist’s profits
– Profit earned by monopolist is equal to the
difference between the price it charges and its
average production cost times the amount of
output it produces and sells.
– Monopolist typically earns positive economic
profits.
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Summary Discussion of Learning
Objectives (cont'd)
• Price discrimination
– Selling at more than one price with the price
differences being unrelated to differences in
production costs.
– Monopolist sells some of its output at higher
prices to consumers with less elastic demand.
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Summary Discussion of Learning
Objectives (cont'd)
• Social cost of monopolies
– Price exceeds marginal cost.
– The price is higher and output is lower for a
monopolist as compared to a perfectly
competitive industry.
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Appendix G: Consumer Surplus in a
Perfectly Competitive Market
• Given the market clearing price that
prevails in the perfectly competitive
market, consumer surplus is:
– the difference between the total amount that
consumers would have been willing to pay and
the total amount that they actually pay
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Figure G-1 Consumer Surplus in a Perfectly
Competitive Market
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Appendix G: How Society Loses from
Monopoly
• Deadweight Loss
– The portion of consumer surplus that no one in
society is able to obtain in a situation of
monopoly
– No one in society, not even the monopoly, can
obtain this deadweight loss
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Appendix G: How Society Loses from
Monopoly (cont’d)
• As a result of monopoly, consumers are
worse off in two ways:
– The monopoly profits that result constitute a
transfer of a portion of consumer surplus away
from consumers to the monopolist
– The failure of the monopoly to produce as
many units as would have been produced
under perfect competition eliminates consumer
surplus that otherwise would have been a
benefit to consumers
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Figure G-2 Losses Generated by Monopoly
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