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Chapter 10
Pure Monopoly
 A pure monopolist is the sole supplier of a product Or service for
which there are no close substitute.
 A monopoly survives because of entry barriers such as economies
of scale, patents and licenses, the ownership of essential resources and
strategic actions to exclude rivals.
 The monopolist’s demand curve is down sloping and its marginalrevenue curve lies below its demand curve.
 The downloading demand curve means that the monopolist is a
price maker.
 The monopolist will operate in the elastic region of demand since
in the inelastic region it can increase total revenue and reduce total
cost by reducing output.
 The monopolist maximize the profit (or minimize loss) at the
output where MC=MR and charges the price that correspond to that
output on its demand curve.
 The monopolist has no supply curve, since any of several prices
can be associated with a specific quantity of output supplied.
 Assuming identical costs, a monopolist will be less efficient than a
purely competitive industry because the monopolist produce less
output and charges a higher price.
 The inefficiencies of monopoly may be effect OR lessened by
economies of scale and less likely by technological progress but they
may be intensified by the presence of X-inefficiency and rent-seeking
expenditures.
 Price discrimination occurs when a firm sells a product at different
price that are not based on cost differences.
 The conditions necessary for price discrimination are: a.
monopoly power b. the ability to segregate buyers on the basis of
demand elasticities and c. the inability of buyers to resell the product.
 Compared with single pricing by a monopolist, perfect Price
discrimination returns in greater profit and greater output. Many
consumer pay higher prices but other buyers pay prices below the
single price.
 Monopoly price can be reduced and output increased through
government regulations.
 The socially optimal price (P=MC) achieves allocative efficiency
but may result in losses; the fair-return price (P=ATC) yield a normal
profit but fails to achieve allocative efficiency.
MCQ’s on “Pure Monopoly”
I. At a monopolist's current output, ATC = $10, P = $11, MC = $8 and
MR = $7. This firm is realizing:
o An Economic profit that could be increased by producing
more output
o An economic profit that could be increased by producing
less output
o An economic loss that could be reduced by producing more
output
o An economic loss than could be reduced by producing less
output
II. Use the following graph to answer the next question: Refer to the
diagram. At output q2:
o Marginal revenue exceeds marginal cost by the greatest
amount
o Demand is inelastic
o Profit is maximized
o Marginal revenue is zero
III. In long run equilibrium, profit-maximizing competitive firms and a
monopolistic firms both:
o Earn zero economic profits
o Set price equal to marginal revenue
o Produce at minimum average total cost
o Produce the output at which marginal revenue equals marginal
cost
IV. Use the following diagram to answer the next question: Refer to
the diagram. This non-discriminating monopolist will produce:
o M units at price A and make a profit
o N units at price B and earn zero profits
o M units at price C and incur a loss
o Q units at price J and earn zero profits
V. Use the following diagram to answer the next question: Refer to
the diagram. If this firm produces its profit-maximizing output, its
potential profit is:
o Zero
o Area afhc
o Area afgb
o Area bghc
VI. Suppose a monopolist could segment its market into two distinct
submarkets and prevent resale between them. Its profits would
increase if it charged a higher price to the group whose:
o Demand is more elastic
o Demand is more inelastic
o Demand is greater
o Cost is lower
VII. Answer the next question on the basis of the following table
showing the demand schedule facing a non-discriminating monopolist.
Refer to the data. The marginal revenue of the fourth unit of output is:
o $10
o $8
o $4
o $2
VIII. Use the following diagram to answer the next question. Refer to
the diagram. A regulatory commission that wished to establish a
socially optimum output level for this firm would set price at:
o P2 and the firm would break even
o P3 and the firm would earn a profit
o P1 but the firm would incur a loss
o P2 but the firm would incur a loss
IX.
Use the following diagram of a pure monopolist to answer the
next question.
Refer to the diagram.
Which of the following
is a correct statement?
o Maximum profits are obtained by selling at price $a
o Maximum profits are obtained by producing output g
o The firm's per-unit profits are $c – $a
o Demand is elastic at price $c
X. The allocative inefficiency of non-discriminating monopoly arises
from the fact that:
o Price exceeds marginal cost
o Output falls short of the output at which average cost is
minimized
o Output exceeds that at which average cost is minimized
o Price exceeds minimum average cost
B
B
D
D
D
C
A
D
C
A
Problems on Pure Monopoly
Problem 1:
Suppose a monopoly's demand schedule is given by the first two
columns of the following table. Its total cost of production is given in
the next column.
Output
Price
Total Cost Total Revenue
MC
MR
0
$24
$10
1
$21
$14
2
$18
$20
3
$15
$28
4
$12
$38
5
$9
$50
a) Fill in the Total Revenue column by computing the firm's total
revenue associated with each output level.
b) By comparing total cost and total revenue, find the output level
that maximizes the firm's profit.
c) What price should the firm set to achieve maximum profit?
d) Complete the final two columns to verify that the same
conclusions are reached using the MR = MC rule.
Answer:
a) Total revenue is the product of output and price. For example, if
the firm wishes to sell two units, it sets a price of $18 and its total
revenue is 2 x $18 = $36. The completed table is shown below.
Output
Price
Total Cost Total Revenue
MC
MR
0
$24
$10
$0
1
$21
$14
$21
2
$18
$20
$36
3
$15
$28
$45
4
$12
$38
$48
5
$9
$50
$45
b) The table is presented below total profit at each unit of output.
Output
Total Cost
Total Revenue
Total Profit
0
$10
$0
$0
1
$14
$21
$7
2
$20
$36
$16
3
$28
$45
$17
4
$38
$48
$10
5
$50
$45
$ -5
The profit is maximized at an output of 3 units.
c) According to the demand schedule, price must be set at $15 to
sell three units.
d) Comparing MR to MC,
Output
Price
Total Cost Total Revenue
MC
MR
0
$24
$10
$0
1
$21
$14
$21
$4
$21
2
$18
$20
$36
$6
$15
3
$15
$28
$45
$8
$9
4
$12
$38
$48
$10
$3
5
$9
$50
$45
$12
$ -3
Output should be expanded to produce the third unit, but not the
fourth. The marginal revenue of the fourth unit is less than its marginal
cost, and will cause profit to decrease.
Problem 2:
Suppose a price-discriminating monopoly has segregated its market
into two submarkets and can prevent resale between the two. Assume
that its marginal cost is constant and equal to its average total cost of
$8. The firm's demand schedule for the first group is given by the first
two columns of the following table.
Output
Price
Total Revenue
MR
0
$24
1
$22
2
$20
3
$18
4
$16
5
$14
6
$12
7
$10
8
$8
a) Find the firm's total revenue schedule for this submarket, entering
the data into the table where indicated. Use these data to determine
the marginal revenue schedule in this submarket.
b) What output level and price will maximize the firm's profit in this
submarket?
c) The firm's demand schedule for the second group is given by the
first two columns of the following table.
Output
0
1
2
3
4
5
6
7
8
Price
$33
$30
$29
$24
$21
$18
$15
$12
$9
Total Revenue
MR
Find the firm's total and marginal revenue schedules in this second
submarket. What output level and price will maximize the firm's profit
in this submarket?
d) Based on these prices, which submarket has the more elastic
demand?
e) What is this firm's total economic profit?
Answer:
a) The completed table is shown below:
Output
0
1
2
3
4
Price
$24
$22
$20
$18
$16
Total Revenue
$0
$22
$40
$54
$64
MR
$22
$18
$14
$10
5
$14
$70
$6
6
$12
$72
$2
7
$10
$70
$ -2
8
$8
$64
$ -6
b) Using the MR = MC rule, profit is maximized at 4 units of output,
implying a price of $16.
c) The completed table is shown below.
Output
Price
Total Revenue
MR
0
$33
$0
1
$30
$30
$30
2
$29
$54
$24
3
$24
$72
$18
4
$21
$84
$12
5
$18
$90
$6
6
$15
$90
$0
7
$12
$84
$ -6
8
$9
$72
$ -12
d) Since the price is higher in the second submarket, demand is more
elastic in the first submarket.
e) The firm earns revenue of 4x$16 = $64 in the first submarket and
revenue of 4x$21 = $84 in the second. Its total revenue is then $64 +
$84 = $148. Its total cost is 8x$8 = $64, so its total economic profit is
$148 – $64 = $84.
Question on Pure Monopoly
Question 1:
Use the demand schedule to the upper right to calculate total revenue
and marginal revenue at each quantity.
a) Plot the demand, total-revenue, and marginal-revenue curves and
explain the relationships between them.
b) Explain why the marginal revenue of the fourth unit of output is
$3.50, even though its price is $5.00.
c) Use Chapter 6's total-revenue test for price elasticity to designate
the elastic and inelastic segments of your graphed demand curve.
d) What generalization can you make as to the relationship between
marginal revenue and elasticity of demand?
e) Suppose the marginal cost of successive units of output was zero.
What output would the profit-seeking firm produce?
f) Finally, use your analysis to explain why a monopolist would never
produce in the inelastic region of demand:
Answers:
Table of total revenue and marginal revenue is below:
Quantity
Demanded (Q)
$7.00
0
$6.50
1
$6.00
2
$5.50
3
$5.00
4
$4.50
5
$4.00
6
$3.50
7
$3.00
8
$2.50
9
a) See the Graph:
Price (P)
Total Revenue
Marginal
Revenue
$0
$6.50
$12
$16.50
$20
$22.50
$24
$24.50
$24
$22.50
$1
$6.50
$5.50
$4.50
$3.50
$2.50
$1.50
$0.50
$ -1.50
Because TR is increasing at a diminishing rate, MR is declining. When
TR turns downward, MR becomes negative. Marginal revenue is below
D because to sell an extra unit, the monopolist must lower the price on
the marginal unit as well as on each of the preceding units sold.
b) Four units sell for $5.00 each, but three of these four could have
been sold for $5.50 had the monopolist been satisfied to sell only three.
Having decided to sell four, the monopolist had to lower the price of
the first three from $5.50 to $5.00, sacrificing $.50 on each for a total of
$1.50. This “loss” of $1.50 explains the difference between the $5.00
price obtained on the fourth unit of output and its marginal revenue of
$3.50.
c) Demand is elastic from P = $6.50 to P = $3.50, a range where TR is
rising. The curve is of unitary elasticity at P = $3.50, where TR is at its
maximum. The curve is inelastic from then on as the price continues to
decrease and TR is falling.
d) When MR is positive, demand is elastic. When MR is zero,
demand is of unitary elasticity. When MR is negative, demand is
inelastic.
e) If MC is zero, the monopolist should produce 7 units where MR is
also zero.
f) It would never produce where demand is inelastic because MR is
negative there while MC is positive.
Question2:
Suppose a pure monopolist is faced with the demand schedule shown
below and the same cost data as the competitive producer discussed in
question 4 at the end of Chapter 9.
a) Calculate the missing total-revenue and marginal-revenue
amounts,
b) Determine the profit-maximizing price and profit-earning output
for this monopolist.
c) What is the monopolist's profit? Verify your answer graphically
and by comparing total revenue and total cost:
Answers:
a) Table of total revenue and marginal revenue is below:
Quantity
Marginal
Price (P)
Total Revenue
Demanded (Q)
Revenue
$115
0
$0
$100
$100
1
$100
$66
$83
2
$166
$47
$71
3
$213
$39
$63
4
$253
$23
$55
5
$275
$13
$48
6
$288
$6
$42
7
$294
$2
$37
8
$296
$1
$33
9
$297
$ -7
$29
10
$290
b) See the Graph:
Question3:
Suppose that a price-discriminating monopolist has segregated its
market into two groups of buyers, the first group described by the
demand and revenue data that you developed for question 2. The
demand and revenue data for the second group of buyers is shown in
the accompanying table.
a) Assume that MC is $13 in both markets and MC = ATC at all
output levels. What price will the firm charge in each market?
b) Based solely on these two prices, what can you conclude about
the relative elasticities of demand in the two markets?
c) What will be this monopolist's total economic profit?
Answers:
a) Group 1 (from Question 2) will be sold 6 units at a price of $48;
group 2 will buy 5 units at a price of $37.
b) Based solely on the prices, it would appear that group 1’s demand
is more inelastic than group 2’s demand. .
c) The monopolist’s total profit will be $330 ($210 from group 1 and
$120 from group 2).
Question 4:
It has been proposed that natural monopolists should be allowed to
determine their profit-maximizing outputs and prices and then
government should tax their profits away and distribute them to
consumers in proportion to their purchases from the monopoly. Is this
proposal as socially desirable as requiring monopolists to equate price
with marginal cost or average total cost?
Answers:
No, the proposal does not consider that the output of the natural
monopolist would still be at the suboptimal level where P > MC. Too
little would be produced and there would be an under allocation of
resources. Theoretically, it would be more desirable to force the
natural monopolist to charge a price equal to marginal cost and
subsidize any losses. Even setting price equal to ATC would be an
improvement over this proposal. This fair-return pricing would allow
for a normal profit and ensure greater production than the proposal
would.