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Chapter 9
Monopoly
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western
Monopoly
• Monopoly firm - The only seller of a good
or service with no close substitutes
• Monopoly market
– The market in which the monopoly firm
operates
• Barriers to entry
– Economies of scale
– Legal barriers
– Network externalities
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Barriers to Entry
• Economies of scale
– One firm can operate at lower average
cost than other firms
– Natural monopoly - arises when one firm
• can produce for the entire market
• at lower cost per unit
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Figure 1: A Natural Monopoly
• Figure 1 A Natural Monopoly
Dollars
$15
Three firms –each produce 100 units
Each operate at C on LRATC curve
Cost per unit = $15
Two firms- each produce 150 units
Each firm operate at B on LRATC
Cost per unit = $12 (higher)
C
B
12
A
5
One firm – produce 300 units
Operate at A on LRATC curve
Cost per unit=$5
LRATC
100
150
300
Articles of
Clothing
per Day
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Barriers to Entry
• Legal barriers
– Protection of intellectual property
• Patents - temporary grant of monopoly
• Copyrights - grant of exclusive rights to sell
a literary, musical, or artistic work
– Government franchise
• Grant of exclusive rights over a product
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Barriers to Entry
• Network Externalities
–The added benefits for all users of a
good or service that arise because
other people are using it too
–Joining a large network is more
beneficial than joining a small
network
6
Monopoly Behavior
• Goal
– Earn highest profit possible
• Economic constraints
– Cost – to produce any level of output
• Input prices
• Technology
– Given market demand curve
• the highest price it can charge
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Monopoly Price or Output Decision
• The output level
– And the maximum price it can charge
and still sell that output level
• The price
– And the maximum output the firm can
sell at that price
• The MR curve lies below the demand curve
– Downward-sloping demand curve
– MR<P
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Figure 2: Demand and Marginal Revenue
• Figure 2 Demand and Marginal Revenue for Patty’s Pool
Dollars
$13
A
10
9
B
C
Demand
0
-1
3
4
MR
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The Profit-Maximizing Output Level
• To maximize profit
– Produce the quantity where MC = MR
– MC curve crosses the MR curve from
below
• Price and output are not independent
decisions, but different ways of
expressing the same decision
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The Profit-Maximizing Output Level
• Figure 3 Monopoly Price and Output Determination
Monthly $60
Price per
Subscriber
40
MC
E
D
10,000
30,000
MR
Number of Subscribers
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Monopoly and Market Power
• Market power
– The ability of a seller to raise price
without losing all demand for the product
being sold
• Price setter
– A firm with market power that selects its
price, rather than accepting the market
price as a given
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Profit and Loss
• Profit
– When P > ATC
– Total profit = Profit per unit * Q
– Profit per Unit = P – ATC
• Loss
– When P < ATC
– Total loss = Loss per unit * Q
– Loss per unit = ATC - P
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Profit and Loss
• Figure 4 Monopoly Profit and Loss
(a)
MC ATC
Dollars
(b)
ATC
MC AVC
Dollars
$50
E
$40
40
32
E
Total Loss
Total
Profit
D
D
10,000
Number of
MR Subscribers
10,000
MR
Number of
Subscribers
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Equilibrium in Monopoly Markets
• Monopoly market – equilibrium
– The monopoly is maximizing profit
• Short run
– Produce where MR=MC
– Profit if P>ATC
– Loss if P<ATC
• If P>AVC – produce
• If P<AVC – shut down
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Equilibrium in Monopoly Markets
• Long run
– Monopolies may earn economic profit
– Monopoly suffering an economic loss should always exit the industry
• If regulated - the government may decide to
subsidize it
• If privately owned – exit the industry
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Monopoly vs. Perfect Competition
• Economic profit
– Reduced to zero by entry of other firms –
in perfect competition
– Continue indefinitely – in monopoly
• For a given technology, monopoly
market
– Higher price
– Lower output
• than a perfectly competitive market
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Monopoly and Perfect Competition
• Figure 5 Comparing Monopoly and Perfect Competition
(a) Competitive Market
Price
per
Unit
(b) Competitive Firm
Dollars
per Unit
S
2. and each firm produces
1,000 units, where P = MC.
MC
ATC
E
$10
$10
d=MR
D
100,000
1. In this competitive market
of 100 firms, equilibrium
price is $10…
Quantity of
Output
1,000
3. When monopoly takes
over, the old market
supply curve . . .
Quantity of
Output
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Monopoly and Perfect Competition
• Figure 5 Comparing Monopoly and Perfect Competition
(c) Monopoly
Price
per
Unit
$15
4. becomes the monopoly's MC curve.
S = MC
F
5. The monopoly produces where MR = MC,
E
10
MR
100,000
60,000
D
Quantity of
Output
6. with a higher price and lower market
output than under perfect competition.
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