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Monopoly
Market Structure – A classification system for the key traits of a
market, including
• the number of firms,
• the similarity of the products they sell, and
• the ease of entry and exit
Monopoly
one firm with market power
unique product (no close substitutes)
impossible entry and exit
price maker (monopoly company sets the price)
firm demand curve is downward sloping (must
discount to sale more)
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Monopoly
Barriers to Entry and Exit
Legal barriers
– Licenses
– Patents and copyrights
– Public franchises
– Tariffs, quotas and other trade restrictions
Strategic barriers
– Predatory pricing
– Marketing (product differentiation)
Structural barriers
– Economies of scale (Natural monopoly)
– Vertical integration
– Control of essential resources (technologies / commodities)
– Brand loyalty
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eStudy.us Revenue with Market Power
TR  PQ
TR TR1  TR0
MR 

Q
Q1  Q0
Q
P
TR
MR
0
$21
$0
----
1
$19
$19
$19
2
$17
$34
$15
3
$15
$45
$11
$20
4
$13
$52
$7
$15
5
$11
$55
$3
$10
6
$9
$54
- $1
7
$7
$49
- $5
8
$5
$40
- $9
9
$3
$27
- $13
MR  P
$25
$5
D
$0
-$5
-$10
0
1
2
3
4
5
6
7
8
9 10
MR
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Short-run Equilibrium
Q
P
TR
MR
TFC
TVC
TC
MC
AFC
AVC
ATC
Profit
0
$21
$0
----
$10
$0
$10
----
$10
$0
$10.00
-$10
1
$19
$19
$19
$10
$4
$14
$4
$10
$4.00
$14.00
$5
2
$17
$34
$15
$10
$7
$17
$3
$5
$3.50
$8.50
$17
3
$15
$45
$11
$10
$11
$21
$4
$3.33 $3.67
$7.00
$24
4
$13
$52
$7
$10
$18
$28
$7
$2.50 $4.50
$7.00
$24
5
$11
$55
$3
$10
$28
$38
$10
$2.00 $5.60
$7.60
$17
6
$9
$54
- $1
$10
$47
$57
$19
$1.67 $7.83
$9.50
-$3
7
$7
$49
- $5
$10
$74
$84
$27
$1.43 $10.57
$12.00
-$35
8
$5
$40
- $9
$10
$112
$122
$38
$1.25 $14.00
$15.25
-$82
9
$3
$27
- $13
$10
$162
$172
$50
$1.11 $18.00
$19.11
-$145
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Short-run Equilibrium
Profit maximization
– When MR > MC – increase production
– When MR < MC – decrease production
– When MR = MC – Maximum profit
• Produce quantity where MR = MC
• Intersection of the marginal-revenue curve and the
marginal-cost curve
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Short-run Equilibrium
Profit Max: MR = MC
$25
MC
ATC
AVC
D
MR
$0
0
1
2
3
4
5
6
7
8
9
10
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Short-run Equilibrium
$25
MC
ATC
AVC
When Q=4
Revenue
$13.00 P
$52
TVC $18
TFC
$7.00 ATC
$4.50 AVC
$10
Total Cost
$28
Profit
$24
D
MR
$0
0
1
2
3
4
5
6
7
8
9
10
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Natural Monopoly
Natural Monopoly – Infinite economics of scale leading to a
single company having lowest cost
$
National law allows for natural monopoly so
long firms surrender pricing power
AC
Q
Water service
Sewer service
Power service
Regulation: should try to price near perfect
competition (P = MC) rather than (P > MC)
Should a municipality own these services?
Regulators generally do a poor job protecting society interest.
Case: Power service in Lubbock, TX and San Diego, CA
Trash service
Is trash collection a natural monopoly?
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Long Run View
Monopoly allocates
resources inefficiently
$
Pm > Ppc
and
Qm < Qpc
AC
MC
Pm
Ppc
Dperfect competition
Dmonopoly
MR
Qm Qpc
Q
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Inefficiency of monopoly
Monopoly produces quantity where MC = MR
– which produces less than the socially efficient
quantity of output
– charges a Price > Marginal Cost
– which creates a deadweight loss (triangle
between the demand curve and marginal cost
curve)
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Inefficiency of monopoly
$
Deadweight
Loss
Marginal Cost
Pmonopoly
Demand
Marginal Revenue
0
Qmonopoly Qefficient
Quantity
• Monopoly charges a price above marginal cost and not all consumers who value the good at more than its cost
• Quantity produced and sold by a monopoly is below the socially efficient level
• Deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the
good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer)
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Price Discrimination
Sell the same good at different prices to different
customers
Price Discrimination is a rational strategy to increase
profit • Charge each customer a price closer to his or her
willingness to pay
• Sell more than is possible with a single price
Requires the ability to separate customers according to their
willingness to pay
• Certain market forces can prevent firms from price discriminating
• Arbitrage – buy a good in one market, sell it in other market at a
higher price
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Price Discrimination
Can raise economic welfare by eliminating the inefficiency
of monopoly pricing
• More consumers get the good
• Higher producer surplus (higher profit)
Without price discrimination
•
•
•
•
Single price > MC
Consumer surplus
Producer surplus (Profit)
Deadweight loss
Perfect price discrimination
• Charge each customer a different price
• Exactly his or her willingness to pay
• Monopolist - gets the entire surplus
(Profit)
• No deadweight loss
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Price Discrimination
(a) Monopolist with Single Price
(b) Monopolist with Perfect Price Discrimination
Price
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Profit
Marginal
revenue
0
Marginal cost
Marginal cost
Quantity
sold
Demand
Demand
Quantity
0
Quantity
sold
Quantity
Panel (a) shows a monopolist that charges the same price to all customers. Total surplus in this market equals
the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopolist that can perfectly
price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit.
Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus,
and lowers consumer surplus.
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Price Discrimination
Examples of price discrimination
– Movie tickets
– Airline prices
– Discount coupons
– Financial aid
– Quantity discounts
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Public Policy
Antitrust and Monopoly
Increasing competition with antitrust laws
– Sherman Antitrust Act, 1890
• Reduce the market power of trusts
– Clayton Antitrust Act, 1914
• Strengthened government’s powers
• Authorized private lawsuits
– Prevent mergers
– Break up companies
– Prevent companies from coordinating their
activities to make markets less competitive
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Public Policy
Regulation and Monopoly
– Regulate the behavior of monopolists
• Price
– Common in case of natural monopolies
– Marginal Cost pricing
$
ATC
Regulated
price
Loss
ATC
MC
D
0
Quantity
• May be less than ATC
• No incentive to reduce costs
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Public Policy
Ownership and Monopoly
– Private owners
• Incentive to minimize costs (maximize profit)
– Public owners (government owned)
• If government does a bad job
• Losers are the customers and taxpayers
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Summary
Competition vs. Monopoly Comparison
Competition
Monopoly
Goal of firms
Maximize profits
Maximize profits
Rule for maximizing
MR = MC
MR = MC
Can earn economic profits in short run?
Yes
Yes
Number of firms
Many
One
Marginal revenue
MR = P
MR < P
Price
P = MC
P > MC
Produces welfare-maximizing level of output?
Yes
No
Entry in long run?
Yes
No
Can earn economic profits in long run?
No
Yes
Price discrimination possible?
No
Yes
Similarities
Differences
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