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CHAPTER
7
Monopoly
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
1
2
3
4
5
Define what a monopoly is.
Explain why price exceeds marginal revenue in monopoly.
Describe how a monopoly sets output and price.
Illustrate how monopoly and competitive outcomes differ.
List the pros and cons of monopoly structures.
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7-1
CHAPTER 7
The goal of this chapter is to examine how a
market controlled by a single producer—a
monopoly—behaves.
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7-2
MONOPOLY STRUCTURE
A monopoly is one firm that produces the
entire market supply of a particular good
or service.
•
•
•
•
Barriers to entry.
Market power over price and quantity.
The firm is the industry.
The firm’s demand curve is the market
demand curve.
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MONOPOLY STRUCTURE
Monopolists do not maximize profit
where price equals marginal cost.
For perfectly competitive firms:
• Price = MR because it is a price taker.
• Profit maximizing rule is MR = MC.
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7-4
MONOPOLY STRUCTURE
Because monopolists face a downward
sloping demand curve, marginal revenue is
not constant.
• Marginal revenue is the change in total
revenue from a unit increase in quantity.
• A monopolist can sell additional output
only if it reduces prices.
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MONOPOLY STRUCTURE
Marginal revenue is always less than price
for a monopolist.
Quantity
Price
Total Revenue
Marginal
Revenue
A
1
X
$13
=
$13
B
2
X
$13
=
24
$11
C
3
4
$13
$13
=
=
33
40
9
D
X
X
E
5
X
$13
=
45
5
F
6
X
$13
=
48
3
G
7
X
$13
=
49
1
7
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MONOPOLY STRUCTURE
MR curve is always below the demand curve.
PRICE (per pound)
$14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
A
Marginal revenue is
less than price for a
monopoly.
B
C
D
b
E
F
c
G
d
Demand (price
charged by
monopolist)
e
f
Marginal revenue
g
1 2 3 4 5 6 7 8 9 10
QUANTITY (pounds of fish per hour)
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MONOPOLY BEHAVIOR
A monopolist maximizes profits by
producing a rate of output where MR = MC.
• A monopolists identifies the price
corresponding to this output using the
demand curve.
• Demand curve indicates highest price
consumers are willing to pay for a specific
quantity of output.
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MONOPOLY BEHAVIOR
PRICE OR COST (per pound)
A monopolist’s production decisions are:
1. Output by setting MR = MC.
2. Price using the demand curve.
$14
13
12
D
11
10
9 Total profit
8
d
7
6
5
4
3
Marginal
2
Cost
1
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distribution without the prior written
consent of McGraw-Hill Education.
0
Average
Total cost
Profit per unit = p – ATC
Total profit = (p – ATC) x q
Demand
MR = MC
Marginal
revenue
1 2 3 4 5 6 7 8 9
QUANTITY (pounds of fish per hour)
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MONOPOLY BEHAVIOR
The profit maximization rule of setting
MR = MC applies to all firms.
• A monopoly firm produces an
output where MC = MR (< p).
• A perfectly competitive firm
produces an output where MC = MR
(= p).
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MONOPOLY BEHAVIOR
PRICE OR COST (per pound)
A monopolist produces less output and
charges a higher price than a competitive
industry.
13
12
11
10
9
8
7
MC = MR
6
5
4
3
Marginal
2
cost
1
0
1
Average
total cost
D
E
d
• Monopolist price of
$10 and output of 4.
MC = p
• Competitive price of
$9
and
output
of
5.
Demand
Marginal
revenue
2 3 4 5 6 7 8 9
QUANTITY (pounds of fish per hour)
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7-11
BARRIERS TO ENTRY
Monopolists earn positive profits due to
complete barriers to entry.
• Barriers to entry are obstacles making it
difficult or impossible for firms to enter
the market.
• Positive profit requires the restriction
of output through limiting the number
of firms in the industry.
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PATENT PROTECTION
Several barriers exist that prohibit entry.
•
•
•
•
•
Patent: Exclusive rights to an innovation
Legal harassment: Sue potential entrants.
Exclusive license: Contract restricting
factors of production.
Bundling products: Selling
complementary products.
Government franchise: Exclusive
production right.
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COMPARATIVE OUTCOMES
A monopoly’s market power allows it to
change the way the market responds to
consumer demands.
• A monopolist prohibits entry of new
firms, keeping price high.
• A perfectly competitive firm cannot
prohibit entry of new firms, price tends
to fall.
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COMPARATIVE OUTCOMES
High price and profit signal consumers’
demand for more output.
In a competitive industry:
1. High profit attract new suppliers.
2. Production and supply expand.
3. Price falls.
4. Economic profit squeezed to zero.
5. Pressure to innovate to keep ahead.
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COMPARATIVE OUTCOMES
High price and profit signal consumers’
demand for more output.
In a monopoly industry:
1. Barriers to entry prohibit competition.
2. Production and supply constrained.
3. Price remains high.
4. Economic profit remains.
5. No pressure to innovate.
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NEAR MONOPOLIES
Market power is not solely concentrated
with monopolists.
• Two or more firms may rig the market
to replicate monopoly outcomes and
profits.
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NEAR MONOPOLIES
Three significant industry structures
provide firms with some market power.
1. Duopoly: Two firms dominate market.
•
•
•
These firms set price and output even if
other firms are present.
May engage in price wars.
May engage in price fixing.
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NEAR MONOPOLIES
2. Oligopoly: Several firms dominate the
market.
•
•
•
•
•
Goods are close substitutes.
May collude to control price or output.
May engage in price wars.
Relay on clever advertising to persuade
consumers to their product.
Barriers to entry are high.
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NEAR MONOPOLIES
3. Monopolistic competition: Many firms
selling a differentiated product.
•
•
•
•
No one firm has complete market power.
Contend with competing brands.
Each has monopoly power on their brand.
Few barriers to entry.
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WHAT GETS PRODUCED
Firms with market power alter the output
of goods and services in specific ways.
1. Less is produced
2. Sold at higher price.
The result is fewer workers are needed and
fewer customers purchase the products,
but producer make profits.
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RESEARCH AND DEVELOPMENT
In principle, monopolies have a greater
ability to pursue research and
development.
• Have profits to invest in expensive R&D.
• No incentive to improve products.
• Continue to make profits by maintaining
market power.
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ENTREPRENEURIAL INCENTIVES
In principle, monopolies potentially drive
entrepreneurial activities.
However:
• Positive profit by innovation is not
exclusive to monopoly industry.
• Innovators in perfect competition have
the ability to earn large profits.
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ECONOMIES OF SCALE
One firm producing all output may benefit
consumers if lower costs are achieved at
higher output rates.
• Economies of scale are present if
average costs fall as the size (scale) of
plant and equipment increases.
• Firm could use its size to achieve
greater efficiency.
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NATURAL MONOPOLY
A natural monopoly is an industry in
which one firm can achieve economies of
scale over the entire range of market
supply.
• Large monopolist may not achieve
greater efficiency.
• Consumers may not benefit if
monopolist doesn’t lower prices.
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CONTESTABLE MARKETS
A monopolist earning large profits entices
potential rivals to enter the market.
• A contestable market is an imperfectly
competitive industry subject to
potential entry if prices or profits
increase.
• How contestable a market is depends
not so much on its structure as it does
on its barriers to entry.
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STRUCTURE VERSUS BEHAVIOR
If potential rivals force a monopolist to
behave like a competitive firm, then a
monopoly imposes no cost on consumers.
• Potential rivals must have a reasonable
chance to enter the market and reduce
the monopoly’s market power.
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AIR TRANSPORTATION INDUSTRY
Market structure explains why it can be
cheap to fly to one place and expensive to
fly somewhere else of equal distance.
• Collectively, airlines look competitive.
• Air routes between cities are limited
markets.
• Must analysis each route separately to
understand market power.
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AIR TRANSPORTATION INDUSTRY
Airlines price routes differently depending
on how many airlines fly the route.
• If several airlines fly a route, airlines
behave competitively.
• If one or two airlines fly a route, airlines
behave like monopolists and duopolists.
• 1 in 10 domestic routes is monopolized.
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AIR TRANSPORTATION INDUSTRY
Airports dominated by one or two carriers
have higher fares.
• Fares from airports with 1-2 carriers are
45-85% higher than at more
competitive airports.
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AIR TRANSPORTATION INDUSTRY
Fares change significantly when
competitors enter/exit market.
• Entry and exit can be used to assess
market structure on prices.
• Monopolies may use a sharp,
temporary price reduction to drive out
competitors or discourage entry, called
predatory pricing.
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AIR TRANSPORTATION INDUSTRY
Large carriers maintain monopoly routes
by owning landing rights and gates.
• Act as barriers to entry.
• New carriers unable to enter.
• Lottery system for new slots didn’t
improve competition as large carriers
paid substantial sums to lottery winners
to sell.
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SUMMARY
1.
2.
3.
4.
5.
Defined what a monopoly is.
Explained why price exceeds marginal
revenue in monopoly.
Described how a monopoly sets output
and price.
Illustrated how monopoly and competitive
outcomes differ.
Listed the pros and cons of monopoly
structures.
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
7-33