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MICROECONOMICS
FINANCIAL CRISIS UPDATED EDITION
TAYLOR l WEERAPANA
Chapter 10
Monopoly
Monopoly
Monopoly: one firm in an industry selling a
product for which there are no close substitutes.
Examples of monopolies:
1) De Beers, the company that controls 80
percent of the world’s diamond market
2) Microsoft
3) Your local utilities companies
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Characteristics of a Monopoly
Profit Maximizer: Maximizes profits.
Price Maker: Decides the price of the good or
product to be sold, but does so by determining
the quantity in order to demand the price desired
by the firm.
High Barriers to Entry: Other sellers are unable
to enter the market of the monopoly.
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Characteristics of a Monopoly
Single seller: In a monopoly, there is one seller of
the good that produces all the output. Therefore,
the whole market is being served by a single
company, and the company is the same as the
industry.
Price Discrimination: A monopolist can change
the price and quality of the product.
Market power: a firm’s power to set its price
without losing its entire share of the market
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Market Power:
Monopoly vs. Competition
1) There Is No One to Undercut a Monopolist’s
Price. In a monopoly, there is only one seller. If
that seller chooses to sell at a higher price, it
does not need to worry about being
undercut/undersold by other sellers.
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Market Power:
Monopoly vs. Competition
2) The Impact of Quantity Decisions on the
Price. In a monopoly, a decrease or an increase in
the firm’s quantity will have a big effect on the
equilibrium price in the market, because it is the
only seller.
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Monopoly vs. Competitive Markets
Marginal revenue and price: In a perfectly
competitive market, price equals marginal cost.
In a monopolistic market, however, price is set
above marginal cost
Number of competitors: Competitive markets are
populated by an infinite number of buyers and
sellers. Monopoly involves a single seller
Barriers to Entry: Competitive markets have free
entry and exit. There are no barriers to entry,
exit or competition. Monopolies have high
barriers to entry.
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Monopoly vs. Competitive Markets
Excess Profits: A competitive company can make
excess profits in the short term, but eventually
excess profits go to zero. A monopoly can
preserve excess profits because barriers to entry
prevent competitors from entering the market
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Market Power :
Monopoly vs. Competition
A monopoly faces a downward-sloping demand
curve, implying that a change in quantity will
change prices.
A competitive firm faces a horizontal demand
curve, implying that a change in quantity will have
no effect on prices.
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Figure 1: How the Market Power of a
Monopoly and a Competitive Firm Differ
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Monopoly
How do companies create a monopoly?
Barriers to entry: anything that prevents firms
from entering a market.
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Sources of Monopoly Power
Monopolies get their market power from barriers to
entry
There are three major types of barriers to entry
 Economic
•
Economic barriers include economies of scale, capital
requirements, cost advantages and technological
(技术性) superiority (优势)
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Sources of Monopoly Power
 Legal
•
Legal rights can provide opportunity to monopolize
the market of a good.
•
•
Intellectual property rights, including patents (专利) and
copyrights (版权), give a monopolist exclusive control of
the production and selling of certain goods.
Property rights may give a company exclusive control of
the materials necessary to produce a good
 Deliberate (故意)
•
A company wanting to monopolize a market may
work to exclude competitors or get rid of competition.
Such actions include collusion (共谋), using the
government, and force
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Sources of Monopoly Power Economic barriers
Economies of scale: Monopolies have
decreasing costs for higher production. This
gives monopolies an advantage over potential
competitors
Capital requirements: Production processes that
require large investments of money limit the
number of companies in an industry
Technological superiority: A monopoly may be
better able to use the best possible technology
in producing its goods while new companies do
not have the money to use the best technology
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Sources of Monopoly Power
Economic barriers
Substitute goods: A monopoly sells a good for
which there is no substitute. The absence of
substitutes makes demand for the good inelastic
Control of natural resources: A prime source of
monopoly power is the control of resources that
are critical to the production of a final good
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Sources of Monopoly Power
Economic barriers
Network externalities: The use of a product by a
person can affect the value of that product to
other people. This is the network effect. There is
a direct relationship between the amount of
people using a product and the demand for that
product.
The more people who are using a product, the
greater the probability of an individual starting to
use the product. This effect accounts for fads
and fashion trends. The most famous current
example is the market dominance of the
Microsoft operating system in personal
computers
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Effects of a Monopoly’s
Decision on Revenues
If a firm charges a single price to all its customers,
then the decision to sell one more unit will require
the firm to decrease the price of all the units it
wants to sell. As a result, the marginal revenue of
a monopoly will be lower than the price of the good
(P > MR).
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Figure 2: Total Revenue,
Marginal Revenue, and Demand
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Effects of a Monopoly’s
Decision on Revenues
Note that in Table 1 and Figure 2, the firm
achieves maximum total revenue at Q = 8. At a
quantity higher than 8, the total revenue line is
downward sloping.
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Effects of a Monopoly’s
Decision on Revenues
Because the single price monopoly must charge a
lower price to everyone in order to sell one
additional unit, the marginal revenue received by
the firm is lower than the price of the good. This is
illustrated in Figure 3.
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Figure 3: Finding a Quantity of Output to
Maximize Profits
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Why is the
Marginal Revenue Declining?
When a monopoly raises output, the effect of the
increase in quantity on total revenue is twofold:
A positive effect, since one more additional unit
is sold.
A negative effect, since selling one more item
forces the firm to lower prices.
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Why is the
Marginal Revenue Declining?
If the positive effect (or
the blue rectangle) is
larger than the negative
effect (or the red
rectangle), then an
increase in output results
in a larger total revenue,
and the marginal revenue
is positive.
Source: p.276
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Why is the
Marginal Revenue Declining?
If the positive effect (or the
blue rectangle) is smaller
than the negative effect
(or the red rectangle), then
an increase in output
results in a smaller total
revenue, and the marginal
revenue is negative.
Source: p.276
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Graph Showing the Two
Effects on Marginal Revenue
Increasing Q from 3 to 4
will result in $120 in
revenue (shaded in
blue) and a decline of
$30 in revenue ($10
decrease x 3 units,
shown in red). The net
change in revenue is
$90 < P.
Source: p.276
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The Average Revenue
Average revenue (AR)= total revenue divided by
the quantity.
AR = TR/Q = P  Q  P
Q
The average revenue is represented by the
demand curve.
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Finding Output to Maximize
Profits at the Monopoly
Recall from Chapter 6:
Profits: the total revenue received from selling
the product minus the total costs of producing
the product, or:
Profits = total revenue – total costs
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Finding Output to Maximize
Profits at the Monopoly
If TR > TC, then the profit-maximizing quantity is
the quantity where the distance between TR and
TC is maximized.
If TR < TC, then the profit-maximizing quantity is
the quantity where the distance between TR and
TC is minimized.
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Figure 3: Finding a Quantity
of Output to Maximize Profits
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Finding Output to Maximize
Profits at the Monopoly
One characteristic of the profit-maximizing level of
quantity is that the slopes of the total revenue and
the total cost curves are the same, or:
Slope of Total Revenue = Slope of Total Cost
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MR = MC at Monopoly vs.
MR = MC at a Competitive Firm
The rule for finding the profit-maximizing output for
a monopoly is the same as in a competitive
market. In both markets, the rule for profit
maximization is:
MR = MC
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Figure 4: Marginal Revenue
and Marginal Cost
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MR = MC at Monopoly vs.
MR = MC at a Competitive Firm
The difference in profit maximization for a
monopoly and a competitive firm lies only
in the shape of the total revenue curve.
In a competitive firm, the total revenue curve is
linear.
In a monopoly, the total revenue curve is a
concave (凹) function.
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Figure 5: Profit Maximization for a Monopoly
and a Competitive Firm
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Why Monopolies Exist
Reasons Why Monopolies Exist:
1) Natural monopoly: a single firm in an industry in
which the average total cost is declining over
the entire range of production, and the
minimum efficient scale is larger than the
market size.
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Why Monopolies Exist
2) Patents and copyrights: grants the holder of a
patent or a copyright the sole right to produce
goods within a specified time period. Patents are
awarded for inventions, while copyrights are
awarded for movies, books, computer software,
and songs.
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Why Monopolies Exist
Why award patents and copyrights?
Monopoly rights through patents and copyrights
help innovation by giving inventors more incentives
to invent new products or take a risk and try new
ideas.
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Peter Pan, and the Great Ormond
Street Hospital Children’s Charity
Sir J M Barrie’s story of Peter Pan and Neverland
has been a part of many childhoods – and many
adulthoods too. Barrie gave all the rights to the
story to Great Ormond Street Hospital in 1929.
Since then, the hospital has received royalties
every time a production of the play is put on, as
well as from the sale of Peter Pan books and other
products.
Source: copied from gosh.org
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Peter Pan, and the Great Ormond
Street Hospital Children’s Charity
Although UK copyrights expire 50 years after an
author’s death, Great Ormond Street has the
unique right to royalties from Peter Pan, forever.
Throughout the European Union, Peter Pan’s
copyright was good until 2007, while in the United
States, an extended copyright expires in 2023.
Source: copied from gosh.org
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Why Monopolies Exist
3) Licenses: governments create monopolies by
giving or selling to one firm a license to produce
a product.
Examples of Licenses:
The Coca-Cola Company has a monopoly to
sell beverages at the Olympics.
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Why Monopolies Exist
4) Creating other barriers to entry
Examples of Barriers to Entry:
Professional Certification, such as passing the
California Bar Exam (law exam).
Threats of potential entry, where a firm keeps
prices low when a potential entrant into the
market exists.
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Why Monopolies Exist
Contestable market: a market in which the threat
of competition is enough to encourage firms to act
like competitors.
Example:
College bookstores – the possibility of textbook stores
opening up outside of campus forces college
bookstores to keep prices low.
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Price Discrimination
Price discrimination: a situation in which different
consumers are charged different prices for the
same good.
Examples:
Senior citizen discounts at movie theaters.
Lower airline ticket prices for flights with
Saturday-night overnight stays.
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Consumers with Different
Price Elasticities of Demand
Customers who have high price elasticities (budget
vacation travelers, for example) are charged lower
prices.
Customers who have low price elasticities
(business travelers, for example) are charged
higher prices.
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Consumers with Different Price
Elasticities of Demand
To successfully price discriminate:
The monopoly must be able to identify and
separate the customers with a low elasticity of
demand from those with a high elasticity.
The monopoly must be able to prevent resale.
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Consumers with Different Price
Elasticities of Demand
Ways to separate high and low demanders:
Saturday night stay for budget travelers.
Senior citizens show IDs before they get a
discount at a movie theater.
Students need to show parent’s income tax
returns to get a need-based scholarship.
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Quantity Discounts
Another form of price discrimination is by charging
a lower price to those who buy more.
Examples:
Theme parks offer annual passes that are
cheaper than if you purchase tickets
individually.
Toothbrushes are cheaper per unit in warehouse
clubs than in convenience stores, as long as
you buy a lot at a time.
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Key Terms
monopoly
barriers to entry
market power
price-maker
average revenue
price-cost margin
natural monopoly
contestable market
price discrimination
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Homework
Problem 3 (a, b, c)
Problem 7 (a, b)
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