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Chapter 8: Pure Monopoly
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
Characteristics of a
Pure Monopoly
 Single supplier: the firm is the sole producer of a specific
product.
 No close substitutes: this product is unique.
 Price maker: the firm has considerable control over price,
since it controls the total quantity supplied.
 Blocked entry: there is no immediate competition,
because there are barriers to entry.
 Those barriers may be economic (economies of scale create
natural monopolies), technological, legal, or of some other type.
Examples: local telephone company, local gas and electric
company, small town gas station.
LO: 8-1
8-2
Monopoly Demand and
Marginal Revenue
 Because monopoly is the only supplier, the monopoly
demand is the market demand.
 Because market demand slopes downward, in order for
a monopolist to increase sales it must lower its price.
 If the monopolist increases output by one more unit, the
price charged for all units sold will fall.
 Each additional unit of output sold increases total revenue by an
amount equal to its own price less the sum of the price cuts that
apply to all price units of output.
 Consequently, marginal revenue is less than price for
every level of output except the first.
LO: 8-2
8-3
Monopoly Demand and
Marginal Revenue
• A monopolist is selling 3
units at $142.
• To sell more (4), price
must be lowered to $132.
• All customers must pay
the same price.
• TR increases $132 minus
$30 (3x$10).
$142
132
122
112
Loss = $30
D
102
Gain = $132
92
82
0
1
2
3
4
5
6
LO: 8-2
8-4
Marginal Revenue is Less
than Price
• A monopolist is selling 3 units
at $142.
• To sell more (4), price must be
lowered to $132.
• All customers must pay the
same price.
• TR increases $132 minus $30
(3x$10).
• $102 becomes a point on
the MR curve.
• Try other prices to
determine other MR points.
$142
132
122
112
Loss = $30
D
102
Gain = $132
92
82
MR
0
1
2
3
4
5
6
LO: 8-2
8-5
Monopolist’s Profit
Maximization
 Each output is associated with a unique price; by
changing the market output, a monopolist is
indirectly determining the market price.
 To determine the price-quantity combination that will
maximize profit, cost data is needed.
 A monopolist will employ the MR = MC Rule in
order to maximize profit.
 A monopolist produces a level of output where MR = MC.
This determines the profit maximizing output, Qm.
 Price (Pm) is determined by the market demand curve.
LO: 8-2
8-6
Monopolist’s Profit
Maximization
Cost Data
Revenue Data
(2)
Price
(1)
Quantity (Average
Of Output Revenue)
0
1
2
3
4
5
6
7
8
9
10
LO: 8-2
$172
162
152
142
132
122
112
102
92
82
72
(3)
Total
Revenue
(1) X (2)
$0 ]
162 ]
304 ]
426 ]
528 ]
610 ]
672 ]
714 ]
736 ]
738 ]
720
(4)
Marginal
Revenue
$162
142
122
102
82
62
42
22
2
-18
(5)
(6)
(7)
(8)
Average Total Cost Marginal Profit (+)
Total Cost (1) X (5)
Cost
or Loss (-)
$190.00
135.00
113.33
100.00
94.00
91.67
91.43
93.75
97.78
103.00
$100 ]
190 ]
270 ]
340 ]
400 ]
470 ]
550 ]
640 ]
750 ]
880 ]
1030
$90
80
70
60
70
80
90
110
130
150
$-100
-28
+34
+86
+128
+140
+122
+74
-14
-142
-310
Can you See Profit Maximization?
8-7
Monopolist’s Profit
Maximization
Price, Costs, and Revenue
$200
175
MC
150
Pm=$122
125
100
75
Economic
Profit
ATC
ATC=$94
D
MR=MC
50
25
MR
Qm=5
0
LO: 8-2
1
2
3
4
5
6
7
8
9
10
Quantity
8-8
Misconceptions about
Monopoly
 Not Highest Price
 The “highest price possible” is not ideal because it results
in lower output and reduces total revenue.
 Total, Not Unit, Profit
 The monopolist seeks to maximize total profit, not unit
profit.
 Profitability Not Assured
 A monopolist may suffer from weak demand, bad market
conditions or resource cost increases, and thus experience
short-term losses.
LO: 8-2
8-9
Inefficiency of Monopoly
 Compared to pure competition, a monopoly lacks
productive efficiency and allocative efficiency.
 It is inefficient (compared to pure
competitions in which P=MC=minimum ATC).
 A monopolist charges a higher price and sells a
smaller level of output than firms in a purely
competitive industry.
 Pm exceeds MC
 Pm exceeds ATC
LO: 8-3
8-10
Pure Competition is Efficient,
Monopoly is Inefficient
Pure
Monopoly
Purely
Competitive
Market
S=MC
MC
Pm
P=MC=
Minimum
ATC
Pc
b
c
Pc
a
D
D
MR
Qc
Qm
Qc
LO: 8-3
8-11
Other Aspects of
Monopoly’s Inefficiency
 Monopoly increases income inequality because
monopoly profits are not equally distributed.
 Monopolists levy a “private tax” on consumers by
transferring income from consumers to shareholders who
own the monopoly.
 Cost may be different in monopoly and pure competition
LO: 8-3
 Economies of scale may make monopoly’s costs lower.
 X-inefficiency –prices higher than ATC allow for various costs
increases.
 Rent-seeking expenditures required to maintain barriers to
entry
 Monopolists can afford to lag in technological advances.
8-12
Price Discrimination
 In order to engage in price discrimination, the firm
must:
 have monopoly power
 be able to segregate the market into difference groups
 be able to prevent resale of the product
 Price discrimination allows monopoly to increase its
profits.
Price discrimination is the business practice of selling the
same good at different prices to different consumers when
the price differences are not justified by differences in costs.
LO: 8-4
8-13
Monopoly and Antitrust
Policy
 Monopoly is not widespread because barriers to
entry are seldom completely successful.
 If the monopoly appears to be unsustainable over a long
period of time, say, because of emerging new
technology, society can simply choose to ignore it.
 In contrast, the government may want to file charges
against a monopoly under the antitrust laws if
 the monopoly was achieved through anticompetitive actions,
 creates substantial economic inefficiency,
 and appears to be long-lasting.
LO: 8-5
8-14
Antitrust Law
 The antitrust law is the Sherman Act of 1890, which has
two main provisions:
 Section 1 “Every contract, combination in the form of a trust or
otherwise, or conspiracy, in restraint of trade or commerce
among the several States, or with foreign nations is declared to
be illegal.”
 Section 2 “Every person who shall monopolize, or attempt to
monopolize, or combine or conspire with any person or persons,
to monopolize any part of the trade or commerce among the
several States, or with foreign nations, shall be deemed guilty of
a felony . . .” (as later amended from “misdemeanor”).
 The Department of Justice is enforcing the antitrust law
in the U.S.
LO: 8-5
8-15