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Monopoly
Monopoly
is a situation in which there is a single seller
of a product for which there are no good
substitutes.
When a monopoly exists, there are
generally high barriers to entry into the
industry.
What are the reasons for these barriers?
(1) Legal Barriers
patent - grant of an exclusive right to use a
specific process or produce a specific product
for a period of time (17 years in the U.S.)
 licenses and franchises - permission, granted
by a government, to enter an industry or
occupation

(2) A single firm has sole control of
a resource essential to an industry.
(3) Economies of Scale
Costs per unit in an industry may be low only
when a firm produces a lot of output.
Consequently, small firms will be unable to
enter the industry because costs are too high.
Market Demand Curve
price
Because the monopoly firm is the
only seller of a good, the market
demand curve for the good is the
same as the demand curve for the
firm’s product.
Demand
quantity
Remember for a perfectly competitive firm:
MR = P.
This is not true for the monopolist.
For a monopolist, MR < P.
So the MR curve lies below the demand curve.
Quantity
10
11
Price
20
19
TR
200
209
MR
--9
Drawing the MR curve when the demand curve is
a straight line: MR has the same Y-intercept and
is twice as steep as the demand curve .
$
MR
Demand
quantity
Determining the optimal output
and price, and the maximum
profit: 7 Steps
Step 1 a. Draw and label the axes.
$
quantity
Step 1 b. Draw and label the ATC and MC curves.
$
MC
ATC
quantity
Step 1 c. Draw and label the D and MR curves.
MC
$
ATC
MR
D
quantity
Step 2: Find the profit-maximizing output where
MR = MC
MC
$
ATC
MR
Q*
D
quantity
Step 3: Determine the price
from the demand curve, above Q*.
MC
$
ATC
P*
MR
Q*
D
quantity
Step 4: Determine the cost per unit
from the ATC curve, above Q*.
MC
$
ATC
P*
ATC*
MR
Q*
D
quantity
Step 5: Determine the TR = PQ box.
MC
$
ATC
P*
ATC*
MR
Q*
D
quantity
Step 6: Determine the TC = ATC . Q box.
MC
$
ATC
P*
ATC*
MR
Q*
D
quantity
Step 7: Find profit p = TR - TC.
MC
$
P*
ATC*
ATC
profit
MR
Q*
D
quantity
In the previous set of graphs, the monopolist was
earning a positive economic profit.
It is also possible for the monopolist to have a loss
or to breakeven.
Let’s look at a monopolist with a loss.
Step 1: Draw and label the axes and curves. (For a
loss, the ATC curve must be entirely above D.)
MC
ATC
$
AVC
MR
D
quantity
Step 2: Find the profit-maximizing (or lossminimizing) output where MR = MC
MC
ATC
$
AVC
MR
Q*
D
quantity
Step 3: Determine the price
from the demand curve, above Q*.
ATC
MC
$
AVC
P*
MR
Q*
D
quantity
Step 4: Determine the cost per unit
from the ATC curve, above Q*.
MC
ATC
$
ATC*
P*
AVC
MR
Q*
D
quantity
Step 5: Determine the TR = PQ box.
MC
ATC
$
ATC*
P*
AVC
MR
Q*
D
quantity
Step 6: Determine the TC = ATC . Q box.
MC
ATC
$
ATC*
P*
AVC
MR
Q*
D
quantity
Step 7: Find profit or loss p = TR - TC.
MC
$
ATC*
P*
ATC
AVC
loss
MR
Q*
D
quantity
A Monopolist Breaking Even
(Zero Economic Profit)
Step 1: Draw and label the axes and curves. (To
break even, D must be tangent to the ATC curve.)
MC
$
ATC
MR
D
quantity
Step 2: Find the profit-maximizing output where
MR = MC
MC
$
ATC
MR
Q*
D
quantity
Step 3: Determine the price
from the demand curve, above Q*.
MC
$
ATC
P*
MR
Q*
D
quantity
Step 4: Determine the cost per unit
from the ATC curve, above Q*.
MC
$
ATC
ATC* = P*
MR
Q*
D
quantity
Step 5: Determine the TR = PQ box.
MC
$
ATC
ATC* = P*
MR
Q*
D
quantity
Step 6: Determine the TC = ATC . Q box.
MC
$
ATC
ATC* = P*
MR
Q*
D
quantity
Step 7: Find profit p = TR - TC.
Since TR = TC, p = 0
MC
$
ATC
ATC* = P*
MR
Q*
D
quantity
Monopoly Possibilities
short run:
positive profits, losses, or breaking even.
long run:
positive profits, or breaking even.
What is bad about monopoly?
 Consumer
options are limited.
 Profits do not signal firms to enter the industry.
(They can’t get in because of the barriers to
entry.)
 There is allocative inefficiency. ( P > MC )
The monopolist does not produce all units that
consumers value more than it costs to make
them.
Allocative Inefficiency ( P* > MC* )
MC
$
ATC
P*
ATC*
MC*
MR
Q*
D
quantity
Natural Monopoly
a situation in which ATC declines continually
with increased output.
So a single firm would be the lowest cost
producer of the output demanded.
ATC doesn’t turn upward until a very high output
level, beyond the amounts that consumers will buy.
$
ATC
quantity
Remember: the MC curve is below the ATC
curve when ATC is sloping downward.
$
MC
ATC
quantity
Draw the demand and MR curves.
$
D
MR
MC
ATC
quantity
What can the government do about a
natural monopoly?



government take over the industry
let it operate freely
government regulation of monopolist
Natural Monopoly: operating freely
$
D
P*
MR
MC
ATC
Q*
quantity
Regulation


marginal cost pricing (P = MC)
average cost pricing (P = ATC)
Natural Monopoly:
marginal cost pricing regulation
$
D
MR
MC
Pm
ATC
Qm quantity
Natural Monopoly:
marginal cost pricing regulation
$
D
P < ATC
Firm has a loss!
So this won’t work.
MR
MC
Pm
ATC
Qm quantity
Natural Monopoly:
Average Cost Pricing Regulation
$
D
MR
Pa
ATC
MC
Qa
quantity
Natural Monopoly:
Average Cost Pricing Regulation
Zero economic profits:
this can work.
$
D
MR
Pa
ATC
MC
Qa
quantity