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Chapter 10
The Theory of
Monopoly
Introduction to Economics (Combined Version)
5th Edition
Varieties of Monopoly
 A closed monopoly is protected by legal
restrictions on competition. For example,
state law in Washington prevents anyone
from offering competing car ferry service
to islands served by the Washington State
Ferry System.
 A natural monopoly is an industry in
which long-run average cost is minimized
when just one firm serves the entire
market. Distribution of natural gas to
residential customers is an example.
 An open monopoly is a case in which a
firm becomes, at least for a time, the sole
supplier of a product without having the
special protections against competition
that is enjoyed by a closed or natural
monopoly. Apple’s first iPad was an
example, which is now widely imitated
Introduction to Economics (Combined Version)
5th Edition
A Washington State Ferry
Marginal Revenue and the Demand Curve
 The area under the D curve at
any point is equal to total
revenue at that point. (R=P*Q)
 With a negatively sloped
linear demand curve, revenue
increases at first, then reaches
a maximum, and then
decreases as the price
decreases.
 Maximum revenue is at the
midpoint of the demand curve.
 The change in total revenue
when quantity changes by one
unit is known as marginal
revenue.
Introduction to Economics (Combined Version) 5th Edition
Marginal Revenue and
Demand: Another View
 Total revenue is found by
multiplying price by output at
each point on the demand curve.
 Marginal revenue is the increase
in total revenue that results from
a one-unit increase in output.
 When demand is elastic,
marginal revenue is more than
zero and total revenue is
increasing.
 When demand is inelastic,
marginal revenue is less than
zero and total revenue is
decreasing.
 Marginal revenue is less than
price at all levels of output.
Introduction to Economics (Combined Version) 5th Edition
Profit Maximization
 A monopolist maximizes
profits by producing the
quantity of output when
the marginal cost equals
the marginal revenue.
 The price it charges for the
product is determined by
the height of the demand
curve (rather than the
height of the marginal
revenue curve) at the
profit-maximizing output.
 Beyond 13 units of output,
total revenue continues to
rise for a while, but profit
falls because total cost
rises even more rapidly.
Introduction to Economics (Combined Version) 5th Edition
Short-Run Loss Minimization for a Monopoly
 When the demand curve
lies below the average total
cost curve at all points, the
best the monopolist can do
in the short run is
minimize loss by
producing at the point
where marginal cost equals
marginal revenue.
 If the demand curve were
to shift downward even
further, preventing the
firm from obtaining a price
that would cover average
variable cost, the short-run
loss-minimizing strategy
would be to shut down.
Introduction to Economics (Combined Version) 5th Edition
Zero-Profit Long-Run Equilibrium
 Here the firm earns
enough revenue to
cover all costs but not
enough for an economic
profit.
 A monopoly could be
driven to this position
in the long run because
of
 competition from
substitute products
 costs of defending its
monopoly position
against rent seekers
Introduction to Economics (Combined Version) 5th Edition
Limit Pricing
 A strategy of limit pricing
sets a price lower than the
one that yields somewhat
less than the maximum
short-run profit but, at the
same time, makes the
market a less attractive
target for would-be
competitors.
 A variant of limit pricing
known as: “sliding down
the demand curve”
introduces a new product at
a high price and later
Consumer electronic companies often use the
“sliding down the demand curve” strategy
lowers it to slow entry of
Introduction to Economics (Combined Version) 5th Edition
competitors
Price Discrimination
 Price discrimination is
charging different prices to
different buyers
 Examples:
Scholarship aid can be viewed as a type of price
discrimination in which selected customers are offered
discounts according to their elasticity of demand
 Child ticket discounts
 Business vs. leisure hotel
rooms
 Different prices on an airline
flight
 Prices that are vary with the
income of the country where
the good is sold
 Using coupons to attract pricesensitive customers
Introduction to Economics (Combined Version) 5th Edition
Example of Simple Price Discrimination
 A pharmaceutical company
produces a drug at constant
marginal cost, MC.
 Profit maximizing point for the
U.S. is (Q0,P0).
 At P0 nothing is sold in Mexico.
 If Mexico is treated as a separate
market, profit-maximizing point
will be (Q1, P1).
 Sales of additional units Q1 will
increase both total producer and
consumer surplus.
Introduction to Economics (Combined Version) 5th Edition
Two-Part Pricing
 In two-part pricing, the
firm charges a fixed
access fee and also a perunit user fee.
 Examples
Night clubs that impose a cover charge plus additional
charges for food and drink are an example of two-part
pricing
 Membership fee plus
greens fee per play at a
golf club
 Monthly fixed charge plus
charge per call for a cell
phone
Introduction to Economics (Combined Version) 5th Edition
Deadweight Loss under
Simple Monopoly
 Under perfect competition (a) the
price consumers are willing to pay
for the last unit produced just equals
the opportunity cost of producing it.
All possible producer and consumer
surplus is realized.
 Under simple monopoly, production
stops short of that point so there is a
deadweight loss.
 Strategies like two-part pricing,
limit pricing, or price discrimination
may reduce deadweight loss
compared to the case of simple
monopoly shown here.
Introduction to Economics (Combined Version) 5th Edition
Does Monopoly Promote Inequality?
 Monopoly can give rise to
great wealth for some people,
but not always.
 Some monopolies are small
businesses like the only pizza
outlet in a small town.
 Sometimes shareholders in a
monopoly are pension funds
or others than benefit people
of moderate income.
 Not all monopolies make
profits in the long run because
of indirect competition.
Introduction to Economics (Combined Version) 5th Edition
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