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Chapter 10
Monopoly,
Cartels, and
Price
Discrimination
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
In this chapter you will learn to
1. Explain why marginal revenue is less than price for a
profit-maximizing monopolist.
2. Describe how entry barriers allow monopolists to
maintain positive profits in the long run.
3. Describe how firms can form a cartel to restrict industry
output and increase price and profits.
4. Describe the various forms of price discrimination.
Copyright © 2008 Pearson Addison-Wesley. All rights reserved.
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A Single-Price Monopolist
Cost and Revenue in the Short Run
A monopolist faces the (downward-sloping) market demand
curve.
If the monopolist charges the same price for all units sold, its
total revenue (TR) is:
TR = p x Q
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Avenue and Marginal Revenue
Average revenue (AR) is total revenue divided by quantity:
AR = TR/Q = (p x Q)/Q = p
Marginal revenue (MR) is the revenue resulting from the sale
of an additional unit of production:
MR = TR/Q
The monopolist must reduce the price to increase sales –
therefore the MR curve is below the demand curve.
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Figure 10.1 A Monopolist’s
Average and Marginal Revenue
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Figure 10.2 Short-Run Profit
Maximization for a Monopolist
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Monopolist’s Profit-Maximizing
Behavior
There is no unique relationship between market price and the
quantity of output supplied.
 A monopolist does not have a supply curve
The monopolist is the only producer in an industry.
 A monopolist is the industry.
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Competition and Monopoly
Compared
Unlike a competitive firm, the monopolist does not have a
supply curve because it chooses its price.
The monopolist is the industry, so that its profit-maximizing
conditions is the equilibrium of the industry.
Can we compare the monopoly outcome to the competitive
outcome?
In a perfectly competitive industry price equals MC. But a
monopolist produces at a lower level of output, with price
exceeding MC.
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Figure 10.3 The Inefficiency of
Monopoly
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Entry Barriers and Long-Run
Equilibrium
Despite incentives to enter, effective entry barriers allow
monopoly profits to persist in the long run.
Entry barriers are of two types:
- “natural” – such as economies of scale
- “created” – by advertising campaigns or
– by government regulation
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10-10
The Very Long Run and Creative
Destruction
In the very long run, technological changes and innovations
can circumvent effective entry barriers.
Joseph Schumpeter defended monopoly on the basis that the
pursuit of monopoly profits provides incentives to innovate.
He called the replacement of one monopolist by another
through innovation the process of creative destruction.
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Entry Barriers
APPLYING ECONOMIC CONCEPTS 10.1
Entry Barriers for Irish Pubs
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Creative Destruction
Joseph Schumpeter (1882-1950)
“What we have to accept is that [monopoly] has come to be the most
powerful engine of progress and in particular of the long-run expansion
of total output not only in spite of, but to a considerable extent through,
this strategy [of creating monopolies], which looks so restrictive when
viewed in the individual case and from the individual point of time.”
LESSONS FROM HISTORY 10.1
Creative Destruction Through
History
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Figure 10.4 The Effect of Forming
a Cartel in a Competitive Industry
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Figure 10.5 A Cartel
Member’s Incentive to Cheat
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Problems of Cartels
Any one firm within the cartel has an incentive to cheat.
But if all firms cheat, the price will fall back toward the
competitive level, and joint profits will not be maximized.
Enforcing output restrictions and preventing entry are
difficult. Thus, cartels rarely last for long.
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Price Discrimination
A producer practices price discrimination by charging different
prices for the same products that have the same cost.
Central to this is that different consumers value the product at
different amounts.
Any firm facing a downward-sloping demand curve can
increase profits if it is able to price discriminate.
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When Price Discrimination Is
Possible
1. When firms have market power.
2. When consumers differ in their valuations of the product.
3. When firms can prevent arbitrage.
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Different Forms of Price
Discrimination
Price Discrimination Among Units of Output
A firm captures consumer surplus by charging different prices
for different units sold.
“Perfect” price discrimination transfers all consumer surplus
to the seller.
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Figure 10.6 Price Discrimination
among Units of Output
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Figure 10.7 A Numerical Example
of Profitable Price Discrimination
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The Consequences of Price
Discrimination
Price discrimination increases firms’ profits (otherwise they
wouldn’t do it!).
For price discrimination by the unit, firms will often increase
their output and overall efficiency will increase.
The effect on consumers is unclear – they may lose consumer
surplus, but they could also gain surplus (if output increases
as a result).
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