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Monopoly
Tutorial 9
Perfect Competition
 Characteristics of Monopoly:
- One seller
- No close substitutes
- Barriers to Entry
• Legal
• Technical:
o Ownership of unique resources, such as mineral deposits or land locations
o Natural Monopoly
 As ALL firms select an output level to maximize economic profits, to
analyze the firm’s output choice, we need:
- The firm’s cost curves
- The demand curve facing the firm
Page 2
Demand Curve facing a Monopoly
 The demand curve facing a monopoly is the market demand curve,
which is downward sloping.
p
a
If a monopoly’s demand curve is
linear, it can be shown that its
marginal revenue curve is also linear,
with the same intercept and twice as
steep as the demand curve
Elastic:
Q↑(P↓)  TR ↑
MR > 0
Mid-point
Inelastic:
Q↑(P↓)  TR ↓
MR < 0
D
a/b
Q
MR
Page 3
Demand Curve facing a Monopoly
Mathematical Deviation (for reference only):
If a monopoly’s demand curve is linear, it can be shown that its marginal
revenue curve is also linear, with the same intercept and twice as steep as the
demand curve
A general form of the inverse demand function of any linear demand curve is:
p  a  bQ
(8.2)
where a and b are positive constants. The total revenue function can be
expressed as
R  p(Q)  Q  aQ  bQ 2
Differentiating the revenue function with respect to Q, the marginal revenue can
be derived:
dR
(8.3)
MR (Q) 
 a  2bQ
dQ
Page 4
Monopoly Profit Maximization
p($)
MC
AC
p*
A
AC*
MR
D
Q
Q*
Page 5
Discussion Question 1
Consider the market for the Olympic souvenir featuring Fuwa, the official
Beijing Olympic mascots. Only the firm obtaining the license from the
Beijing Organizing Committee for the Olympic Game (BOCOG) has a
monopoly on selling the official Olympic souvenirs. During the summer,
the Beijing government devoted much effort to fight counterfeited
Olympic souvenirs. Explain how the sale of counterfeited souvenirs
would affect the monopoly
Page 6
Discussion Question 1
 Suppose the market demand for official Olympic souvenirs drops due to
counterfeit. How would a decrease in demand affect the monopoly?
p($)
MC
p1
p2
If the monopoly
makes a loss, what
will it do?
AC
A
B
MR1
MR2
Q2 Q1
D1
D2
Q
Page 7
Discussion Question 1
 Stores around Beijing reported
total sales of close to 2.3 billion
yuan during the first seven
months this year, and have
generated over 212 million yuan
of taxes, according to the Beijing
Youth Daily quoting data from the
city's local taxation bureau.
(Source: Olympic souvenir stores see sales
boom as team China collects gold , People’s
Daily Online, August 22, 2008)
Page 8
Discussion Question 3
 In question 1, the firm becomes monopoly because it obtains a license
from the BOCOG. If it costs the firm certain amount of money to gain the
exclusive right from the BOCOG, what is the maximum amount that the
firm is willing to pay?
 Because, by assumption, no entry is possible into a monopoly market,
the monopolist’s positive profits can exist even in the long run. For this
reason some economists refer to the profits that a monopoly earns in the
long run as monopoly rents.
- The profits can be regarded as a return to that factor forming the basis of the
monopoly, such as a monopoly right granted from government in a form of
patent.
- Hence, another possible owner might be willing to pay that amount in rent for
the right to the monopoly.
Page 9
Example: CCTV’s Monopoly Rent
 CCTV, the state monopoly broadcaster
of the 2008 Olympic Game in China,
have paid about $9m for the right of
coverage, from which it has generated
about $400m in advertising revenues.
 China’s broadcasting costs for these
games were tied up in a rights deal
signed in the 1990s (before China was
awarded the 2008 games and when
China was not winning many medals)
to cover the games from 2000 – 2008.
 Timo Lumme, marketing director for the
International Olympic Committee, said
the IOC would now negotiate with
mainland China for future games rights,
and that he expected to extract a sum
well in excess of $100m!
Source: Financial Times, 21 Aug, 2008
Page 10
Welfare Analysis (Chapter 8)
 An analysis of the consequences of changing economic conditions on the
welfare of market participants.
 One commonly used measure of the welfare of society, is the sum of the
consumer surplus and producer surplus:
TS  CS  PS
 Consumer Surplus = Willingness to pay – Price actually paid
- the area under the market demand curve and above the market price up to the
quantity the consumers buy.
 Producer Surplus = Price actually received – Willingness to sell
- the area above the market demand curve and below the market price up to the
quantity the firms sell.
Page 11
Competitive Market Equilibrium
p
Willingness to pay > marginal cost
S (∑MC)
(willingness to pay) p1
p*
(marginal cost) p2
D (willingness to pay)
Q
Q1
Q*
Q2
Page 12
Welfare Analysis of Monopoly
 Recall that welfare, which is defined as the sum of consumer surplus and
producer surplus (i.e. TS = CS + PS), is maximized in the perfectly
competitive market equilibrium. Therefore, it is concluded that resources
are allocated efficiently under a perfectly competitive market.
 To evaluate the welfare effects of a monopoly, we need a precisely
defined basis of comparison. It is convenient to think of a monopoly as
arising from the “capture” of a competitive industry and to treat the
individual firms that constituted the competitive industry as now being
single plants in the monopolist’s empire.
 It can be easily shown that the social welfare with a monopoly is lower
than that with a competitive market.
Page 13
Welfare Analysis of Monopoly
p($)
A
MC
pm
B
C
pc
E
D
MR
D
Qm
Q
Qc
Competition
Monopoly
Change
CS
A+B+C
A
– (B + C)
PS
D+E
B+D
B–E
A+B+C+D+E
A+B+D
DWL = – C – E
W = CS + PS
Page 14
Discussion Question 2

Tamiflu, a pricey antiviral pill invented in 1996 in Vietnam and made in part from a spice
used in Chinese cookery, had emerged as the world’s first line of defense against bird flu
in 2005. The patent to produce Tamiflu was held by Swiss pharmaceuticals giant Roche.
The revenues of Tamiflu were over $254 million in 2004 and more than $1000 million in
2005 due to the threat of bird flu.
(Source: “Bird flu drug maker won’t share patent,” www.sfgate.com, October 13, 2005.)
a) As many countries anticipated of the outbreak of bird flu, they started to stockpile Tamiflu.
Explain how it would affect the market of Tamiflu and the profits of Roche.
b) Because of the high price, many developing countries could not afford to buy large
amount of Tamiflu. The World Health Organization suggested Roche to voluntarily give
up the patent and allow other firms to produce the life-saving drugs. However, the
company spokesman Terry Hurly replied, “Roche … fully intends to remain the sole
manufacturer of Tamiflu.”
Show the consumer surplus, producer surplus and total surplus in the diagram and
discuss why WHO made such suggestion.
Why government still grant patent?
Page 15
Regulation of Monopoly
 Optimal price regulation (price ceiling): MC Pricing
p($)
MC
pm
MRr
pc
Price Ceiling
MR
D
Qm
Qc
Q
Page 16
Regulation of Monopoly
 There are two problems in regulating monopoly by price ceiling:
- How to determine the optimal price?
Discussion Question 4: Describe the effects on output and welfare if the
government regulates a monopoly so that it may not charge a price above ,
which lies between the unregulated monopoly price and the optimally regulated
price.
- MC pricing to regulate a natural monopoly?
p($)
pm
pc
D
MR
Qm
Qc
AC
MC
Q
Page 17
Barriers to Entry: Natural Monopoly
 Natural Monopoly
- If one firm can produce the total output of the market at lower cost than several
firms could, the market is a natural monopoly.
p($)
Total cost of producing Q1 with 1 firm = AC1 x Q1
Total cost of producing Q1 with 2 firms = AC2 x Q1
AC2
AC1
AC
D
MR
Q1/2
Q1
MC
Q
Page 18
Price Discrimination
 In some circumstances a monopoly may be able to increase profits by
departing from a single-price policy for its output. (Why?)
 A monopoly engages in price discrimination if it sells otherwise
identical units of output at different prices and the price differential is not
reflecting the cost differential.
 Certain features must be present for a firm to exercise price
discrimination:
- The firm must have some market power
- The firm must have some information about the consumers’ willingness to pay
differ among consumers
- The firm must be able to prevent resale:
Page 19
First-Degree (Perfect) Price Discrimination
The monopoly sells each unit at a price =
maximum willingness to pay
p($)
A
MC
pm
B
pc
C
E
D
MR
Qm
D = MRd
Q
Qc
Competition
Monopoly
Perfect Price Discrimination
CS
A+B+C
A
0
PS
D+E
B+D
A+B+C+D+E
A+B+C+D+E
A+B+D
A+B+C+D+E
0
C+E
0
W = CS + PS
DWL
Page 20
Third-Degree (Multimarket) Price Discrimination
 Exercising first-degree price discrimination is usually difficult (why?).
However, the firm may know which groups of consumers are likely to be
more willing to pay than others.
 Firms use two approaches to divide consumers into groups:
- Directly based on observable characteristics
• Age, gender, student status, country, …
- Allows consumers to self-select the group to which they belong (usually based
on their willingness to spend time to obtain a lower price)
• E.g. Coupons,…
Page 21
Second-Degree (Quantity) Discrimination
 In many markets each
consumer buys more than one
unit of the good in a given time
period. As a typical
consumer’s demand curve is
typically downward sloping,
the consumer’s willingness to
pay decreases as successive
units are purchased.
 Quantity Discount: The
consumer pays one price for
units consumed in the first
block (up to a given quantity)
and a different price for
subsequent blocks.
p($)
p1
pm
A
B
C
D
E
F
p2
pc
G
I
H
J
MC
MR
D
Q1
Qm
2nd block:
Qm – Q1
Q2
Qc
Q
3rd block:
Q2 – Qm
Page 22
Discussion Question 5
 The HK supermarket giant, ParknShop are issuing “MoneyBack Rewards Card,”
which are needed to take advantage of discounts.
 Supermarkets can then set consumer-specific prices to willing customers and
collecting information on their purchases. Ideally, supermarkets can use that data
to offer customized discount coupons to individuals. What type of price
discrimination – first-degree, second-degree, or third-degree – are these
personalized discounts.
Page 23
Discussion Question 5
 While the supermarket is exercising price discrimination, which type of
price discrimination they are using depends on how they use the card:
- If the supermarket can obtain perfect information from the discount card, it may
be able to exercise perfect (or close to perfect) price discrimination.
- If the supermarket only records the amount the consumers have bought and
offers quantity discount, it is an example of second-degree price discrimination.
- If the (so-called “personalized”) discount offers are actually the same to
everyone who are willing to use the discount card, it is actually a mechanism to
classify the customers into price-sensitive group and non-sensitive group. This
is an example of third-degree price discrimination.
Page 24