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MONOPOLY
A monopoly is a firm which is the sole producer of a
good or service for which there are no close
substitutes.
The monopolist’s demand curve is the same as the
market demand curve.
The firm must have some way to keep prospective
entrants out of the industry, i.e., there must be
barriers to entry.
Monopoly
slide 1
BARRIERS TO ENTRY
Barriers to entry prevent other firms from
entering an industry in which a monopolist
may be earning profit.
Government franchises
Patents and copyrights
Economies of scale
Ownership of a scarce input
Monopoly
slide 2
Because the demand curve the monopolist sees is
negatively sloped, the monopolist can choose price as
well as the quantity of output. (Price and quantity sold
are linked by the demand curve. The demand curve
sets the limit that can be charged for each quantity
produced.)
Monopoly
slide 3
REVENUE CURVES FOR A
MONOPOLIST
The market demand curve for a good is the
firm’s average revenue curve.
Monopoly
slide 4
The demand curve shown here is the market demand curve
for cable TV hookups in East Lansing. Because the
Ripoff Cable TV Co. has an exclusive franchise, the
market demand curve is also the firm’s average revenue
curve. (AR = price)
$/Q
To sell 7,000 hookups per
month, they can charge
$52. per hookup per month
p = $52/mo.
7
Monopoly
Thousand hookups
demand
Q
slide 5
From the demand curve we can find the firm’s total revenue curve
(TR as a function of Q).
Total revenue is price times quantity.
We can then compare total revenue with total costs at each output to
find the output and price where profits are maximized.
When 3,000 hookups are
sold, they can charge $68
and the total revenue from
sales is $204 thousand.
$/Q
p = $68/mo.
3
Monopoly
AR = demand
Q
Thousand hookups
slide 6
Q
0
1
2
3
4
5
6
7
8
9
10
11
Monopoly
P (=AR)
80
76
72
68
64
60
56
52
48
44
40
36
TR
0
76
144
204
256
300
336
Here are other points on
the demand curve and
some corresponding
amounts of total revenue.
Fill in the remaining values for TR.
Go to hidden slide
slide 7
Plot the remaining points on the TR curve.
TR
450
400
350
300
250
200
150
100
Hidden slide
50
Q
0
0
Monopoly
2
4
6
8
10
12
14
slide 9
100
$/Q
80
60
40
D=AR
20
0
Q
0
2
4
6
8
10
12
Here’s the demand
curve with the
corresponding
total revenue
curve.
14
700
600
Thous. $
500
400
TR
300
Notice that the TR
curve is not a
straight line!
200
100
0
0
2
4
6
8
10
12
14
Thous. Hookups
Monopoly
slide 11
Monopoly
TC
10
30
54
82
114
154
204
266
342
434
546
682
Here is the
total cost curve
of the Ripoff
Cable TV Co.
Thous. $
Q
0
1
2
3
4
5
6
7
8
9
10
11
700
600
500
400
300
200
100
0
TC
Q
0
2
4
6
8
10
Thous. Hookups
12
14
slide 12
Q
0
1
2
3
4
5
6
7
8
9
10
11
Monopoly
TR
0
76
144
204
256
300
336
364
384
396
400
396
TC
10
30
54
82
114
154
204
266
342
434
546
682
Profit
-10
46
132
98
42
-38
-146
-286
Profit = TR - TC
We can put the total
revenue and total cost
curves together to find
total profit. Compute the
remaining values for
profit.
Hidden slide
slide 13
700
TC
600
Thous. $
500
TR
400
300
200
100
0
Q
0
2
4
6
8
10
12
14
Thous. $
Thous. Hookups
700
600
500
400
300
200
100
0
-100 0
-200
-300
Profit is maximized here
at 5,000 units of output.
The same problem can be
solved by the marginal/
average approach.
PROFIT
Q
2
4
6
8
10
12
14
Thous. Hookups
Monopoly
slide 15
For a monopolist, average revenue is declining as output
increases so marginal revenue must be less than
average revenue.
It is important to understand why MR is less than AR in
this case.
Monopoly
slide 16
Q
0
1
2
3
4
5
6
7
8
9
10
11
P (=AR)
80
76
72
68
64
60
56
52
48
44
40
36
Monopoly
TR
0
76
144
204
256
300
336
364
384
396
400
396
MR
76
68
60
52
44
36
Compute the
missing values of
Marginal Revenue.
MR = (300-256)/
(5-4)
Hidden slide
slide 17
$/Q
80
70
60
50
40
D=AR
30
20
Hidden slide
10
Q
0
-10
Monopoly
0
2
4
6
8
10
12
14
MR
slide 19
Marginal revenue is always less than price for a
monopolist because the firm must reduce price in
order to sell more.
$/Q
To sell an extra unit of output,
the monopolist must lower
price, thus losing the shaded
area on all of the previous
units sold at a price of p.
p
p’
Demand or AR
q
Monopoly
q+1
Q
slide 21
An increase in sales of one unit
requires a reduction in price.
$/Q
These rectangles have
the same area.
p
p’
So this area is MR,
which is less than p’.
Demand or AR
q
Monopoly
q+1
Q
slide 22
What values of output and price maximize
profit for the Ripoff Cable TV Co.?
$/Q
MC
Here are the
average and
marginal cost and
revenue curves
for the same
problem.
130
115
100
85
70
AC
55
40
AR=demand
25
10
-5
Q
0
2
4
6
8
10MR 12
Thousand hookups
Monopoly
slide 23
In this case the best output is 5,000 hookups,
and the best price is $60 per month.
Then choose price by
going to the demand
curve.
130
115
MC
Choose output
where MC = MR
100
85
70
AC
60
55
40
AR=demand
25
10
-5
Q
0
Monopoly
2
8
5 6
Thousand hookups
4
10MR 12
slide 24
To compute the amount of profits in monopoly, find average profit
(AR-AC) at the profit maximizing output and multiply by Q
$/Q
MC
130
115
100
85
70
AC
55
Total Profits
40
AR=demand
25
10
-5
Q
0
2
4
6
8
10MR 12
Thousand hookups
Monopoly
slide 25
To compute the amount of LOSS in monopoly, find average loss (AC-AR)
at the “profit” maximizing output, and multiply by Q.
$/Q
MC
130
115
100
AC II
85
TOTAL LOSS
70
AVC
55
40
AR=demand
25
10
-5
Q
0
2
4
6
8
10MR 12
Thousand hookups
Monopoly
slide 26
Summary of monopoly pricing:
To maximize profit a monopolist should choose output
where MC = MR.
Price is determined from the demand curve.
Monopoly
slide 27
What values of output and price maximize
profit for the Ripoff Cable TV Co.?
$/Q
MC= SS
130
115
100
85
70
AC
60
55
55
40
AR=demand
25
10
-5
Q
0
Monopoly
2
5 66.3
8
Thousand hookups
4
10MR 12
slide 28
Do monopolists choose the best output and price from
society’s point of view?
Another way to ask the question is whether the
monopolist operates in society’s interest, and if not,
what can be done to remedy the evils of monopoly.
Monopoly
slide 29
This requires us to formulate some rule for determining
when social welfare is improved by some change, and
when social welfare is maximized.
The rule we'll use is that social welfare is measured by
the sum of producer and consumer surplus. So society
ought to produce where the sum of producer and and
consumer surplus is as large as possible.
Monopoly
slide 30
Another method for finding the best output takes a
different approach, using the concepts of marginal
social benefit and marginal social cost.
DEFINITIONS:
Marginal social benefit (MSB): The MSB is the increase
in social welfare that results from consuming another
unit of a good.
Marginal social cost (MSC): The MSC is the cost to
society of producing another unit of a good.
Monopoly
slide 31
Monopoly summary
To maximize profit, the monopolist will produce where
MC = MR.
From society’s point of view monopolists produce too
small an output, and sell it at too high a price.
The best output from society’s point of view is where
MC = P.
We can measure the deadweight loss due to monopoly as
the (roughly) triangular area between the MC curve
and the demand curve.
Monopoly
slide 32