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Chapter 8
Monopoly
Market Structures
Perfect competition
 Imperfect competition

– Monopoly
– Oligopoly
– Monopolistic competition
Imperfect Competition

Perfect Competition
– An ideal market that maximizes economic surplus
– A situation that does not always exist

Imperfect competition
–
–
–
–
–
Have some control over price
Price may be greater than the cost of production
Long-run economic profits are possible
Reduce economic surplus to varying degrees
Are very common
The Essential Difference
The perfectly competitive firm faces a
perfectly elastic demand for its product.
 The imperfectly competitive firm faces a
downward-sloping demand curve.

In perfect competition





Supply and demand determine equilibrium
price. The firm has no market power.
At the equilibrium price, the firm sells all it
wishes.
If the firm raises its price, sales will be zero.
If the firm lowers its price, sales will not
increase.
The firm’s demand curve is the horizontal line
at the market price.
In Imperfect Competition
The firm has some control over price or
some market power.
 The firm faces a downward sloping
demand curve.

The Demand Curves Facing Perfectly and
Imperfectly Competitive Firms
Perfect Competition vs.Monopoly
Many
buyers and
sellers
Only
one seller of a
unique product with no
close substitute
Homogeneous
product
Free
entry and exit
Barrier
to entry
 Market Power
Market Power: Definition
If a firm can raise the price of its product
(above market equilibrium price) without
losing all of its sales, then the firm has
market power.
 A firm’s ability to raise the price of a
good without losing all its sales

What a Monopolist Does
Five Sources of Market Power
(barriers to entry)
Exclusive control over inputs
 Patents and Copyrights
 Government Licenses or Franchises
 Network Economies
 Economies of Scale (Natural
Monopolies)

Natural Monopoly

Firms with economies of scale
– Average total cost declines sharply as
output increases
• large fixed costs
• low variable costs
• low marginal costs
Total and Average Total Costs for a
Production Process with Economies of
Scale
Market Power: Measurement
Elasticity of demand:

E = (ΔQ/Q)/(ΔP/P)
 The less elastic is the demand for the
firm’s product, the more market power
the firm has.

Market Power: Measurement
Cross-Price Elasticity:

Exy=(ΔQx/Qx)/(ΔPy/Py).
 The lower the cross-price elasticity
 (the lower the degree of substitution),
the larger the market power.

Short-Run Decision Concerning
output level

Goal: maximize profit

Demand facing the industry is the demand
facing the firm: downward sloping

MR below D
Short-Run Decision Concerning output
level

Rule: produce at MR=MC.

Positive Economic Profit: when
P>ATC at MR=MC

Operating at a loss: when
AVC<P<ATC at MR=MC

ShutDown: when P<AVC at MR=MC
Short-Run Equilibrium: Monopoly
P
MC
ATC
G
AVC
E
MR
O
M
D
Q
Principles:

MC tells how much to produce (produce
up to the amount where MR=MC)

ATC tells how much profit or loss is
made if the firm decides to produce
(profit = (P - ATC)Q).

AVC tells whether to produce (keep
producing only when P>AVC at MR=MC)
The Monopolist’s Profit
Profit = TR − TC
= (PM × QM) −
(ATCM × QM)
= (PM − ATCM) × QM
Monopoly versus Perfect Competition







profit-maximizing quantity of output
P = MR = MC for perfectly
competitive firm
P > MR = MC for monopolist
Compared with a competitive industry, a
monopolist
Produces a smaller quantity: QM < QC
Charges a higher price: PM > PC
Earns a monopoly profit
The Monopolist’s Benefit from SellingFigure
an 10.3
Additional Unit
• If P = $6, then TR = $6 x 2 = $12
$6,then
thenTR
TR= =$5$6x x3 2= =$15
$12
• If• IfPP= =$5,
• If PMR
= $5,
TRthe
= $5
3 = $15
• The
of then
selling
3rdxunit
= $3 (15-12)
• The
MR
selling
unit
= $3 (15-12)
• For
the
3rdofunit,
MR the
= $33rd
<P
= $5
• For the 3rd unit, MR = $3 < P = $5
5
5
3
3
Marginal Revenue in
Graphical Form

P
Q
TR
6
2
12
5
3
15
4
4
16
3
5
15
MR
3
1
-1
Observations
– MR is the change between
two quantities
– MR < P
– MR declines as quantity
increases
– MR < P because price must
be lowered to sell an
additional unit
Figure 10.4
Marginal Revenue in Graphical Form
The Marginal Revenue Curve for a
Monopolist with a Straight-Line Demand
Curve
Figure 10.5
Observations
The vertical intercept, a, is the same for MR and D
The horizontal intercept for MR, Q0/2, is one half the
demand intercept, Q0.
The Demand and Marginal Cost
Curves for a Monopolist Figure 10.6
The Monopolists Profit-Maximizing
Output Level
Figure 10.7
Even a Monopolist May Suffer
an Economic Loss
Figure 10.8
The Demand and Marginal Cost
Curves for a Monopolist
Figure 10.9
The Deadweight Loss from Monopoly
Figure 10.10
Monopoly Causes Inefficiency
Preventing Monopoly
Non-natural monopoly (not caused by
economy of scale):
antitrust prevention;
break up;
 Natural Monopoly:
public ownership – cost, quality, politics
price regulation

Regulated and Unregulated Natural
Monopoly
Even a Monopolist May Suffer Figure 10.8
an Economic Loss