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CHAPTER 11A/24
MONOPOLY
Prof. Charles Fusi
INTRODUCTION
In New York City, a taxicab requires a medallion as legal
possession of a license to operate the taxi business.
Thus, the medallion constitutes a barrier to entry to
New York City’s taxicab industry.
In this chapter, you will learn how governmentally
imposed and other types of barriers to entry give rise to
monopolies, or single-firm industries.
Lecture by Prof. Charles Fusi
11A/24-2
LEARNING OBJECTIVES

Identify situations that can give rise to monopoly

Describe the demand and marginal revenue conditions a
monopolist faces

Discuss how a monopolist determines how much output to
produce and what price to charge

Evaluate the profits earned by a monopolist

Understand price discrimination

Explain the social cost of monopolies
Lecture by Prof. Charles Fusi
11A/24-3
CHAPTER OUTLINE








Definition of a Monopolist
Barriers to Entry
The Demand Curve a Monopolist Face
Elasticity and Monopoly
Cost and Monopoly Profit Maximization
Calculating Monopoly Profit
On Making Higher Profits: Price Discrimination
The Social Cost of Monopolies
Lecture by Prof. Charles Fusi
11A/24-4
DEFINITION OF A MONOPOLIST

Monopolist

A single supplier of a good or service for which
there is no close substitute

The monopolist therefore constitutes the entire
industry
Lecture by Prof. Charles Fusi
11A/24-5
BARRIERS TO ENTRY

Question


How does a firm obtain monopoly power?
Answer

Barriers to entry that allow the firm to make longrun economic profits

Barriers to entry are restrictions on who can start
as well as stay in business.
Lecture by Prof. Charles Fusi
11A/24-6
BARRIERS TO ENTRY (CONT'D)

Barriers to entry include:

Ownership of resources without close substitutes

Economies of scale

Legal or governmental restrictions
Lecture by Prof. Charles Fusi
11A/24-7
BARRIERS TO ENTRY (CONT'D)

Ownership of resources without close
substitutes

The Aluminum Company of America (ALCOA) at
one time owned most of of the world’s bauxite
Lecture by Prof. Charles Fusi
11A/24-8
BARRIERS TO ENTRY (CONT'D)

Economies of scale

Low unit costs and prices drive out rivals

The largest firm can produce at the lowest
average total cost
Lecture by Prof. Charles Fusi
11A/24-9
BARRIERS TO ENTRY (CONT'D)

Natural Monopoly

A monopoly that arises from the peculiar
production characteristics in an industry

It usually arises when there are large economies
of scale

One firm can produce at a lower average cost
than can be achieved by multiple firms
Lecture by Prof. Charles Fusi
11A/24-10
FIGURE 11A/24-1 THE COST CURVES THAT MIGHT
LEAD TO A NATURAL MONOPOLY
Lecture by Prof. Charles Fusi
11A/24-11
BARRIERS TO ENTRY (CONT'D)

Legal or governmental restrictions

Licenses, franchises, and certificates of
convenience

Examples include

Electrical utilities

Radio and television broadcasting
Lecture by Prof. Charles Fusi
11A/24-12
BARRIERS TO ENTRY (CONT'D)

Legal or governmental restrictions

Patents


Tariffs


Intellectual property
Taxes on imported goods
Regulation

Government enforcement of safety and quality
Lecture by Prof. Charles Fusi
11A/24-13
THE DEMAND CURVE A MONOPOLIST FACES

The monopolist faces the industry demand
curve because the monopolist is the entire
industry
Lecture by Prof. Charles Fusi
11A/24-14
THE DEMAND CURVE A MONOPOLIST FACES
(CONT'D)

Recall that under perfect competition

Firm faces perfectly elastic demand curve, it is a
price taker

The forces of supply and demand establish the
price per unit

Marginal revenue, average revenue, and price
are all the same
Lecture by Prof. Charles Fusi
11A/24-15
THE DEMAND CURVE A MONOPOLIST FACES
(CONT'D)

Marginal revenue equals the change in total
revenue due to a one-unit change in the
quantity produced and sold
Lecture by Prof. Charles Fusi
11A/24-16
THE DEMAND CURVE A MONOPOLIST FACES
(CONT'D)

Perfect competition versus monopoly

The perfect competitor doesn’t have to worry
about lowering price to sell more

In a purely competitive situation, the firm
accounts for a small part of the market

It can sell its entire output, whatever that may be, at
the same price
Lecture by Prof. Charles Fusi
11A/24-17
THE DEMAND CURVE A MONOPOLIST FACES
(CONT'D)

Perfect competition versus monopoly

The more the monopolist wants to sell, the lower
the price it has to charge on the last unit sold

To sell the last unit, the monopolist has to lower
the price because it is facing a downward sloping
demand curve
Lecture by Prof. Charles Fusi
11A/24-18
FIGURE 11A/24-2 DEMAND CURVES FOR THE
PERFECT COMPETITOR AND THE MONOPOLIST
Lecture by Prof. Charles Fusi
11A/24-19
THE DEMAND CURVE A MONOPOLIST FACES
(CONT'D)
Monopoly
Perfect Competition
Single seller
Many sellers
Faces entire
industry demand
Faces perfectly
elastic demand
Must lower price
to sell more
Must produce more
to sell more
Not all units sold for
same price (MR < P)
All units sold for same
price (P = MR)
Lecture by Prof. Charles Fusi
11A/24-20
FIGURE 11A/24-3 MARGINAL REVENUE:
ALWAYS LESS THAN PRICE
Lecture by Prof. Charles Fusi
11A/24-21
ELASTICITY AND MONOPOLY


The monopolist faces a downward-sloping
demand curve (its average revenue curve)
That means that it cannot charge just any
price with no changes in quantity (a common
misconception) because, depending on the
price charged, a different quantity will be
demanded
Lecture by Prof. Charles Fusi
11A/24-22
ELASTICITY AND MONOPOLY (CONT'D)

Question


If a monopoly raises price, what will happen to
quantity demanded?
Hint

Remember how consumers respond to a change
in price
Lecture by Prof. Charles Fusi
11A/24-23
ELASTICITY AND MONOPOLY (CONT'D)

Recall

A monopolist is a single seller of a well-defined
good or service with no close substitute


Think of some imperfect substitutes.
The demand curve slopes downward because
individuals compare marginal satisfaction to cost
Lecture by Prof. Charles Fusi
11A/24-24
ELASTICITY AND MONOPOLY (CONT'D)


After all, consumers have limited incomes
and unlimited wants
The market demand curve, which the
monopolist alone faces in this situation,
slopes downward because individuals
compare the marginal satisfaction they will
receive to the cost of the commodity to be
purchased
Lecture by Prof. Charles Fusi
11A/24-25
COSTS AND MONOPOLY PROFIT MAXIMIZATION

We assume profit maximization is the goal of
the pure monopolist, just as it is for the
perfect competitor
Lecture by Prof. Charles Fusi
11A/24-26
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

Perfect competitor has only to decide on the
profit-maximizing output rate because price
is given


The perfect competitor is a price taker
For the pure monopolist, we must seek a
profit-maximizing price output combination

The monopolist is a price searcher
Lecture by Prof. Charles Fusi
11A/24-27
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

Price Searcher

A firm that must determine the price-output
combination that maximizes profit because it
faces a downward-sloping demand curve
Lecture by Prof. Charles Fusi
11A/24-28
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

We can determine the profit-maximizing
price-output combination with either of two
equivalent approaches:

By looking at total revenues and total costs
or

By looking at marginal revenues and marginal
costs
Lecture by Prof. Charles Fusi
11A/24-29
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

Total revenues-total costs approach


Maximize the positive difference between total
revenues and total costs
Marginal revenue-marginal cost approach

Profit maximization will also occur where
marginal revenue equals marginal cost
Lecture by Prof. Charles Fusi
11A/24-30
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

Question


Why produce where marginal revenue equals
marginal cost?
Answer

This is where the greatest positive difference
between total revenue and total cost occurs
Lecture by Prof. Charles Fusi
11A/24-31
FIGURE 11A/24-4 MONOPOLY COSTS,
REVENUES, AND PROFITS, PANEL (A)
Lecture by Prof. Charles Fusi
11A/24-32
FIGURE 11A/24-4 MONOPOLY COSTS, REVENUES,
AND PROFITS, PANELS (B) AND (C)
Lecture by Prof. Charles Fusi
11A/24-33
COSTS AND MONOPOLY PROFIT MAXIMIZATION
(CONT'D)

Producing past where MR = MC


Result is that incremental cost will exceed
incremental revenue
Producing less than where MR = MC

The monopolist is not maximizing profits through
this approach either
Lecture by Prof. Charles Fusi
11A/24-34
FIGURE 11A/24-5 MAXIMIZING PROFITS
Lecture by Prof. Charles Fusi
11A/24-35
COST AND MONOPOLY PROFIT MAXIMIZATION
(CONT’D)

Real-World Informational Limitations



Price searching by a less-than perfect competitor
is a process
A monopolist can only estimate the actual
demand curve and make an educated guess
when it sets its profit-maximizing profit
For the perfect competitor, price is given already
by the intersection of market demand and supply
Lecture by Prof. Charles Fusi
11A/24-36
CALCULATING MONOPOLY PROFIT

Monopoly profit is given by the shaded area
in Figure 24-6, which is equal to total
revenues (P  Q) minus total costs (ATC  Q)
Lecture by Prof. Charles Fusi
11A/24-37
FIGURE 11A/24-6 MONOPOLY PROFIT
Lecture by Prof. Charles Fusi
11A/24-38
CALCULATING MONOPOLY PROFIT (CONT'D)

No guarantee of profits

The term monopoly conjures up the notion of a
greedy firm ripping off the public

If ATC is everywhere above AR, or demand

No price-output combination allows the
monopolist to cover costs
Lecture by Prof. Charles Fusi
11A/24-39
FIGURE 11A/24-7 MONOPOLIES: NOT ALWAYS
PROFITABLE
Lecture by Prof. Charles Fusi
11A/24-40
INTERNATIONAL EXAMPLE: A MEXICAN CEMENT MONOPOLY
FINDS A WAY TO INCUR LOSSES



In Mexico, a single company, Cemex, accounts for almost 80
percent of the nation’s cement production and sales.
Thus, Cemex sells cement to Mexican consumers at almost
twice the market price in the United States, where a number
of firms make and sell cement.
Recently, Cemex has been incurring losses as a result of
falling demand in 2008 and its debt costs from short-term
loans that the company had borrowed during periods of
expansion.
Lecture by Prof. Charles Fusi
11A/24-41
ON MAKING HIGHER PROFITS: PRICE
DISCRIMINATION

Price Discrimination

Selling a given product at more than one price,
with the difference being unrelated to
differences in cost
Lecture by Prof. Charles Fusi
11A/24-42
ON MAKING HIGHER PROFITS: PRICE
DISCRIMINATION (CONT'D)

Price Differentiation

Establishing different prices for similar products
to reflect differences in marginal cost in
providing those commodities to different groups
of buyers
Lecture by Prof. Charles Fusi
11A/24-43
ON MAKING HIGHER PROFITS: PRICE
DISCRIMINATION (CONT'D)

Necessary conditions for price discrimination
1.
The firm must face a downward-sloping demand
curve
2.
The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with
predictably different elasticities of demand
3.
The firm must be able to prevent resale of the
product or service
Lecture by Prof. Charles Fusi
11A/24-44
EXAMPLE: WHY STUDENTS PAY DIFFERENT PRICES TO ATTEND
COLLEGE

Out-of-pocket tuition rates for any two college students can
differ by considerable amounts, even if the students happen
to major in the same subjects and enroll in many of the
same courses.

The reason for this is that colleges offer students diverse
financial aid packages depending on their “financial need.”

To document their “need” for financial aid, students must
provide detailed information about family income and
wealth. This information helps the college determine the
prices that different families are most likely to be willing and
able to pay, so that it can engage in price discrimination.
Lecture by Prof. Charles Fusi
11A/24-45
FIGURE 11A/24-8 TOWARD PERFECT PRICE DISCRIMINATION
IN COLLEGE TUITION RATES
Lecture by Prof. Charles Fusi
11A/24-46
THE SOCIAL COST OF MONOPOLIES

Comparing monopoly with perfect
competition

Let’s assume a monopolist comes in and buys
up every single perfect competitor

Notice the monopolist produces a smaller
quantity and sells at a higher price
Lecture by Prof. Charles Fusi
11A/24-47
THE SOCIAL COST OF MONOPOLIES (CONT'D)

Comparing monopoly with perfect
competition

Monopolists raise the price and restrict
production compared to a perfectly competitive
situation

Consumers pay a price that exceeds the
marginal cost of production and resources are
misallocated in such a situation
Lecture by Prof. Charles Fusi
11A/24-48
FIGURE 11A/24-9 THE EFFECTS OF
MONOPOLIZING AN INDUSTRY
Lecture by Prof. Charles Fusi
11A/24-49
YOU ARE THERE: A TEXAS VETERINARY BOARD WHITTLES
DOWN VETS’ COMPETITION

The Texas Board of Veterinary Medical Examiners has determined that
horse-teeth floaters, who provide basic dental services for horses, must
be certified or else they must work under the supervision of a licensed
veterinarian.

This way, many skilled horse-teeth floaters without a license will no
longer able to compete with licensed veterinarians in the market for
horse dental services.
Lecture by Prof. Charles Fusi
11A/24-50
ISSUES & APPLICATIONS: THIS MEDALLION IS NOT SIMPLY A
DECORATIVE PENDANT



The number of taxi medallions issued by New York City is
controlled by the city’s Taxi and Limousine Commission.
The commission’s medallions serve as a barrier to entry in
the taxicab market.
The medallions can be bought and sold, and the market
clearing prices have generally risen since 2004, now
exceeding $600,000 for individual owners and $800,000
for corporate owners.
Lecture by Prof. Charles Fusi
11A/24-51
FIGURE 11A/24-10 MARKET PRICES OF NEW YORK
CITY TAXI MEDALLIONS
Lecture by Prof. Charles Fusi
11A/24-52
SUMMARY DISCUSSION OF LEARNING
OBJECTIVES (CONT'D)

Why a monopoly can occur


Barriers to entry
Demand and marginal revenue conditions
faced by a monopolist


Because the monopolist constitutes the entire
industry, it faces the entire market demand
curve.
Marginal revenue is less than price.
Lecture by Prof. Charles Fusi
11A/24-53
SUMMARY DISCUSSION OF LEARNING
OBJECTIVES (CONT'D)

How a monopolist determines how much
output to produce and what price to charge

Seeks to maximize its economic profits

Produces where marginal revenue equals
marginal cost

Charges maximum price for the amount of
output where MR = MC
Lecture by Prof. Charles Fusi
11A/24-54
SUMMARY DISCUSSION OF LEARNING
OBJECTIVES (CONT'D)

A monopolist’s profits

Profit earned by monopolist is equal to the
difference between the price it charges and its
average production cost times the amount of
output it produces and sells.

Monopolist typically earns positive economic
profits.
Lecture by Prof. Charles Fusi
11A/24-55
SUMMARY DISCUSSION OF LEARNING
OBJECTIVES (CONT'D)

Price discrimination

Selling at more than one price with the price
differences being unrelated to differences in
production costs.

Monopolist sells some of its output at higher
prices to consumers with less elastic demand.
Lecture by Prof. Charles Fusi
11A/24-56
SUMMARY DISCUSSION OF LEARNING
OBJECTIVES (CONT'D)

Social cost of monopolies

Price exceeds marginal cost.

The price is higher and output is lower for a
monopolist as compared to a perfectly
competitive industry.
Lecture by Prof. Charles Fusi
11A/24-57
APPENDIX G: CONSUMER SURPLUS IN A PERFECTLY
COMPETITIVE MARKET

Given the market clearing price that prevails
in the perfectly competitive market,
consumer surplus is:

the difference between the total amount that
consumers would have been willing to pay and
the total amount that they actually pay
Lecture by Prof. Charles Fusi
11A/24-58
FIGURE G-1 CONSUMER SURPLUS IN A PERFECTLY
COMPETITIVE MARKET
Lecture by Prof. Charles Fusi
11A/24-59
APPENDIX G: HOW SOCIETY LOSES FROM MONOPOLY

Deadweight Loss


The portion of consumer surplus that no one in
society is able to obtain in a situation of
monopoly
No one in society, not even the monopoly, can
obtain this deadweight loss
Lecture by Prof. Charles Fusi
11A/24-60
APPENDIX G: HOW SOCIETY LOSES FROM MONOPOLY
(CONT’D)

As a result of monopoly, consumers are
worse off in two ways:


The monopoly profits that result constitute a
transfer of a portion of consumer surplus away
from consumers to the monopolist
The failure of the monopoly to produce as many
units as would have been produced under
perfect competition eliminates consumer surplus
that otherwise would have been a benefit to
consumers
Lecture by Prof. Charles Fusi
11A/24-61
FIGURE G-2 LOSSES GENERATED BY MONOPOLY
Lecture by Prof. Charles Fusi
11A/24-62