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Monopoly
Chapter 13
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Imperfectly Competitive Industry and
Market Power
An imperfectly competitive industry is one in
which single firms have some control over the
price of their output.
Market power is an imperfectly competitive
firm’s ability to raise price without losing all
demand for their product.
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Pure Monopoly
An industry with a single firm:
that produces a product for which there are no close
substitutes, and
in which significant barriers to entry prevent other
firms from entering the industry to compete for
profits.
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Barriers to Entry
A barrier to entry is something that prevents
new firms from entering and competing in
imperfectly competitive industries. Examples
include:
government franchises are monopolies by virtue of
government directive.
patents are a barrier to entry that grant exclusive use
of the patented product or process to the inventor.
economies of scale and other cost advantages
ownership of a scarce factor of production (DeBeers)
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Firms with market power must
decide:




How much output to produce
How to produce output
How much to demand in each input market
What price to charge for output
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Price and Output Decisions in Pure
Monopoly Markets
Basic assumptions:
Entry to the market is strictly blocked.
Firms act to maximize profits.
The monopolist cannot price discriminate (all buyers
pay the same price)
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Demand in Monopoly Markets
With only one firm in the monopoly market, there
is no distinction between the firm and the
industry. In a monopoly, the firm is the industry
and therefore faces the industry demand curve.
The total quantity supplied is what the firm
decides to produce.
For a monopolist, an increase in output involves
not just producing more and selling it, but also
reducing the price of its output in order to sell it.
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Marginal Revenue Facing a
Monopolist (Table 13.1)
 At every level except one unit, the monopolist’s marginal revenue is
below price. This is because to sell more output and raise total
revenue the firm lowers the price for all units sold.
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Marginal Revenue and Total Revenue
(Figure 13.4)
 A monopoly’s marginal
revenue curve bisects the
quantity axis between the
origin and the point where
the demand curve hits the
axis.
 A monopoly’s MR curve
shows the change in total
revenue that results as a firm
moves along the segment of
the demand curve that lies
exactly above it.
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Price and Output Choice for a ProfitMaximizing Monopolist (Figure 13.5)
 The profit-maximizing level
of output for a monopolist is
the one where MR = MC.
 Beyond that point, where
marginal cost exceeds
marginal revenue, the firm
would reduce its profits.
 Relative to a competitively
organized industry, a
monopolist restricts output,
charges higher prices, and
earns economic profits.
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Price and Output Choice for a Monopolist
Suffering Losses in the Short Run (Figure 13.6)
 It is possible for a
profit-maximizing
monopolist to suffer
losses in the short
run.
 At 10,000 units
variable costs are
covered but the
business will fail in
the long run.
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Comparison of Monopoly and Perfectly
Competitive Outcomes (Figure 13.8)
 Quantity produced
by the monopoly will
be less than the
competitive level of
output, and the
monopoly price will
be higher.
 Remember that the
MC curve is also the
supply curve for the
entire industry.
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Welfare Loss of Monopoly
(Figure 13.9)
 The triangle ABC
roughly measures the
net social gain from
moving to 4000 units
under perfect
competition or the
social loss that results
when monopoly
decreases output to
2000 units.
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Collusion
Collusion is the act of working with other
producers in an effort to limit competition and
increase joint profits.
Successful collusion leads to the same market
outcome as the monopoly.
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Rent-Seeking Behaviour
Rent-seeking behaviour refers to actions taken
by households or firms to preserve extranormal
profits.
This includes actions such as government
lobbying and has two important implications:
it comsumes resources without producing social
value
can lead to government failure
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Government Failure and Public
Choice Theory
Government failure occurs when the government
becomes the tool of the rent seeker and the
allocation of resources is made even less
efficiently by the intervention of government.
Public choice theory is an economic theory that
proceeds on the assumption that the public
officials who set economic policies and regulate
the players, act in their own self-interest, just as
firms do.
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Natural Monopoly
A natural monopoly occurs in an industry that
realizes such large economies of scale in
producing its product that single-firm production
of that good or service is the most efficient.
Economies of scale must be realized at a scale
that is close to total demand in the market.
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Natural Monopoly
(Figure 13.10)
 Average cost declines until a
single firm is producing
nearly the entire amount
demanded in the market.
 With one firm producing
500,000 units the average
cost is $1 and when five
firms each produce 100,000
units the average cost is $5.
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Regulating a Natural Monopoly
Acknowledging a single firm as a natural
monopoly and allowing it to operate under the
protection of a government franchise essentially
requires that the government becomes involved
in regulating the firm.
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Regulating a Natural Monopoly (cont.)
Governments have three possibilities in
regulating a natural monopoly:
set the price equal to marginal cost in which case the
monopolist will always suffer a loss
set a price ceiling which is a maximum price per unit
above which the producer of a good or service
cannot legally charge
use average-cost pricing where the price is set to
cover the average cost per unit including a fair return
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The Problem of Regulating a
Monopoly (Figure 13.11)
 An unregulated monopolist
produces where MC = MR,
at 400,000 units.
 If prices were set at MC
the firm would always
suffer a loss.
 A compromise would be to
set prices at $0.75 which
covers costs and allows a
normal profit rate.
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Market Power in Input Markets:
Monopsony
Monopsony is a market in which there is only
one buyer for a good or service.
An example is the market for labour in a one
company town.
Marginal factor cost is the additional cost of
using one more unit of a given factor of
production.
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Monopsony vs. Perfect Competition
in a Labour Market (Figure 13.12)
 For a monopsonist the marginal
cost of hiring one more worker
is higher than the wage rate,
since the firm increases all
wages to attract the new
worker.
 The monopsonist only hires up
to the point where MRPL = MFC.
 Wages are held below MRPL and
less labour is hired than under
perfect competition.
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Review Terms & Concepts
 average-cost pricing
 barrier to entry
 collusion
 government failure
 government franchise
 imperfectly competitive
industry
 marginal factor cost
(MFC)
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 market power
 monopsony
 natural monopoly
 patent
 price ceiling
 public choice theory
 pure monopoly
 rent-seeking behavior
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