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Monopoly
CHAPTER
9
© 2003 South-Western/Thomson Learning
1
Barriers to Entry
A monopoly is the sole supplier of a
product with no close substitutes
The most important characteristic of a
monopolized market is barriers to entry
 new firms cannot profitably enter the
market
Barriers to entry are restrictions on the
entry of new firms into an industry
Legal restrictions
Economies of scale
Control of an essential resource
2
Legal Restrictions
One way to prevent new firms from
entering a market is to make entry
illegal
Patents, licenses, and other legal
restrictions imposed by the government
provide some producers with legal
protection against competition
3
Patent and Invention Incentives
A patent awards an inventor the
exclusive right to produce a good or
service for 20 years
Patent laws
Encourage inventors to invest the time and
money required to discover and develop
new products and processes
Also provide the stimulus to turn an
invention into a marketable product, a
process called innovation
4
Licenses and other Entry Restrictions
Governments often confer monopoly
status by awarding a single firm the
exclusive right to supply a particular
good or service
Broadcast TV and radio rights
State licensing of hospitals
Cable TV and electricity on local level
5
Economies of Scale
A monopoly sometimes emerges
naturally when a firm experiences
economies of scale as reflected by the
downward-sloping, long-run average
cost curve
In these situations, a single firm can
sometimes supply market demand at a
lower average cost per unit than could
two or more firms at smaller rates of
output
6
Exhibit 1: Economies of Scale as a Barrier to Entry
Cost per unit
$
Put another way, market
demand is not great enough
to permit more than one
firm to achieve sufficient
economies of scale  a
single firm will emerge from
the competitive process as
the sole seller in the market.
Long-run
average cost
Quantity per period
7
Natural Monopoly
Because such a monopoly emerges from
the nature of costs, it is called a natural
monopoly
A new entrant cannot sell enough
output to experience the economies of
scale enjoyed by an established natural
monopolist  entry into the market is
naturally blocked
8
Control of Essential Resources
Another source of monopoly power is a
firm’s control over some
nonreproducible resource critical to
production
Professional sports teams try to block the
formation of competing leagues by signing
the best athletes to long-term contracts
Alcoa was the sole U.S. maker of aluminum
for a long period of time because it
controlled the supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade
9
Local Monopolies
Local monopolies are more common
that national or international
monopolies
Numerous natural monopolies for
products sold in local markets
However, as a rule long-lasting
monopolies are rare because, as we will
see, a profitable monopoly attracts
competitors
10
Revenue for the Monopolist
Because a monopoly, by definition,
supplies the entire market, the demand
for goods or services produced by a
monopolist is also the market demand
The demand curve for the monopolist’s
output therefore slopes downward,
reflecting the law of demand
As seen in the following discussion this
has important implications for revenues
11
Demand, Average and Marginal Revenue
Suppose De Beers controls the entire
diamond market and suppose they can
sell three diamonds a day at $7,000
each  total revenue of $21,000
Total revenue divided by quantity is the
average revenue per diamond which is
also $7,000
Thus, the monopolist’s price equals the
average revenue per diamond
12
Demand, Average and Marginal Revenue
To sell a fourth diamond, De Beers must
lower the price to $6,750  total
revenue for 4 diamonds is $27,000 and
average revenue is again $6,750
The marginal revenue from selling the
fourth diamond is $6,000  marginal
revenue is less than the price or average
revenue
Recall that these were equal for the
perfectly competitive firm
13
Exhibit 2: Loss or Gain from Selling
One More Unit
$7,000
LOSS
6,750
Price per
Diamond
D = Average
revenue
G
A
I
N
By selling another diamond, De Beers gains
the revenue from that sale, $6,750 from the
4th diamond as shown by the blue-shaded
vertical rectangle marked gain.
However, to sell that 4th unit, De Beers
must sell all four diamonds for $6,750 each
 it must sacrifice $250 on each of the
first three diamonds which could have sold
for $7,000 each.
The loss in revenue from the first three
units, $750, is shown by the red shaded
horizontal rectangle marked Loss.
The net change in total revenue from selling
the 4th diamond equals the gain minus the
loss  $6,750 - $750 = $6,000.
0
3
4
1 - carat diamonds per day
14
Exhibit 3: Revenue Schedule
Revenue for De Beers, a Monopolist
1-Carat
Price
diamonds (average
per day
revenue)
(Q)
(p)
(1)
(2)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
Total
revenue
(TR = Q x p)
(3) =(1) x (2)
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
Marginal
revenue
(MR = TR / Q)
(4)
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
The first two columns contain the
pertinent price and quantity
information.
Total revenue (quantity times price) is
provided in the third column. As De
Beers expands output, total revenue
increases until quantity reaches 15
diamonds when total revenue tops out.
Marginal revenue (the change in total
revenue from selling one more diamond)
appears in the fourth column. Note that
for all units of output except the first,
marginal revenue is less than the price,
and the gap between the two widens as
the price declines because the loss from
selling all diamonds at this lower price
increases.
Exhibit 4 depicts this information
graphically.
15
Exhibit 3: Monopoly Demand and Marginal and
Total Revenue
Notice also that when demand is
elastic, a decrease in price
increases total revenue 
marginal revenue is positive.
Conversely, when demand is
inelastic, a decrease in price
reduces total revenue  marginal
revenue is negative
Dollars per diamond
Note that the marginal revenue
curve is below the demand curve
and total revenue is at a maximum
when marginal revenue equals
zero.
(a) Demand and Marginal Revenue
Elastic
Unit elastic
$3,750
Inelastic
0
D = Average revenue
Marginal revenue
16
32
1-carat diamonds per day
(b) Total Revenue
$60,000
Total dollars
Demand and marginal revenue are
shown in the upper panel and total
revenue is in the lower panel.
Total revenue
0
16
32
16
1-carat diamonds per day
Firm’s Costs and Profit Maximization
The monopolist can choose either the
price or the quantity, but choosing one
determines the other
Because the monopolist can select the
price that maximizes profit, we say the
monopolist is a price maker
More generally, any firm that has some
control over what price to charge is a
price maker
17
Profit Maximization
Exhibits 5 and 6 repeat the revenue
data from the previous exhibits and also
include short-run cost data
The cost data are similar to those
already introduced in the preceding
chapters
The key issue is which price-quantity
combination should De Beers select to
maximize profits
18
Exhibit 5: Short-Run Revenues and Costs for the
Monopolist
Short-run Costs and Revenue for a Monopolist
Diamonds
per day
(Q)
(1)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Price
(average
Total
revenue) revenue
(p)
(TR = Q x p)
(2)
(3) =(1) x (2)
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
Marginal
Revenue
(MR =
TR / Q)
(4)
Total
Cost
(TC)
(5)
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
$15,000
19,750
23,500
26,500
29,000
31,000
32,500
33,750
35,250
37,250
40,000
43,250
48,000
54,500
64,000
77,500
96,000
121,000
Marginal
Average
Total
Cost
Total Cost Profit or
( MC =
(ACT =
Loss =
TC / Q)
TC/Q)
TR - TC
(6)
(7)
(8)
4,750
3,750
3,000
2,500
2,000
1,500
1,250
1,500
2,000
2,750
3,250
4,750
6,500
9,500
13,500
18,500
25,000
$19,750
11,750
8,830
7,750
6,200
5,420
4,820
4,410
4,140
4,000
3,930
4,000
4,190
4,570
5,170
6,000
7,120
-$15,000
-12,250
9,000
-5,500
-2,000
1,500
5,000
8,250
10,750
12,250
12,500
11,750
9,000
4,000
-4,500
-7,500
-36,000
-61,500
The profitmaximizing
monopolist
employs the same
decision rule as the
competitive firm 
the monopolist
produces that
quantity where
total revenue
exceeds total cost
by the greatest
amount  $12,500
per day when
output is 10 units
per day. Total
revenue is $52,500
and total cost is
$40,000
19
Exhibit 5: Short-Run Revenues and Costs for the
Monopolist
Short-run Costs and Revenue for a Monopolist
Diamonds
per day
(Q)
(1)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Price
(average
Total
revenue) revenue
(p)
(TR = Q x p)
(2)
(3) =(1) x (2)
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
Marginal
Revenue
(MR =
TR / Q)
(4)
Total
Cost
(TC)
(5)
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
$15,000
19,750
23,500
26,500
29,000
31,000
32,500
33,750
35,250
37,250
40,000
43,250
48,000
54,500
64,000
77,500
96,000
121,000
Marginal
Average
Total
Cost
Total Cost Profit or
( MC =
(ACT =
Loss =
TC / Q)
TC/Q)
TR - TC
(6)
(7)
(8)
4,750
3,750
3,000
2,500
2,000
1,500
1,250
1,500
2,000
2,750
3,250
4,750
6,500
9,500
13,500
18,500
25,000
$19,750
11,750
8,830
7,750
6,200
5,420
4,820
4,410
4,140
4,000
3,930
4,000
4,190
4,570
5,170
6,000
7,120
-$15,000
-12,250
9,000
-5,500
-2,000
1,500
5,000
8,250
10,750
12,250
12,500
11,750
9,000
4,000
-4,500
-7,500
-36,000
-61,500
Applying the
marginal rule
would imply that
the monopolist
increases output as
long as selling
additional
diamonds adds
more to total
revenue than to
total cost. Again
profit is maximized
at $12,500 when
output is 10
diamonds per day,
per unit costs are
$4,000 and the
price is $5,250.
Exhibit 6 provides
a graphical
illustration of this
process. 20
Exhibit 6: Monopoly Costs and Revenue
The intersection of the two marginal curves
at point e in panel (a) indicates that profit
is maximized when 10 diamonds are sold.
At this rate of output, we move up to the
demand curve to find the profitmaximizing price of $5,250. The average
total cost of $4,000 is identified by point b
 the average profit per diamond equals
the price of $5,250 minus the average total
cost of $4,000  $1,250  economic profit
is the equal to $1,250 * 10 units sold 
$12,500 as shown by the blue shaded area.
In panel (b), the firm’s profit or loss is
measured by the vertical distance
between the total revenue and total cost
curves  again profit is maximized
where De Beers produces 10 diamonds
per day
(a) Per-Unit Cost and Revenue
Marginal cost
Average total cost
a
$5,250
4,000
Profit
b
e
MR
0
10
16
D = Average revenue
32
Diamonds per day
(b) Total Cost and Revenue
Maximum
profit
Total cost
$52,500
40,000
Total revenue
15,000
0
10
16
32 Diamonds per day
21
Short-Run Losses and the Shutdown Decision
A monopolist is not assured of profit
The demand for the monopolists good or
service may not be great enough to
generate economic profit in either the short
run or the long run
In the short run, the loss-minimizing
monopolist must decide whether to
produce or to shut down
If the price covers average variable cost, the
firm will produce
If not, the firm will shut down, at least in
the short run
22
Exhibit 7: The Monopolist Minimizes Losses in the
Short Run
Recall that average variable cost and
average fixed cost sum to average
total cost .
Loss minimization occurs at
point e, where the marginal
revenue curve intersects the
marginal cost curve  Q and p
are the loss minimization
quantity and price, respectively.
Marginal cost
a
Loss
p
Average total cost
b
Average variable cost
c
Notice that at point b, the firm is
covering its average variable cost
 it is making some contribution
to its fixed costs. However, it is
not covering all of its costs. The
average loss per unit, measured by
ab, is identified by the yellow
0
shaded area.
e
Demand = Average revenue
Marginal revenue
Q
Quantity per period
23
Monopolist’s Supply Curve
The intersection of a monopolist’s
marginal revenue and marginal cost
curve identifies the profit maximizing
quantity, but the price is found on the
demand curve
Thus, there is no curve that shows both
price and quantity supplied  there is
no monopolist supply curve
24
Long-Run Profit Maximization
For a monopoly, the distinction between
the long and short run is not as
important
If a monopoly is insulated from
competition by high barriers that block
new entry, economic profit can persist
in the long run
However, short-run profit is no
guarantee of long-run profit
25
Long-Run Profit Maximization
A monopolist that earns economic profit
in the short-run may find that profit can
be increased in the long run by
adjusting the scale of the firm
Conversely, a monopoly that suffers a
loss in the short run may be able to
eliminate that loss in the long run by
adjusting to a more efficient size
26
Price and Output Comparison
Purpose here is to compare monopoly
using the benchmark established in our
discussion of perfect competition
When there is only one firm in the
industry, the industry demand curve
becomes the monopolist’s demand
curve  the price the monopolist
charges determines how much gets sold
Exhibit 8 provides our comparison
27
Exhibit 8: Perfect Competition and Monopoly
quantity Qc.
The monopolist maximizes
profit by equating marginal
revenue with marginal cost
 point b  equilibrium
price pm and output Qm.
a
Dollars per unit
The horizontal supply curve is
based on the assumption of a
constant-cost industry.
Equilibrium in perfect
competition is at point c, where
market demand and supply
intersect to yield price pc and
p'm
pc
m
b
c
Sc = MC = ATC
D = AR
MRm
Q'm
Q'c Quantity per period
The price shows the consumers’ marginal benefit at that output rate, point m, which
exceeds the marginal cost, point b. Because the marginal benefit consumers attach to
additional units exceeds the marginal cost of producing those additional units, society
would be better off if output were expanded beyond Qm  the monopolist restricts
output below the level that maximizes social welfare  consumer surplus is shown by
the yellow triangle ampm
28
0
Exhibit 8: Perfect Competition and Monopoly
The monopolist earns economic
profit equal to the shaded
rectangle  a transfer from
consumer surplus to monopoly
profit  this amount is not lost to
society and so is not considered a
welfare loss from monopoly.
Dollars per unit
a
Consumer surplus under perfect
competition is the large triangle acpc
while under monopoly it shrinks to
the smaller triangle ampm
p'm
pc
m
b
c
Sc = MC = ATC
D = AR
MRm
Q'm
Q'c Quantity per period
Notice that consumer surplus has been reduced by more than the profit triangle.
Consumers have also lost the triangle mcb which was part of the consumer surplus
under perfect competition  the deadweight loss of monopoly because it is a loss to
consumers but a gain to nobody. This loss results from the allocative inefficiency
arising from the higher price and reduced output.
0
29
Why the Welfare Loss Might Be Lower
If economies of scale are extensive
enough, a monopolist may be able to
produce output at a lower cost per unit
than could competitive firms
If this is true, the price or at least the
cost of production could be lower under
monopoly than under competition
30
Why the Welfare Loss Might Be Lower
The welfare loss shown in Exhibit 8 may
also overstate the true cost of monopoly
because monopolists may, in response
to public scrutiny and political pressure,
keep prices below what the market
could bear
Finally, a monopolist may keep the price
below the profit maximizing level to
avoid attracting new competitors
31
Why the Welfare Loss Might Be Higher
Another line of thought suggests that
the welfare loss of monopoly may, in
fact, be greater than shown in our
example
If resources must be devoted to
securing and maintaining a monopoly
position, monopolies may involve more
of a welfare loss that simple models
suggest
32
Why the Welfare Loss Might Be Higher
Consider, for example, radio and TV
broadcasting rights confer on the
recipient the exclusive right to use a
particular band of the scarce broadcast
spectrum
In the past, these rights have been
given away by government agencies to
the applicants deemed most deserving
33
Why the Welfare Loss Might Be Higher
Because these rights are so valuable,
numerous applicants spend millions on
lawyers’ fees, lobbying expenses, and
other costs associated with making
themselves appear the most deserving
The efforts devoted to securing and
maintaining a monopoly position are
largely a social waste because they use
up scarce resources but add not unit to
output
34
Why the Welfare Loss Might Be Higher
Activities undertaken by individuals or
firms to influence public policy in a way
that will directly or indirectly
redistribute income to them are referred
to as rent seeking
Second, monopolists insulated from the
rigors of competition in the
marketplace, may also become efficient
35
Why the Welfare Loss Might Be Higher
Finally, monopolists have also been
criticized for being slow to adopt the
latest production techniques, to develop
new products, and generally lacking
innovativeness
36
Price Discrimination
A monopolist can sometimes increase
economic profit by charging higher
prices to customers who value the
product more
The practice of charging difference
prices to different customers when the
price differences are not justified by
differences in cost is called price
discrimination
37
Conditions for Price Discrimination
Conditions
The demand curve for the firm’s product
must slope downward  the firm has some
market power and control over price
There are at least two groups of consumers
for the product, each with a different price
elasticity of demand
The producer must be able, at little cost, to
charge each group a different price for
essentially the same product
The producer must be able to prevent those
who pay the lower price from reselling the
product to those who pay the higher price
38
Model of Price Discrimination
Exhibit 9 shows the effects of price
discrimination
Consumers are divided into two groups
with different demands
39
Exhibit 9: Price Discrimination
(b)
Dollars per unit
Dollars per unit
(a)
$3.00
LRAC, MC
1.00
MR
0
400
$1.50
1.00
D
Quantity per period
0
LRAC, MC
D'
MR'
500 Quantity per period
At a given price, the price elasticity of demand in panel b(elastic) is greater than in panel a (inelastic).
For simplicity, assume the firm produces at a constant long-run average and marginal cost of $1. This
firm maximizes profits by finding the price in each market that equates marginal revenue with
marginal cost  consumers with the lower price elasticity pay $3 and those with the higher price
elasticity pay $1.50 in markets with elastic demand the price will be lower than in markets where
demand is inelastic.
40
Examples of Price Discrimination
Because businesspeople face
unpredictable yet urgent demands for
travel and communication, and because
employers pay such expenses,
businesspeople are less sensitive to
price than householders
Telephone companies are able to sort
out their customers by charging
different rates based on the time of day
41
Perfect Price Discrimination
If a monopolist could charge a different
price for each unit sold, the firm’s
marginal revenue curve from selling one
more unit would equal the price of that
unit  the demand curve would become
the marginal revenue curve
A perfectly discriminating monopolist
charges a different price for each unit of
the good
Exhibit 10 provides our example
42
Exhibit10: Perfect Price Discrimination
A perfectly discriminating
monopolist would maximize
profits at point e where
marginal revenue equals
marginal cost  price set at
point e
D o lla r s p e r u n it
a
Profit
e
c
Long-run
average cost
= marginal cost
D = Marginal
revenue
0
Q
43
Quantity per period
Perfect Price Discrimination
Perfect price discrimination gets high
marks based on allocative efficiency
Because such a monopolist does not
have to lower price to all customers
when output expands, there is no
reason to restrict output
In fact, because this is a constant-cost
industry, Q is the same quantity
produced in perfect competition
44
Perfect Price Discrimination
As in perfect competition, the marginal
benefit of the final unit of output
produced just equals its marginal cost
And although perfect price
discrimination yields no consumer
surplus, the total benefits consumers
derive just equal the total amount they
pay for the good
Since the monopolist does not restrict
output, there is no deadweight loss
45