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15
Monopoly
PRINCIPLES OF
ECONOMICS
FOURTH EDITION
N. G R E G O R Y M A N K I W
PowerPoint® Slides
by Ron Cronovich
© 2007 Thomson South-Western, all rights reserved
In this chapter, look for the answers to
these questions:






Why do monopolies arise?
Why is MR < P for a monopolist?
How do monopolies choose their P and Q?
How do monopolies affect society’s well-being?
What can the government do about monopolies?
What is price discrimination?
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Introduction
 A monopoly is a firm that is the sole seller of a
product without close substitutes.
 In this chapter, we study monopoly and contrast
it with perfect competition.
 The key difference:
A monopoly firm has market power, the ability
to influence the market price of the product it
sells. A competitive firm has no market power.
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2
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3
Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The government gives a single firm the
exclusive right to produce the good.
E.g., patents, copyright laws, branding
4
Why Monopolies Arise
3. Natural monopoly: a single firm can produce
the entire market Q at lower ATC than could
several firms. (Economies of scale)
Example: 1000 homes
need electricity.
ATC is lower if
one firm services
all 1000 homes
than if two firms
each service
500 homes.
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MONOPOLY
Cost
Electricity
Economies of
scale due to
huge FC
$80
$50
ATC
500
1000
Q
5
Monopoly vs. Competition: Demand Curves
In a competitive market,
the market demand curve
slopes downward.
but the demand curve
for any individual firm’s
product is horizontal
at the market price.
The firm can increase Q
without lowering P,
so MR = P for the
competitive firm.
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P
A competitive firm’s
demand curve
D
Q
6
Monopoly vs. Competition: Demand Curves
A monopolist is the only
seller, so it faces the
market demand curve.
To sell a larger Q,
the firm must reduce P.
P
A monopolist’s
demand curve
Thus, MR ≠ P.
D
Q
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1:
A monopoly’s revenue
ACTIVE LEARNING
Moonbucks is
the only seller of
cappuccinos in town.
The table shows the
market demand for
cappuccinos.
Fill in the missing
spaces of the table.
What is the relation
between P and AR?
Between P and MR?
Q
P
0
$4.50
1
4.00
2
3.50
3
3.00
4
2.50
5
2.00
6
1.50
TR
AR
MR
n.a.
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ACTIVE LEARNING
Answers
Here, P = AR,
same as for a
competitive firm.
Here, MR < P,
whereas MR = P
for a competitive
firm.
Q
1:
P
TR
AR
0
$4.50
$0
n.a.
1
4.00
4
$4.00
2
3.50
7
3.50
3
3.00
9
3.00
4
2.50
10
2.50
5
2.00
10
2.00
6
1.50
9
1.50
MR
$4
3
2
1
0
–1
9
Moonbuck’s D and MR Curves
P, MR
$5
4
3
2
1
0
-1
-2
-3
0
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Demand curve (P)
MR
1
MONOPOLY
2
3
4
5
6
7
Q
10
When MR is equal to Zero, total revenue is
maximize and you are at unit elasticity.
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Marginal Revenue & Elasticity
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MR and elasticity
 When MR is (+) positive then the Demand
curve is Elastic
 When MR is (-) negative then the
Demand curve is Inelastic
 When MR is (0) zero then the Demand
curve is Unit Elastic. That’s where total
revenue is maximize.
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Understanding the Monopolist’s MR
 Increasing Q has two effects on revenue:
• The output effect:
•
More output is sold, which raises revenue
The price effect:
The price falls, which lowers revenue
 To sell a larger Q, the monopolist must reduce
the price on all the units it sells.
 Hence, MR < P
 MR could even be negative if the price effect
exceeds the output effect (Inelastic)
 (e.g., when Moonbucks increases Q from 5 to 6).
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Why is a Monopolist MR curve less than
the Demand curve?
 They face a downward sloping demand curve.
 In order to increase output they must lower the
price for all.
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Profit-Maximization
 Like a competitive firm, a monopolist maximizes
profit by producing the quantity where MR = MC.
 Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to
pay for that quantity.
 It finds this price from the D curve.
 Monopolist have the Market Power to set the
price.
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Market Power
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market power
 In economics, market power is the ability of a
firm to alter the market price of a good or
service. A firm with market power can raise price
without losing all customers to competitors.
 When a firm has market power it faces a
downward-sloping demand curve.
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Profit-Maximization
1. The profitmaximizing Q
is where
MR = MC.
Costs and
Revenue
MC
P
2. Find P from
the demand
curve at this Q.
D
MR
Q
Quantity
Profit-maximizing output
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Monopolist - Loss
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The Monopolist’s Profit
Costs and
Revenue
As with a
competitive firm,
the monopolist’s
profit equals
MC
P
ATC
ATC
D
(P – ATC) x Q
MR
Q
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Quantity
21
A Monopoly Does Not Have an S Curve
A competitive firm
 takes P as given
 has a supply curve that shows how its Q depends
on P
A monopoly firm
 is a “price-maker,” not a “price-taker”
 Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.
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Case Study: Monopoly vs. Generic Drugs
Patents on new drugs
Price
give a temporary
monopoly to the seller.
The market for
a typical drug
PM
When the
patent expires,
PC = MC
the market
becomes competitive,
generics appear.
D
MR
QM
Quantity
QC
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Profit
Profit
Maximization
Maximization
 Comparing Monopoly and Competition
• For a competitive firm, price equals marginal
cost.
•
P = MR = MC
For a monopoly firm, price exceeds marginal
cost.
P > MR = MC
Market Power = (P- MC)/ P
A positive number relates to the degree of market
power.
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Economic Profit
A Monopoly’s Profit
 Profit equals total revenue minus total costs.
• Profit = TR - TC
• Profit = (TR/Q - TC/Q)  Q
• Profit = (P - ATC)  Q
• Economic profit ~ (P > ATC)
• Supernormal profit
• Producer Surplus
• Monopolist Profit
• Abnormal Profit
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Normal Profit
 The minimum the amount a firm must receive to
carry on production (P = ATC)
 Zero Economic Profit is still a positive profit for
the firm at P =ATC.
 Break-even
 Fair Return Price
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Monopoly vs ATC
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Allocative efficiency - refers to the efficiency with
which markets are allocating resources. A market
will be allocatively efficient if it is producing the
right goods for the right people at the right price.
An allocatively efficient market is therefore one
which has no imperfections. This will be true when
marginal cost is equal to average revenue in the
market.
It occurs where a firm produces at MC = AR
(marginal cost pricing).
P = MC
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Productive efficiency
Productive efficiency also involves producing at the lowest point of the
short run average cost curve (where MC cuts the bottom of the SRAC
curve.)
Usually, productive efficiency refers to the short run (i.e. producing at
lowest point of SRAC curve) But if can also refer to producing at the lowest
point on the Long Run Average Cost curve LRAC i.e. benefiting from
economies of scale
Related to productive efficiency is the concept of Technical efficiency.
Technical efficiency specifically refers to the optimal combination of inputs,
i.e. using minimum combination of labor and capital to produce a certain
quantity of goods.
MC = ATC
29
The Welfare Cost of Monopoly
 Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
 In the monopoly eq’m, P > MR = MC
• The value to buyers of an additional unit (P)
•
•
exceeds the cost of the resources needed to
produce that unit (MC).
The monopoly Q is too low –
could increase total surplus with a larger Q.
Thus, monopoly results in a deadweight loss.
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The Welfare Cost of Monopoly
Competitive eq’m:
quantity = QE
P = MC
total surplus is
maximized
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
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Price
Deadweight
MC
loss
P
P = MC
MC
D
MR
Q M QE
Quantity
31
Economic Profit & Deadweight loss
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Dead weight Loss
 Because a monopoly sets its price above
marginal cost, it places a wedge between the
consumer’s willingness to pay and the
producer’s cost.
• This wedge causes the quantity sold to fall short
of the social optimum. (P=MC)
• This wedge is Dead Weight Loss!
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Monopoly Welfare
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Perfect Competition vs Monopoly Welfare
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Monopoly Vs Perfect Competition
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Monopoly Vs Perfect Competition
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Public Policy Toward Monopolies
 Increasing competition with antitrust laws
• Examples:
•
Sherman Antitrust Act (1890),
Clayton Act (1914)
Antitrust laws ban certain anticompetitive
practices, allow govt to break up monopolies.
 Regulation
• Govt agencies set the monopolist’s price
• For natural monopolies, MC < ATC at all Q,
•
so marginal cost pricing would result in losses.
If so, regulators might subsidize the monopolist
or set P = ATC for zero economic profit.
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Public Policy Toward Monopolies
 Public ownership
• Example: U.S. Postal Service
• Problem: Public ownership is usually less
efficient since no profit motive to minimize costs
 Doing nothing
• The foregoing policies all have drawbacks,
so the best policy may be no policy.
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Price Discrimination
 Discrimination is the practice of treating people
differently based on some characteristic, such as
race or gender.
 Price discrimination is the business practice of
selling the same good at different prices to
different buyers.
 The characteristic used in price discrimination
is willingness to pay (WTP):
• A firm can increase profit by charging a higher
price to buyers with higher WTP.
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Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
charges the same
price (PM) to all
buyers.
A deadweight loss
results.
Price
Monopoly
profit
Consumer
surplus
Deadweight
loss
PM
MC
D
MR
QM
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Quantity
41
Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
produces the
competitive quantity,
but charges each
buyer his or her WTP.
This is called perfect
price discrimination.
Price
Monopoly
profit
MC
D
The monopolist
captures all CS
as profit.
MR
But there’s no DWL.
Q
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Quantity
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Price Discrimination in the Real World
 In the real world, perfect price discrimination is
not possible:
• no firm knows every buyer’s WTP
• buyers do not announce it to sellers
 So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.
 Elasticity?
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Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday night.
Airline prices
Discounts for Saturday-night stayovers help
distinguish business travelers, who usually have
higher WTP, from more price-sensitive leisure
travelers.
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Examples of Price Discrimination
Discount coupons
People who have time to clip and organize
coupons are more likely to have lower income
and lower WTP than others.
Need-based financial aid
Low income families have lower WTP for
their children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.
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Examples of Price Discrimination
Quantity discounts
A buyer’s WTP often declines with additional
units, so firms charge less per unit for large
quantities than small ones.
Example: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s
twice as big.
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Natural monopoly
 An industry is said to be a natural monopoly if
one firm can produce a desired output at a lower
social cost than two or more firms—that is, there
are economies of scale in social costs.
 Multiple firms providing a good or service is less
efficient (more costly to a nation or economy)
than would be the case if a single firm provided
a good or service.
 Examples of natural monopolies include
railways, telecommunications, water services,
electricity, mail delivery
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Natural monopoly
 Monopoly price ~ P > (MC = MR)
 Fair Return Price ~ P = ATC
 Socially Optimum Price ~ P = MC
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Natural monopoly
If the government regulates a Natural
monopoly and sets the price at the
allocatively efficient level of output
(P =MC) the firm will incur a loss. In order
for the firm to continue to produce at this
level, the government would have to
subsidize the firm for the difference
between ATC and (P=MC) at that output.
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Figure 9 Marginal-Cost Pricing for a Natural Monopoly
Price
Average total
cost
Loss
Regulated
price
Average total cost
Marginal cost
Demand
Quantity
0
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MONOPOLY
Copyright © 2004 South-Western
Natural monopoly & DWL
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CONCLUSION
 Profit Maximizing Price and Output?
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CONCLUSION
 Social Optimal Level of Price & Output?
 Allocative efficient level of Price & Output?
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CONCLUSION
 Zero Economic Profit, Fair Return, or Normal
Profit, Zero opportunity cost; Price & Output?
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CONCLUSION
 Revenue – Maximizing Price & Output?
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CONCLUSION
 The area of Consumer Surplus, Producer
Surplus for a Monopoly or a Competitive firm?
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CONCLUSION
 The area of Deadweight Loss?
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Lump Sum Tax / Subsidy
 Increase Lump sum tax ~ AFC, ATC shift up
 Decrease in Lump sum tax ~ AFC, ATC shift
down
 Increase Lump sum subsidy ~ AFC, ATC shift
down
 Decrease in Lump sum subsidy ~ AFC, ATC
shift up
 Lump sum tax / subsidy do NOT change AVC,
MC
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Per Unit Tax / Subsidy
 Increase Per Unit tax ~ AVC, ATC, MC shift up
 Decrease in Per Unit tax ~ AVC, ATC, MC shift
down
 Increase Per Unit subsidy ~ AVC, ATC, MC shift
down
 Decrease in Per Unit subsidy ~ AVC, ATC, MC
shift up
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CONCLUSION: The Prevalence of Monopoly
 In the real world, pure monopoly is rare.
 Yet, many firms have market power, due to
• selling a unique variety of a product
• having a large market share and few significant
competitors
 In many such cases, most of the results from
this chapter apply, including
• markup of price over marginal cost
• deadweight loss
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CHAPTER SUMMARY
 A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry,
including: government-granted monopolies, the
control of a key resource, or economies of scale
over the entire range of output.
 A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it must
reduce price to sell a larger quantity, which causes
marginal revenue to fall below price.
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CHAPTER SUMMARY
 Monopoly firms maximize profits by producing the
quantity where marginal revenue equals marginal
cost. But since marginal revenue is less than
price, the monopoly price will be greater than
marginal cost, leading to a deadweight loss.
 Policymakers may respond by regulating
monopolies, using antitrust laws to promote
competition, or by taking over the monopoly and
running it. Due to problems with each of these
options, the best option may be to take no action.
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CHAPTER SUMMARY
 Monopoly firms (and others with market power) try
to raise their profits by charging higher prices to
consumers with higher willingness to pay. This
practice is called price discrimination.
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