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Seventh Edition
CHAPTER 10
Monopoly
© 2012 McGraw-Hill Ryerson Limited
10-1
CHAPTER 10
Monopoly
Learning Objectives:
LO1: Define a monopoly, explain how they come into existence
and why they must reduce their prices to sell more
LO2: Understand how the profit-maximizing output and price are
determined for a monopolist
LO3: Explain five grounds on which monopolies can be criticized
LO4: Explain the significant difference between monopoly and
perfect competition
© 2012 McGraw-Hill Ryerson Limited
10-2
CHAPTER 10
Monopoly
Learning Objectives:
LO5: Explain three grounds on which monopolies can be
defended
LO6: Discuss ways that governments can change the behaviour of
monopolies
© 2012 McGraw-Hill Ryerson Limited
10-3
LO1
Monopoly
Monopoly
• a market in which a single firm (the monopolist) is
the sole producer
• protected from new competitors by barriers to
entry
Barriers to Entry
• obstacles that make it difficult for new participants
to enter a market
© 2012 McGraw-Hill Ryerson Limited
10-4
LO1
Barriers to Entry
1. technical barriers such as sole ownership of a
resource
2. legal barriers such as public franchise, licences,
patents, and copyrights
3. economic barriers caused by economies of scale
© 2012 McGraw-Hill Ryerson Limited
10-5
LO1
Self-Test
Entry into the following industries is very difficult. What
type of barrier to entry is involved?
a)
Computer operating systems
b)
Commercial aircraft manufacturing
c)
West coast wild salmon fishing
© 2012 McGraw-Hill Ryerson Limited
10-6
LO1
Self-Test
Entry into the following industries is very difficult. What
type of barrier to entry is involved?
a)
b)
c)
Computer operating systems
technical barrier (sole ownership of a resource)
Commercial aircraft manufacturing
economic barrier (economies of scale)
West coast wild salmon fishing
legal barrier (licence fee required)
© 2012 McGraw-Hill Ryerson Limited
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LO1
Monopoly
• able to set price rather than having to accept the
market-determined price
• can set either price or quantity sold, but not both
• since the monopolist is the industry, it faces the
market demand for the product
• demand is a downward-sloping curve
• must decrease the price in order to sell more
© 2012 McGraw-Hill Ryerson Limited
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LO1
© 2012 McGraw-Hill Ryerson Limited
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LO1
• In order to increase sales, a monopolist is forced
to reduce price not just on the last units sold, but
on the whole of its output
© 2012 McGraw-Hill Ryerson Limited
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LO1
© 2012 McGraw-Hill Ryerson Limited
LO1
Monopoly
• Total revenue is maximized when the marginal
revenue is zero
• a monopolist will produce only where the demand
is elastic
© 2012 McGraw-Hill Ryerson Limited
10-12
LO1
Self-Test
Suppose a monopolist was charging a price of $50 for its
product and was selling 15 units. It has now lowered its
price to $48 and is selling 16 units. What is the marginal
revenue? What is the price elasticity of demand over this
price range?
© 2012 McGraw-Hill Ryerson Limited
10-13
LO1
Self-Test
Suppose a monopolist was charging a price of $50 for its
product and was selling 15 units. It has now lowered its
price to $48 and is selling 16 units. What is the marginal
revenue? What is the price elasticity of demand over this
price range?
Marginal revenue: $18.
Total revenue at a price of $50 is $750 (15 x $50).
Total revenue at a price of $48 is $768 (16 x $48)
The extra unit produces extra total revenue of
$18 ($768 – $750).
Elasticity: e = % D Q=
%DP
1/15.5 x 100 = 6.5% = 1.59
2/49 x 100
4.1
© 2012 McGraw-Hill Ryerson Limited
10-14
LO2
Maximizing Profit
Total Revenue Approach
• maximum profit is where the difference between total
revenue (TR) and total cost (TC) is greatest
• the maximum profit point is shown on the total profit
curve, where it occurs at the highest point.
• the maximum profit point also occurs where the slope
of TR (same as MR) equals the slope of TC (same as
MC)
• the break-even points occur where total revenue and
cost are the same
© 2012 McGraw-Hill Ryerson Limited
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LO2
© 2012 McGraw-Hill Ryerson Limited
10-16
LO2
© 2012 McGraw-Hill Ryerson Limited
10-17
LO2
Maximizing Profit
Marginal Revenue Approach
• profits are maximized (or losses minimized) at an
output where MR  MC
• same profit maximization rule as perfectly
competitive firms
© 2012 McGraw-Hill Ryerson Limited
10-18
LO2
© 2012 McGraw-Hill Ryerson Limited
10-19
LO2
© 2012 McGraw-Hill Ryerson Limited
10-20
LO2
Minimizing Loss
• monopolists are not always profitable
• depends on costs – if AC curve is higher than the
demand curve at all output levels, will have a loss
• Can minimize loss using the profit maximization
rule
© 2012 McGraw-Hill Ryerson Limited
10-21
LO2
© 2012 McGraw-Hill Ryerson Limited
10-22
LO2
Self-Test
Complete the following table and indicate the break-even
outputs and the profit maximizing output:
Quantity
20
21
22
23
24
25
26
27
28
29
Price
(=AR)
$100
98
96
94
92
90
88
86
84
82
Total Revenue
(TR)
Total Costs
(TC)
$2060
2080
2112
2142
2177
2216
2257
2322
2417
2530
© 2012 McGraw-Hill Ryerson Limited
Total Profit
(Tπ)
10-23
LO2
Self-Test
Complete the following table and indicate the break-even
outputs and the profit maximizing output:
Quantity
20
21
22
23
24
25
26
27
28
29
Price
(=AR)
$100
98
96
94
92
90
88
86
84
82
Total Revenue
(TR)
2 000
2 058
2 112
2 162
2 208
2 250
2 288
2 322
2 352
2 378
Total Costs
(TC)
$2060
2080
2112
2142
2177
2216
2257
2322
2417
2530
Total Profit
(Tπ)
-60
-22
0
20
31
34
31
0
-65
-152
Break-even (TR=TC) occur at 22 and 27.
Profit-maximizing output occurs at an output of 25
© 2012 McGraw-Hill Ryerson Limited
10-24
LO3
Criticisms of Monopolies
1. able to make economic profits indefinitely
2. are both productively and allocatively inefficient
3. produce less and charge a higher price than a
competitive industry
4. creating a more unequal distribution of income
and wealth within society
5. using their power to practice price
discrimination
© 2012 McGraw-Hill Ryerson Limited
10-25
LO3
Self-Test
The following table shows the demand for haircuts:
Price
$20
19
18
17
16
15
Quantity
1
2
3
4
5
6
a) If this was a single-price barber, what would be the total
revenue for six haircuts?
b) If this barber was able to practice perfect price
discrimination by charging each customer the maximum they
would pay, what would be the total revenue for six haircuts?
© 2012 McGraw-Hill Ryerson Limited
10-26
LO3
Self-Test
The following table shows the demand for haircuts:
Price
$20
19
18
17
16
15
Quantity
1
2
3
4
5
6
a) If this was a single-price barber, what would be the total
revenue for six haircuts? TR $90 ($15 x 6)
b) If this barber was able to practice perfect price
discrimination by charging each customer the maximum they
would pay, what would be the total revenue for six haircuts?
TR $105 ($20 + $19 + $18 + $17 + $16 + $15)
© 2012 McGraw-Hill Ryerson Limited
10-27
LO4
Perfect Competition v Monopoly
•
•
•
Monopolies charge higher prices than perfectly
competitive firms.
Monopolies produce lower outputs than perfectly
competitive firms and these outputs are below
economic capacity.
Monopolies, unlike perfectly competitive firms,
may make economic profits in the short run and
in the long run.
© 2012 McGraw-Hill Ryerson Limited
10-28
LO4
© 2012 McGraw-Hill Ryerson Limited
10-29
LO4
© 2012 McGraw-Hill Ryerson Limited
10-30
LO4
Self-Test
a) If the graph opposite
depicts a competitive market,
what is the equilibrium price
and quantity?
b) If the graph opposite
depicts a monopolist, what is
the equilibrium price and
quantity?
© 2012 McGraw-Hill Ryerson Limited
10-31
LO4
Self-Test
a) If the graph opposite
depicts a competitive market,
what is the equilibrium price
and quantity?
Price: $30; Quantity: 300
b) If the graph opposite
depicts a monopolist, what is
the equilibrium price and
quantity?
Price: $40; Quantity: 200
© 2012 McGraw-Hill Ryerson Limited
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LO5
Defence of Monopolies
1. They capture large economies of scale in
production.
2. They engage in extensive research and
development into new techniques of production
and new products.
3. They attract high-quality staff by offering
relatively high wages and good working
conditions.
© 2012 McGraw-Hill Ryerson Limited
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LO5
Natural Monopoly
• single producer who is able to produce at a lower
cost than competing firms could
• usually in a market with large economies of scale
© 2012 McGraw-Hill Ryerson Limited
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LO4
© 2012 McGraw-Hill Ryerson Limited
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LO5
Public Utilities
• goods or services regarded as essential and
therefore usually provided by government
• competition may well be costly and wasteful
© 2012 McGraw-Hill Ryerson Limited
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LO5
Self-Test
In Figure 10.9 opposite,
suppose there are two
competing rail companies,
each with 50 % of the
market. What would be the
profit or loss for each if
they both charged $1.50?
© 2012 McGraw-Hill Ryerson Limited
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LO5
Self-Test
In Figure 10.9 opposite,
suppose there are two
competing rail companies,
each with 50 % of the
market. What would be the
profit or loss for each if
they both charged $1.50?
At $1.50 the quantity demanded is 100 000, or 50 000 each. The
average cost of servicing 50 000 riders is $2.50. This means that
each company would lose $1.00 for each fare, for a total loss of
$50 000 per day.
© 2012 McGraw-Hill Ryerson Limited
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LO6
Government Control
Some options:
• Taxing the monopolist
• Government price setting
• Nationalization
© 2012 McGraw-Hill Ryerson Limited
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LO6
Taxing the Monopolist
Lump sum Profits Tax:
•
•
•
•
affects fixed cost but not variable cost
increases average cost but marginal cost is
unaffected
output and price levels are unaffected
lower profit (due to higher costs)
© 2012 McGraw-Hill Ryerson Limited
10-40
LO6
© 2012 McGraw-Hill Ryerson Limited
10-41
LO6
Taxing the Monopolist
Monopoly Sales Tax:
•
•
•
•
•
•
tax on each unit sold
increases marginal cost
profit maximizing point shifts
part of the tax is shifted to consumer in the form
of higher price
lower quantity is produced
monopolist’s profit is reduced
© 2012 McGraw-Hill Ryerson Limited
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LO6
© 2012 McGraw-Hill Ryerson Limited
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LO6
Government Price Setting
Socially Optimum Price
•
the price that produces the best allocation of
products (and therefore resources) from society’s
point of view, that is, P  MC
Fair-Return Price
•
a price that guarantees that the firm will earn
normal profits only, that is, where P  AC
© 2012 McGraw-Hill Ryerson Limited
10-44
LO6
© 2012 McGraw-Hill Ryerson Limited
10-45
LO6
Self-Test
On the graph, indicate:
a) Price (PUM) and quantity
(QUM) if monopolist is
unregulated
b) Price (PSO) and quantity
(QSO) if monopolist charges
the socially optimum price
c) Price (PFR) and quantity
(QFR) if monopolist charges
fair-return price
© 2012 McGraw-Hill Ryerson Limited
10-46
LO6
Self-Test
On the graph, indicate:
a) Price (PUM) and quantity
(QUM) if monopolist is
unregulated
b) Price (PSO) and quantity
(QSO) if monopolist charges
the socially optimum price
c) Price (PFR) and quantity
(QFR) if monopolist charges
fair-return price
© 2012 McGraw-Hill Ryerson Limited
10-47
Chapter 10 Summary
•
•
•
•
•
Types of barriers to entry
Profit maximization for a monopolist
Criticisms of monopolies
Defences of monopolies
Ways that governments can control monopolies
© 2012 McGraw-Hill Ryerson Limited
10-48