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Monopoly
© 2003 South-Western/Thomson Learning
What Is a Monopoly?
A monopoly firm is the only seller
of a good or service with no close
substitutes.
The market in which the
monopoly firm operates is called a
monopoly market.
Sources of Monopoly
•Economies of Scale
•Control of Scarce Inputs
•Government-Enforced Barriers
Economies of Scale
Natural Monopoly
A market in which, due to
economies of scale, one firm can
operate at lower average cost than
can two or more firms
Government-Enforced Barriers
Protection of intellectual property(IP):
•Government allows creators of IP to enjoy
a monopoly and earn economic profit, but
only for a limited time
•Once the time is up, other sellers are
allowed to enter the market, and
competition is expected to bring down
prices
Government-Enforced Barriers
Patent
A temporary grant of
monopoly rights over a new
product or scientific discovery.
Government-Enforced Barriers
Copyright
A grant of exclusive rights to
sell a literary, musical, or
artistic work
Government-Enforced Barriers
Government Franchise
A government-granted right to
be the sole seller of a product or
service
–U. S. Postal Service
–Local utilities, etc.
Monopoly Goals and
Constraints
•Monopoly Price or Output
Decision
•Profit and Loss
Monopoly Goals and Constraints
For any level of output a firm might
produce, total cost is determined by
(1) its technology of production, and
(2) the prices it must pay for its inputs.
For any level of output it might produce,
the maximum price it can charge is
determined by the market demand curve
for its product
Monopoly Goals and Constraints
Monthly
$60
Price per
Subscriber
50
48
38
A
B
C
30
F
20
18
G
Demand
5,000
6,000
15,000
20,000
21,000
MR
30,000
Number
of Subscribers
Monopoly Price or Output
Decision
When any firm - including a monopoly faces a downward-sloping demand curve,
marginal revenue is less than the price
of output.
Therefore, the marginal revenue curve
will lie below the demand curve.
Monopoly Price or Output
Decision
A monopoly will never produce a
level of output at which its
marginal revenue is negative.
Monopoly Price or Output
Decision
Monthly
$60
Price per
Subscriber
40
MC
E
D
10,000
MR
30,000
Number
of Subscribers
Profit and Loss
A monopoly earns a profit
whenever P>ATC
and suffers a loss whenever
P<ATC
Monopoly Profit and Loss
(a)
(b)
Dollars
Dollars
MC
ATC
Total
Profit
$40
ATC
Total
Loss MC
AVC
$50
E
40
E
32
D
D
10,000
MR
Number of
Subscribers
10,000
MR
Number of
Subscribers
Equilibrium in Monopoly
Markets
•Short-Run Equilibrium
•Long-Run Equilibrium
•Comparing Monopoly to Perfect
Competition
•Why Monopolies Often Earn Zero
Economic Profit
Short-Run Equilibrium
Any firm - including a monopoly should shut down if P<AVC at the
output level where MR = MC.
Long-Run Equilibrium
•A privately owned monopoly suffering
an economic loss in the long run will
exit the industry, just as would any other
business firm.
•In the long run, therefore, we should
not find privately owned monopolies
suffering economic losses.
Comparing Monopoly to
Perfect Competition
A monopoly market can be
expected to have a higher price
and lower output than an
otherwise similar perfectly
competitive market.
Comparing Monopoly to
Perfect Competition
(a) Competitive Market
Price
per
Unit
(b) Competitive Firm
Dollars
per
Unit
S
MC
ATC
$10
d
$10
E
D
100,000
1,000
Quantity
of Output
(c) Monopoly
Dollars
per
Unit
$15
10
F
S = MC
E
MR
60,000
100,000
D
Quantity
of Output
Quantity
of Output
Two Opposing Effects
1) For any given technology of
production, monopolization leads to
higher prices and lower output.
2) Changes in the technology of
production made possible under
monopoly may lead to lower prices and
higher output.
Monopolies Often Earn Zero
Economic Profit
1.
2.
Government regulation
Rent-seeking activity
Monopolies Often Earn Zero
Economic Profit
Rent-Seeking Activity
Any costly action a firm
undertakes to establish or
maintain its monopoly status
What Happens When Things
Change?
•A monopolist will react to an increase
in demand by producing more output,
charging a higher price, and earning a
larger profit.
•It will react to a decrease in demand
by reducing output, lowering price,
and suffering a reduction in profit.
What Happens When Things
Change?
(a)
(b)
Monthly
Price per
Subscriber
Monthly
Price per
Subscriber
MC
MC
B
$47
$40
A
40
A
D1
D1
10,000
30,000
Number
MR1
of Subscribers
10,000
11,000
D2
MR1
MR2
Number
of Subscribers
Price Discrimination
•Requirements for Price
Discrimination
•Effects of Price Discrimination
Price Discrimination
Single-Price Monopoly
A monopoly firm that is limited to
charging the same price for each
unit of output sold.
Price Discrimination
Price Discrimination
Charging different prices to
different customers for reasons
other than differences in cost.
Price Discrimination
Requirements for Price Discrimination
•There must be a downward-sloping
demand curve for the firm’s output
•The firm must be able to identify
consumers willing to pay more
•The firm must be able to prevent low-price
customers from reselling to high-price
customers
Effects of Price Discrimination
Price discrimination that
harms consumers:
when prices are above the price
consumers would pay under a single
price policy. The additional profit for the
firm is equal to the monetary loss of
consumers
Effects of Price Discrimination
Price discrimination that
benefits consumers:
when the price for some consumers is
below what they would pay under a
single-price policy. This benefits both
the consumer and the firm.
Effects of Price Discrimination
(a)
(b)
Dollars
per
Ticket
Dollars
per
Ticket
Additional profit
from price
discrimination
MC
MC
$160
$120
E
ATC
120
80
D
MR
30
MR
10
Number of Round-trip
Tickets
30
(c)
Dollars
per
Ticket
MC
Additional profit
from price
discrimination
$120
100
G
F
H
MR
30 40
D
Number of Round-trip
Tickets
D
Number of Round-trip
Tickets
Perfect Price Discrimination
Perfect Price Discrimination
Charging each customer the most
he or she would be willing to pay
for each unit purchased
Perfect Price Discrimination
Dollars
per
Doll
H
MR curve before
price discrimination
$30
E
25
10
B
J
D
MR
20 30
MC = ATC
60
Number of
Dolls per Day