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Monopoly
Chapter 9
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Market Power
• Market power is the ability to alter the
market price of a good or service.
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The Downward-Sloping
Demand Curve
• Firms with market power confront
downward-sloping demand curves.
• Competitive firms face a horizontal
demand curve.
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Firm vs. Industry Demand
Price (per bushel)
The competitive firm
Demand facing
competitive firm
$13
The industry
$13
Market
demand
0
Quantity (bushels per day)
McGraw-Hill/Irwin
0
Quantity
(thousands of bushels per day)
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Monopoly
• The demand curve facing the monopoly
firm is identical to the market demand
curve for the product.
• Monopoly is a firm that produces the
entire market supply of a particular good or
service.
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Price and Marginal Revenue
• A monopoly faces a different profit
maximizing situation than competitive
firms.
• Unlike competitive firms, marginal revenue
for a monopolist is not equal to price.
– Profit-maximization rule – Produce at that
rate of output where MR = MC.
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Price and Marginal Revenue
• Marginal revenue is the change in total
revenue that results from a one-unit
increase in the quantity sold.
Marginal Change in total revenue TR
=
=
q
revenue Change in quantity sold
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Price and Marginal Revenue
• So long as the demand curve is downwardsloping, MR will always be less than price.
• The MR curve lies below the demand
(price) curve at every point but the first.
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Price and Marginal Revenue
Quantity
1
2
3
4
5
6
7
McGraw-Hill/Irwin
Price
$13
12
11
10
9
8
7
Total
Revenue
$13
24
33
40
45
48
49
Marginal
Revenue
—
$11
9
7
5
3
1
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Price and Marginal Revenue
$14
A
B
Price (per beshel)
12
C
D
b
10
E
c
8
F
G
Demand
(= price)
d
6
e
4
f
2
Marginal revenue
g
0
McGraw-Hill/Irwin
1
2
3
4
5
6
7
Quantity (bushels per hour)
8
9
10
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Profit Maximization
• We need to find the intersection of
marginal cost and marginal revenue.
• This will give us the profit-maximizing rate
of output.
• Only one price is compatible with the profitmaximizing rate of output.
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Price or Cost (per bushel)
Profit Maximization
$14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
McGraw-Hill/Irwin
Average
total cost
D
Profits
d
Demand
Marginal
cost
1
2
3
4
5
6
Quantity (bushel per hour)
Marginal
revenue
7
8
9
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Market Power at Work:
Computer Market Revisited
• As an example, we’ll use a fictitious
company called Universal Electronics that
acquires an exclusive patent on the
production of microprocessors.
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Market Power at Work:
Computer Market Revisited
• The patent functions as a barrier to entry.
– Barriers to entry – Obstacles that make it
difficult or impossible for would-be producers
to enter a particular market, such as patents.
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Market Power at Work:
Computer Market Revisited
• For comparison purposes, Universal is not
taking advantage of economies of scale.
– Economies of scale – Reductions in
minimum average costs that come about
through increases in the size (scale) of plant
and equipment.
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The Production Decision
• Like any producer, Universal wants to
produce at the rate that maximizes profits.
• Universal faces a production decision
concerning its many plants.
– Production decision – The selection of the
short-run rate of output (with existing plant and
equipment).
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The Production Decision
• A monopolist can foresee the impact of
increased production on market price.
• Instead, prevent production increase by
coordinating the production decisions of its
plants.
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Marginal Revenue
• Each Universal plant faces a downwardsloping demand curve, thus, the marginal
revenue no longer equals price.
• Only firms that confront a horizontal
demand curve equate marginal cost and
price.
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Reduced Output
• The typical Universal plant will produce
fewer computers that would be produced
by a typical perfectly competitive firm.
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The Monopoly Price
• The intersection of the marginal revenue
and marginal cost curves establishes the
profit-maximization rate of output.
• The demand curve tells us how much
consumers are willing to pay for that
output.
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Initial Conditions in the
Monopolized Computer Market
W
C
1000
800
M
B
600
400
200
0
Average total cost
Demand
curve facing
single plant
Marginal
cost
Marginal revenue
of single plant
200 400
800
1200
1600
Quantity (computers per month)
McGraw-Hill/Irwin
1000
Price (per computer)
Price (per computer)
$1200
Monopoly outcome
1200
Competitive
outcome
Competitive
market
supply
A
X
800
Market
demand
600
400
200
0
24,000
Quantity
(computers per month)
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Monopoly Profits
• Total profit equals average profit per unit
times the number of units produced.
Profit per unit = price – average total cost
Profit per unit = p – ATC
Total profits = profit per unit X quantity
Total profits = (p – ATC) X q
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Monopoly Profits
• A monopoly receives larger profits than a
comparable competitive industry by
reducing the quantity supplied and pushing
prices up.
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Monopoly Profits: The Typical
Universal Plant
Marginal cost
Price (per computer)
$1200
W
Average total cost
C
1000
800
Profit
M
600
K
B
Demand curve
facing single plant
400
200
0
McGraw-Hill/Irwin
Marginal revenue of
single plant
200
400
600
800 1000 1200
Quantity (computers per month)
1400
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Monopoly Profits: The Entire
Company
Price (per computer)
Monopolist's equilibrium
$1100
$1000
MC
A
R
X
Competitive short-run
equilibrium
ATC
Competitive
long-run equilibrium
Monopoly
profit
T
V
U
MR
0
McGraw-Hill/Irwin
qM qC
Market demand
Quantity (computers per month)
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Barriers to Entry
• High barriers to entry prevent profit-hungry
entrepreneurs from entering the market to
compete monopoly profits away.
• Monopoly profits persist as long as barriers
to entry prevent competitors from entering
the market.
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A Comparative Perspective on
Market Power
• Outcomes differ under competitive and
monopoly conditions.
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Competitive Industry
• High prices and profits signal consumers’
demand for more output.
• The high profits attract new suppliers.
• Production and supplies expand.
• Prices slide down the market demand
curve.
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Competitive Industry
• A new equilibrium is established.
• Price equals marginal cost at all times.
• Throughout the process, there is great
pressure to reduce costs or improve
product quality.
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Monopoly Industry
• High prices and profits signal consumers’
demand for more output.
• Barriers to entry are erected to exclude
potential competition.
• Production and supplies are constrained.
• Prices don’t move down the market
demand curve.
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Monopoly Industry
• No new equilibrium is established.
• Price exceeds marginal cost at all times.
• There is no squeeze on profits and thus no
pressure to reduce costs or improve
product quality.
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Monopoly Industry
• Because monopoly markets do not tend
towards marginal cost pricing, consumers
do not get the mix of output that delivers
the most utility from available resources.
– Marginal cost pricing – the offer (supply) of
goods at prices equal to their marginal cost.
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Political Power
• A firm with considerable market power
likely to have significant political power as
well.
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The Limits to Power
• Monopolists only have absolute control of
the quantity of output supplied to the
market.
• Monopolists must still contend with the
market demand curve.
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The Limits to Power
• The greater the price elasticity of demand,
the more a monopolist will be frustrated in
its attempts to establish both high prices
and high volume.
– Price elasticity of demand – The percentage
change in quantity demanded divided by the
percentage change in price.
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Price Discrimination
• A monopolist may be able to extract
greater profits by practicing price
discrimination.
• Price discrimination is the sale of an
identical good at different prices to different
consumers by a single seller.
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Entry Barriers
• The preservation of monopoly power
depends on keeping potential competitors
out of the market.
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Entry Barriers
• Patents – offers a producer 20 years of
exclusive rights to produce a particular
product.
• Monopoly franchises – governments
create and maintain monopolies by giving
a single firm the exclusive right to supply a
particular good or service.
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Entry Barriers
• Control of key inputs – a company may
lock out competition by securing exclusive
access to key inputs.
• Lawsuits – may be used to prevent new
companies from successfully entering an
industry.
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Entry Barriers
• Acquisition – when all else fails, purchase
a potential competitor.
• Economies of scale – a monopoly may
persist because of cost advantages over
smaller firms
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Pros and Cons of Market Power
• It is conceivable that monopolies could
benefit society.
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Research and Development
• Because of their greater profits,
monopolists have a greater advantage in
pursuing research and development.
• They do not have a clear incentive to do
so.
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Entrepreneurial Incentives
• Market power can be an incentive for
entrepreneurial activity.
• An innovator can make substantial profits
in a competitive market before the
competition catches up.
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Economies of Scale
• If economies of scale exist, the monopolist
may attain much greater efficiency than a
large number of competitive firms.
• There is no guarantee that such
economies of scale will exist in a given
industry.
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Natural Monopolies
• A natural monopoly is an industry in
which one firm can achieve economies of
scale over the entire range of market
supply.
• Economies of scale act as a “natural”
barrier to entry.
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Contestable Markets
• A contestable market is an imperfectly
competitive market subject to potential
entry if prices or profits increase.
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Contestable Markets
• Contestable markets are characterized by
moderate barriers to entry.
• When potential profits reach a certain level
competitors are enticed to enter the
market.
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Structure vs. Behavior
• The structure of monopoly is, in itself, not a
problem.
• If potential rivals force a monopolist to
behave like a competitive firm, then a
monopoly imposes no cost on consumers
or on society at large.
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Microsoft: Bully or Genius?
• Concerning Microsoft, critics argue that
Microsoft:
– Charges too much for its systems software.
– Suppresses substitute technologies.
– Bullies potential competitors.
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Antitrust Laws
• The legal foundations for antitrust
intervention are contained in three
landmark antitrust laws.
• Sherman Act (1890) – prohibits
“conspiracies in restraint of trade.
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Antitrust Laws
• Clayton Act (1914) – principally aimed at
preventing the development of monopolies
by prohibiting price discrimination,
exclusive dealing agreements, certain
types of mergers, and interlocking boards
of directors among competing firms.
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Antitrust Laws
• The Federal Trade Commission Act
(1914) – created the FTC to study industry
structures and behavior so as to identify
anti-competitive practices.
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The AT&T Case
• The federal government dismantled AT&T
in 1984.
• Prior to the break-up, AT&T supplied 96
percent of all long-distance service and
over 80 percent of local telephone service.
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The Microsoft Case
• Microsoft was accused of:
– Thwarting competitors in operating systems by
erecting entry barriers.
– Using its monopoly position in operating
systems to gain an unfair advantage in the
applications market.
– It bought out its competitors.
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Microsoft’s Defense
• In its defense, Microsoft asserted that:
– It dominates the computer industry because it
produces the best products at attractive
prices.
– The computer industry is highly contestable if
not perfectly competitive.
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The Verdict
• A federal court concluded that Microsoft
abused its monopoly position in operating
systems.
• By limiting consumer choices and stifling
competition, Microsoft had denied
consumers better and cheaper information
technology.
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The Remedy
• The trial judge suggested a structural
remedy, that Microsoft might have to be
broken into two companies to ensure
competition.
• The U.S. Department of Justice decided to
seek a behavioral remedy instead.
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Monopoly
End of Chapter 9
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