Monopoly

Monopolist, a price maker

• While a competitive firm is a price taker, a
monopoly firm is a price maker.
 Monopoly
• A firm is considered a monopoly if . . .
• it is the sole seller of its product.
• its product does not have close substitutes.
 WHY MONOPOLIES ARISE
• The fundamental cause of monopoly is barriers
to entry.
 WHY MONOPOLIES ARISE
• Barriers to entry have three sources:
• Ownership of a key resource.
• The government gives a single firm the exclusive
right to produce some good.
• Costs of production make a single producer more
efficient than a large number of producers.
Monopolists in India
HOW MONOPOLIES MAKE PRODUCTION
AND PRICING DECISIONS
• Monopoly versus Competition

Monopoly Competitive Firm

• Is the sole producer. • Is one of many producers.

• Faces a downward-sloping • Faces a horizontal demand
demand curve 🡺 inelastic curve 🡺 perfectly elastic
demand demand
• Is a price maker • Is a price taker
• Reduces price to increase • Sells as much or as little at
sales same price
 Figure 2 Demand Curves for Competitive and Monopoly
Firms

(a) A Competitive Firm’s Demand (b) A Monopolist’s Demand

Curve Curve
Pric Pric
e e

Deman
d

Deman
d

0 Quantity of Output 0 Quantity of Output

Copyright © 2004 South-Western

 Figure 3 Demand and Marginal-Revenue Curves for a
Monopoly

Price
• Demand curve
$11 (average revenue
10
curve) is downward
9
sloping.
8
• Marginal revenue
7
6 curve is steeper than
5 demand curve.
4
3 Deman
2 Margina (daverage
1 lrevenue revenue)
0
–1 1 2 3 4 5 6 7 8 Quantity of Water
–2
–3
–4
Profit Maximization

• A monopoly maximises profit by producing the

quantity at which marginal revenue equals
marginal cost (MR=MC).
 Figure 4 Profit Maximization for a Monopoly

Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-
Monopol maximizing
quantity . . .
y pric
e
Average total cost
A

Margina Demand
l cos
t

Marginal revenue

0 Q QMAX Q Quantity
Copyright © 2004 South-Western
Profit Maximization (MC=MR)

• For a competitive firm, • For a monopoly firm,

price equals marginal price exceeds marginal
cost. (P = MR = MC) cost. (P > MR = MC)
 Figure 5 The Monopolist’s Profit

Costs and
Revenue Profit= (Price- ATC) * Q
Marginal
cost

Average total cost

Demand

Marginal revenue

0 Quantity
 Figure 5 The Monopolist’s Profit

Costs and
Revenue Profit= (Price- ATC) * Q
Marginal
cost
Monopol E B
y pric
e
Monopol Average total cost
y profit

Average
total D C
cos
Demand
t

Marginal revenue

0 QMAX Quantity
A Monopolist’s Profit

• The monopolist will receive economic profits

as long as price is greater than average total
cost.
• The monopolist can continue to earn profits in
the long run because of blocked entry of new
firms into the industry.
 PRICE DISCRIMINATION
• Price discrimination is the business practice of
selling the same good at different prices to
different customers, even though the costs for
producing for the two customers are the same.
• By practising price discrimination, the
monopolist can increase its total revenue and
profits.
 PRICE DISCRIMINATION
• Examples of Price Discrimination
• Movie tickets (discount for children and senior
citizens)
• Airline prices (early ticketing earns a discount.)
• Discount coupons
• Financial aid
• Quantity discounts
 THE WELFARE COST OF
MONOPOLY
• In contrast to a competitive firm, the monopoly
charges a price above the marginal cost.
• From the standpoint of consumers, this high
price makes monopoly undesirable.
• However, from the standpoint of the firm’s
owners, the high price makes monopoly very
desirable.
The Deadweight Loss

• The Inefficiency of Monopoly

• The monopolist produces less than the socially
efficient quantity of output.
 PUBLIC POLICY TOWARD
MONOPOLIES
• Government responds to the problem of
monopoly in one of four ways.
• Making monopolized industries more competitive.
• Regulating the behaviour of monopolies.
• Turning some private monopolies into public
enterprises.
• Doing nothing at all.
Should monopolies be regulated?
 Summary
• A monopoly is a firm that is the sole seller in its
market.
• It faces a downward-sloping demand curve for
its product.
• A monopoly’s marginal revenue is always
below the price of its good.
 Summary
• Like a competitive firm, a monopoly
maximizes profit by producing the quantity at
which marginal cost and marginal revenue are
equal.
• Unlike a competitive firm, its price exceeds its
marginal revenue, so its price exceeds marginal
cost.
 Summary
• A monopolist’s profit-maximizing level of
output is below the level that maximizes the
sum of consumer and producer surplus.
• A monopoly causes deadweight losses similar
to the deadweight losses caused by taxes.
 Summary
• Policymakers can respond to the inefficiencies
of monopoly behavior with antitrust laws,
regulation of prices, or by turning the
monopoly into a government-run enterprise.
• If the market failure is deemed small,
policymakers may decide to do nothing at all.
 Summary
• Monopolists can raise their profits by charging
different prices to different buyers based on
their willingness to pay.
• Price discrimination can raise economic welfare
and lessen deadweight losses.