© 2006 McGraw-Hill Ryerson Limited. All rights reserved.1 Chapter 11: Monopoly Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia

© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

1

Chapter 11: Monopoly

Prepared by:Kevin Richter, Douglas CollegeCharlene Richter,British Columbia Institute of Technology


2

Chapter Objectives

1. Summarize how and why the decisions facing a monopolist differ from the decisions of perfectly competitive firms.

2a. Explain why MC = MR maximizes total profit for a monopolist.

2b. Determine a monopolist's price, output, and profit graphically and numerically.


3

Chapter Objectives

3. Understand that a monopolist can make a profit, break even, or make a loss.

4. Show graphically the welfare loss from monopoly.

5. Explain why a price-discriminating monopolist will earn more profit than a single-price monopolist.


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Chapter Objectives

6. Explain why there would be no monopoly without barriers to entry.

7. Describe three normative arguments against monopoly.

8. Analyze monopoly pricing in a social context.


5

Introduction

Monopoly is a market structure in which a single firm makes up the entire market.

Monopolies exist because of barriers to entry into a market that prevent competition.


6

Introduction

Legal barriers, such as patents, prevent others from entering the market.

Sociological barriers – entry is prevented by custom or tradition.


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Introduction

Natural barriers – the firm has a unique ability to produce what other firms can’t duplicate.

Technological barriers – the size of the market can support only one firm.


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Differences Between a Monopolist and a Perfect Competitor A competitive firm's marginal revenue is the

market price.

A monopolistic firm’s marginal revenue is not its price – it takes into account that in order to sell more it has to decrease the price of its product.


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Monopolist’s Price and Output Numerically The first thing to remember is that marginal

revenue is the change in total revenue that occurs as a firm changes its output.


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MR = MC Determines the Profit-Maximizing Output If MR > MC, the monopolist gains profit by

increasing output.

If MR < MC, the monopolist gains profit by decreasing output.

If MC = MR, the monopolist is maximizing profit.


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Price a Monopolist Charges

The MR = MC condition determines the quantity a monopolist produces.

The monopolist will charge the maximum price consumers are willing to pay for that quantity.

That price is found on the demand curve.


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Determine Monopoly Price and Output

MC

$3630241812

606

12

Price

1 2 3 4 5 6 7 8 9 10

D

MR

Monopolist price


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Comparing Monopoly and Perfect Competition

$3630241812

606

12

Price MC

1 2 3 4 5 6 7 8 9 10

D

MR

Monopolist price

Competitive price


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Profits and Monopoly

The monopolist will make a profit if price exceeds average total cost.

The monopolist will make a normal return if price equal average total cost.

The monopolist will incur a loss if price is less than average total cost.


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Monopolist Making a Profit

Price

ATC

MC

Quantity

PM

0MR D

QM

ProfitCM

A

B


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Monopolist Breaking Even

Price MC

Quantity

PM

0MR D

QM

ATC


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Monopolist Making a Loss

Price ATCMC

Quantity0MR D

QM

LossPM

CMB

A


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Welfare Loss from Monopoly

The welfare loss of a monopolist is represented by the triangles B and D.

The welfare loss is often called the deadweight loss or welfare loss triangle.


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A

CPM

D

B

MC

MR D

QM

PC

QC0

Price

Quantity

Welfare Loss from Monopoly


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Price-Discriminating Monopolist Price discrimination is the ability to charge

different prices to different individuals or groups of individuals.


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Price-Discriminating Monopolist In order to price discriminate, a monopolist

must be able to:

Identify groups of customers who have different elasticities of demand;

Separate them in some way; and Limit their ability to resell its product between

groups.


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Price-Discriminating Monopolist A price-discriminating monopolist can

increase both output and profit. It can charge customers with more inelastic

demands a higher price. It can charge customers with more elastic

demands a lower price.


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Price-Discriminating Monopolist A perfect price discriminating monopoly will

stop expanding its output when MR = MC, which corresponds to the perfectly competitive output.

The deadweight loss is therefore eliminated under perfect price discrimination.


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Perfect Price Discrimination

10987654321

1 2 3 4 5 6 7 8 9 10 11

D=MR

MC

MRQuantity (number of

consumers)

Price


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Economies of Scale

A natural monopoly is an industry in which one firm can produce at a lower cost than can two or more firms.


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Barriers to Entry and Monopoly Economies of scale:

In cases of natural monopoly, technology is such that minimum efficient scale is so large that average total costs decrease over the range of potential output.


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0 Quantity

Avera

ge C

ost

Natural Monopoly

C3

C2

C1

Q⅓

ATC

Q½ Q1


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Economies of Scale

There is no welfare loss in the natural monopoly situation.

There can actually be a welfare gain because a single firm is so much more efficient than several firms producing the good.


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Natural Monopoly

Loss

MR D

PM

PC

CC

CM

QM QC

ATCMC

0 Quantity

Avera

ge C

ost

Profit


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Barriers to Entry and Monopoly Set-up costs:

In many industries high set-up costs characterize production.

The industry may be highly capital-intensive, requiring a large investment in expensive but highly specialized capital.

Examples are an oil refinery or a diamond mine.


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Barriers to Entry and Monopoly Set-up costs:

In some industries a lot of money may be spent on advertising.

Heavy advertising creates a barrier to entry in those cases, such as in the perfume industry or the automobile industry.


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Barriers to Entry and Monopoly Legislation:

Monopolies can also exist as a result of government charter.

Patents are another way in which government can grant a company a monopoly.


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Barriers to Entry and Monopoly Legislation:

A patent is a legal protection of technical innovation that gives the inventor a monopoly on using the invention.

To encourage research and development of new products, government gives out patents for a wide variety of innovations.


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Barriers to Entry and Monopoly Other barriers to entry:

Sometimes one company can gain ownership of some essential aspect of the production process – a unique input, or control over a resource.

An example is DeBeers. By controlling the world-wide distribution network for diamonds, the company enjoys a monopoly in the diamond industry.


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Normative Views of Monopoly The public does not like the distributional

effects of monopoly.

They believe that it transfers income from “deserving” consumers to “undeserving” monopolists.


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Government Policy and Monopoly: AIDS Drugs

The patents for AIDS drugs are owned by a small group of pharmaceutical companies.

They can charge a very high price for a drug whose marginal cost is very low.


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Government Policy and Monopoly: AIDS Drugs What, if anything, should the government do?

Government could force the producer to charge a price equal to its marginal cost.

Society would be better off but this would create a significant disincentive for drug companies to do further research on other life-threatening diseases.


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Government Policy and Monopoly: AIDS Drugs Another alternative is for the government to

buy the patents and allow anyone to produce the drugs.

Payment would come from increased taxes and would be quite expensive.

The cost of regulation would decrease, but it would raise the question as to which patents the government should buy.


39

Monopoly

End of Chapter 11

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© 2006 McGraw-Hill Ryerson Limited. All rights reserved.1 Chapter 11: Monopoly Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia