CHAPTER 8 MONOPOLY

Slides prepared by Dr. Amy Peng, Ryerson University

CHAPTER 8CHAPTER 8MONOPOLYMONOPOLY

Part Two: Microeconomics Part Two: Microeconomics of Product Marketsof Product Markets

©2007 McGraw-Hill Ryerson Ltd.

Chapter 8 2

In this chapter you will learn:In this chapter you will learn:

8.1 The characteristics of a monopoly8.2 About the profit-maximizing price

and output in pure monopoly8.3 About the economic effects of

monopoly8.4 Why a monopolist prefers to charge

different prices in different markets8.5 The choices facing governments

that regulate monopolies8.6 About the deadweight loss

associated with monopoly


Chapter 8.1 3

MonopolyMonopoly

Characteristics:• Single Seller• No Close Substitutes• Price-Maker• Blocked EntryExamples of Monopoly


Chapter 8.1 4

Quantity (millions)Quantity (millions)

$20$20

1515

1010

00 5050 100100 200200

ATCATC

DD

If ATC declines over the entire market demand,If ATC declines over the entire market demand,least-cost production is realized only ifleast-cost production is realized only if

there is one producer - a natural monopolythere is one producer - a natural monopoly

If ATC declines over the entire market demand,If ATC declines over the entire market demand,least-cost production is realized only ifleast-cost production is realized only if

there is one producer - a natural monopolythere is one producer - a natural monopoly

Barrier to Entry – Barrier to Entry – Figure 8-1 Economies of ScaleFigure 8-1 Economies of Scale


Chapter 8.1 5

Barriers to EntryBarriers to Entry

• Economies of Scale• Legal Barriers to Entry: Patents

and Licences• Ownership or Control of

Essential Resources• Pricing and Other Strategic

Barriers to Entry


Chapter 8.1 6

Monopoly DemandMonopoly Demand

Three basic assumptions:• Monopoly status is secured• Firm is not governmentally

regulated• Firm charges the same price for

all units


Chapter 8.1 7


1. Marginal revenue is less than price

Illustrated…


Chapter 8.1 8

Q P TR

0 $172

1 162

2 152

3 142

4 132

5 122

6 112

7 102

8 92

9 82

10 72

MR

Table 8-1Table 8-1

Q P TR

0 $172

$ 0

1 162 162

2 152 304

3 142 426

4 132 528

5 122 610

6 112 672

7 102 714

8 92 736

9 82 738

10 72 720

MR

$162

MR

$162

142

]]

]]

MR

$162

142

122

102

82

62

42

22

2

-18

Notice that MR < PNotice that MR < PNotice that MR < PNotice that MR < P


Chapter 8.1 9

PP

QQ

DD

132132

When price decreases When price decreases from $142 to $132, onefrom $142 to $132, onemore unit is sold…more unit is sold…

Gain = $132Gain = $132

$142$142

1 2 3 4 5 6 1 2 3 4 5 6

Revenue will increase by $132Revenue will increase by $132with the extra unit soldwith the extra unit sold

Figure 8-2Figure 8-2Price and Marginal Revenue in Price and Marginal Revenue in

MonopolyMonopoly


Chapter 8.1 10 1 2 3 4 5 6 1 2 3 4 5 6

PP

QQ

DD

but revenue lossbut revenue loss= $10 X 3 units= $10 X 3 units

Loss = $30Loss = $30

When price decreases When price decreases from $142 to $132, onefrom $142 to $132, onemore unit is sold…more unit is sold…

Gain = $132Gain = $132Marginal revenue Marginal revenue = $132-30= $132-30= $102 < $132 (price)= $102 < $132 (price)

Marginal revenue Marginal revenue = $132-30= $132-30= $102 < $132 (price)= $102 < $132 (price)

132132$142$142

Price and Marginal Revenue in Price and Marginal Revenue in MonopolyMonopoly


Chapter 8.1 11


1. Marginal revenue is less than price

2. The monopolist is a price-maker3. The monopolist sets prices in the

elastic region of demand

illustrated…


Chapter 8.1 12

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ

Do

llar

sD

oll

ars

Do

llar

sD

oll

ars

200

150

200

50

750

500

250 TRTR

DD

Inelastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ

MRMR

Elastic

TRTR

Figure 8-3 Demand, MR, and TR for a Figure 8-3 Demand, MR, and TR for a MonopolistMonopolist


Chapter 8.2 13

Output and Price DeterminationOutput and Price Determination

• Cost Data– assume competitive resource

markets

• MR=MC Rule

Illustrated…


Chapter 8.2 14

ATC TC$10

0

$190

190

135 270

113 340

100 400

94 470

92 550

91 640

94 750

98 880

103 1030

Q P TR0 $17

2$

0

1 162 162

2 152 304

3 142 426

4 132 528

5 122 610

6 112 672

7 102 714

8 92 736

9 82 738

10 72 720

MR

$162

142

122

102

82

62

42

22

2

-18

MC

$90

80

70

60

70

80

90

110

130

150

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

Table 8-1Table 8-1

produce?produce?

produce?produce?

produce?produce?

produce?produce?


Chapter 8.2 15

ATC TC$10

0

$190

190

135 270

113 340

100 400

94 470

92 550

91 640

94 750

98 880

103 1030

Q P TR0 $17

2$

0

1 162 162

2 152 304

3 142 426

4 132 528

5 122 610

6 112 672

7 102 714

8 92 736

9 82 738

10 72 720

Profitor loss

$-100-28

+34

+86

+128

+140

+122

+74

-14

-142

-310

MR

$162

142

122

102

82

62

42

22

2

-18

MC

$90

80

70

60

70

80

90

110

130

150

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

]]

Profit Maximization Choice

Same results as TR – TC Rule


Chapter 8.2 16

QQ

DD

MRMR

200200

175175

150150

125125

100100

7575

5050

25250 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10

PP

Figure 8-4Figure 8-4Profit Maximization by a MonopolistProfit Maximization by a Monopolist

MCMCFind qFind qFind qFind q

MR = MCMR = MC


Chapter 8.2 17

MCMC

$122= p $122= p

Find pFind pFind pFind p

QQ

DD

MRMR

200200

175175

150150

120120

100100

7575

5050

2525

0 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10

PP

Profit Maximization by a Profit Maximization by a MonopolistMonopolist


Chapter 8.2 18

MCMCFind ATCFind ATCFind ATCFind ATC

QQ

DD

MRMR

200200

175175

150150

120120

100100

7575

5050

2525

0 1 2 3 4 5 6 7 8 9 100 1 2 3 4 5 6 7 8 9 10

PP

ATCATC$122= p $122= p

$94=ATC$94=ATCProfitProfit

ProfitProfit=(p - ATC) X q=(p - ATC) X q=(122-94) X 5=(122-94) X 5=140=140

ProfitProfit=(p - ATC) X q=(p - ATC) X q=(122-94) X 5=(122-94) X 5=140=140

Profit Maximization by a Profit Maximization by a MonopolistMonopolist


Chapter 8.2 19


• Cost Data– assume competitive resource

markets

• MR=MC Rule• No Monopoly Supply Curve


Chapter 8.2 20


• Misconceptions Concerning Monopoly Pricing– Not the highest price– Total, not unit, profit

• Possibility of Losses by Monopolist

Illustrated…


Chapter 8.2 21

MCMC

LossLoss

QQ

DD

MRMR

PP

ATCATC

QQmm

PPmm

AA

VV

AVCAVC

MR = MCMR = MC

Figure 8-5 Figure 8-5 The Loss-Minimizing Position of a The Loss-Minimizing Position of a

MonopolistMonopolist


Chapter 8.3 22

Economic Effects of MonopolyEconomic Effects of Monopoly

• Price, Output, and Efficiency– inefficient relative to a purely

competitive industry

– Pm > MC

– Pm > minimum ATC

Illustrated…


Chapter 8.3 23

QQ

PP

DD

PPcc

QQcc

S = MCS = MC

P=MC=minimum ATCP=MC=minimum ATCP=MC=minimum ATCP=MC=minimum ATC

Figure 8-6 Inefficiency of Figure 8-6 Inefficiency of Monopoly Monopoly

Price and Price and output if the output if the

industry were industry were competitivecompetitive

Price and Price and output if the output if the

industry were industry were competitivecompetitive


Chapter 8.3 24

QQ

PP

DDMRMR

PPcc

QQcc

PPmm

QQmm

S = MCS = MCMonopolistMonopolist

will sell fewerwill sell fewerunits at aunits at a

higher pricehigher pricethan in purethan in purecompetitioncompetition

MonopolistMonopolistwill sell fewerwill sell fewer

units at aunits at ahigher pricehigher pricethan in purethan in purecompetitioncompetition

Inefficiency of Monopoly Inefficiency of Monopoly


Chapter 8.3 25


• Income Transfer– monopoly owners enriched at the

expense of consumers

• Cost ComplicationsEconomies of Scale– simultaneous consumption– network effects

X-Inefficiency

Illustrated…


Chapter 8.3 26

Un

it c

ost

s (d

oll

ars)

Un

it c

ost

s (d

oll

ars)

QuantityQuantity

AverageAverageTotal CostTotal Cost

QQ22

Inefficient internal operation Inefficient internal operation leads to higher-than-necessary leads to higher-than-necessary

costscosts

Inefficient internal operation Inefficient internal operation leads to higher-than-necessary leads to higher-than-necessary

costscosts

Figure 8-7Figure 8-7X-InefficiencyX-Inefficiency

ATCATC22

XX''ATCATCX'X'

QQ11

XXATCATCXX

ATCATC11


Chapter 8.3 27


• Cost Complications– Economies of Scale

• simultaneous consumption• network effects

– X-Inefficiency– Rent-Seeking Expenditures– Technological Advance


Chapter 8.3 28

Assessment and Policy OptionsAssessment and Policy Options

• Legitimate concerns• Three policy options:

1. Charges under Canada’s anticombines laws

2. Regulate prices and operations of natural monopolies

3. Ignore monopolies which are unsustainable over the long term


Chapter 8.4 29

Price Discrimination and Price Discrimination and MonopolyMonopoly

• Same product is sold at more than one price

• Not justified by cost differences• Based on differences in

“willingness to pay”


Chapter 8.4 30

Price DiscriminationPrice Discrimination

• Necessary Conditions.…– Monopoly Power– Market Segregation– No Resale

• Examples– airlines– theatres, golf courses– coupons– international trade


Chapter 8.4 31

QQDDMRMR

MC = ATCMC = ATC

PP

QQbb

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

PPbb

(a) Small Businesses(a) Small Businesses

Figure 8-8Figure 8-8Price Discrimination to Different Groups Price Discrimination to Different Groups

of Buyersof Buyers


Chapter 8.4 32

QQDDMRMR

MC = ATCMC = ATC

PP

QQss

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

PPss

(b) Students(b) Students

Price Discrimination to Different Groups Price Discrimination to Different Groups of Buyersof Buyers


Chapter 8.5 33

Regulated MonopolyRegulated Monopoly

• Natural monopolies traditionally have been subject to rate (price) regulation– e.g., natural gas distributors,

regional telephone companies, electricity suppliers

• Trend to deregulation where possible– e.g., long distance telephone


Chapter 8.5 34

Regulated MonopolyRegulated Monopoly

• May be desirable to maintain but regulate a natural monopoly

• Types of regulation include:– Socially optimal price where P = MC– Fair-return price where P = ATC

Illustrated…


Chapter 8.5 35

QQ

DD

MRMR

MCMCATCATC

PP

UnregulatedUnregulatedmonopoly pricemonopoly priceUnregulatedUnregulated

monopoly pricemonopoly priceMM

QQmm

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

PPmm

Figure 8-9 Figure 8-9 Regulated Monopoly – Socially Regulated Monopoly – Socially

OptimalOptimalSocially Optimal PriceSocially Optimal Price

Price = MCPrice = MCSocially Optimal PriceSocially Optimal Price

Price = MCPrice = MC

QQrr

PPrrLOSSLOSS

Allocatively Allocatively efficient efficient BUTBUTSubsidy requiredSubsidy required


Chapter 8.5 36

QQ

DD

MRMR

MCMCATCATC

PP Fair Return PriceFair Return PricePrice = ATCPrice = ATC

Fair Return PriceFair Return PricePrice = ATCPrice = ATC

ff

MM

QQmm QQrrQQff

Pri

ce a

nd

Co

sts

Pri

ce a

nd

Co

sts

PPmm

PPrr

PPff

rrFIRM BREAKS EVENFIRM BREAKS EVEN

still some underallocationstill some underallocationFIRM BREAKS EVENFIRM BREAKS EVEN

still some underallocationstill some underallocation

Regulated Monopoly – Fair Regulated Monopoly – Fair ReturnReturn


Chapter 8.5 37

Dilemma of RegulationDilemma of Regulation

• Setting price at P = MCfirm earns losses• Setting price at P = ATCstill some underallocation of

resources• Regulation can improve

outcomes


Chapter 8.6 38

Monopoly and Deadweight LossMonopoly and Deadweight Loss

• Net loss of consumer and producer surplus is deadweight loss

• Monopolist also loses producer surplus, but gains producer surplus at the expense of consumer surplus

• Consumers lose consumer surplus


Chapter 8.6 39

QQ

PP

D=MBD=MB

PPcc

QQcc

S = MCS = MC

ConsumerConsumersurplussurplus

ProducerProducersurplussurplus

EfficientEfficientoutputoutput

EfficientEfficientoutputoutput

Outcomes withOutcomes withpure competitionpure competitionOutcomes withOutcomes with

pure competitionpure competition

Figure 8-10 Monopoly and Figure 8-10 Monopoly and Deadweight LossDeadweight Loss


Chapter 8.6 40

QQ

PP

D=MBD=MBMRMR

PPcc

QQcc

PPmm

QQmm

S = MCS = MC

ConsumerConsumersurplussurplus

ProducerProducersurplussurplus

Monopoly’s Monopoly’s gaingain BB

CC

Outcomes withOutcomes withpure monopolypure monopolyOutcomes withOutcomes withpure monopolypure monopoly

DeadweightDeadweightlossloss

DeadweightDeadweightlossloss

Monopoly and Deadweight LossMonopoly and Deadweight Loss


Chapter 8 41

Chapter SummaryChapter Summary

8.1 Characteristics of Pure Monopoly 8.2 Output and Price Determination in

a Monopoly– MR = MC

8.3 Economic Effects of Monopoly 8.4 Price Discrimination and

Monopoly 8.5 Regulated Monopoly

– Socially optimal price or fair-return price 8.6 Monopoly and Deadweight Loss

Documents

CHAPTER 8 MONOPOLY