CHAPTER 13 Monopoly
Michael Parkin
ECONOMICS 5e
Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition
Learning Objectives (cont.)
Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency
Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition
How Monopoly Arises
A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.
How Monopoly Arises
No Close Substitutes
If a good has close substitutes, it faces competition from the producer of the substitute.
Barriers to Entry
Barriers to entry are legal or natural constraints that protect a firm from potential competitors.
How Monopoly Arises
Legal Barriers to Entry
In a legal monopoly competition and entry is restricted by the granting of a public franchise, government license, patent, or copyright.
How Monopoly Arises
Natural Barriers to Entry
A natural monopoly results from a situation in which one firm can supply the entire market at a lower price than two or more firms can.
Example: Electric utility
Natural Monopoly
ATC
Quantity (millions of kilowatt-hours)
5
10
15
0
1
2
3
4
D
Price (cents per kilowatt-hour)
Monopoly Price-
Setting Strategies
Price discrimination is the practice of selling different units of a good or service for different prices (ie., pizza, airlines).
A single-price monopoly is a firm that must sell each unit of its output for the same price (ie., DeBeers).
Single-Price Monopoly
The firm’s demand curve is the market demand curve.
Marginal revenue is not the same as the market price.
Single-Price Monopoly
Bobbie’s Barbershop, in Cairo, Nebraska, is the sole supplier of haircuts in town.
Let’s examine the market for haircuts in Cairo.
Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut)
a 20 0
b 18 1
c 16 2
d 14 3
e 12 4
f 10 5
Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut)
a 20 0 0
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars per
haircut) per hour) (dollars additional haircut)
a 20 0 0
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
18
14
10
6
2
Demand and Marginal Revenue
10
20
16
14
D
MR
c
d
Total revenue loss $4
Total revenue gain $14
Marginal revenue $10
2 3
Quantity (haircuts per hour)
Price & marginal revenue
(dollars per haircut)
Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good.
Marginal Revenue and Elasticity
0
10
20
5
10
D
MR
Elastic
Unit elastic
Inelastic
Maximum
total revenue
Quantity
(haircuts
per hour)
Demand and marginal revenue curves
d
f
Price $ marginal revenue
(dollars per haircut)
–10
– 20
Marginal Revenue and Elasticity
0
10
10
20
30
40
50
Total revenue curve
TR
Quantity
(haircuts
per hour)
5
Total revenue (dollars per hour)
Zero
marginal
revenue
Marginal Revenue and Elasticity
Profit maximizing monopolies will never produce at an output in the inelastic range of its demand curve.
It could charge a higher price, produce a smaller quantity, and earn a larger profit.
Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0
18 1
16 2
14 3
12 4
10 5
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0
18 1 18
16 2 32
14 3 42
12 4 48
10 5 50
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0
18 1 18
16 2 32
14 3 42
12 4 48
10 5 50
18
14
10
6
2
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 20
18 1 18 21
16 2 32 24
14 3 42 30
12 4 48 40
10 5 50 55
18
14
10
6
2
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 20
18 1 18 21
16 2 32 24
14 3 42 30
12 4 48 40
10 5 50 55
18
14
10
6
2
1
3
6
10
15
A Monopoly’s Output
and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 20 -20
18 1 18 21 -3
16 2 32 24 +8
14 3 42 30 +12
12 4 48 40 +8
10 5 50 55 -5
18
14
10
6
2
1
3
6
10
15
TC
0 1 2 3 4 5
10
20
30
50
Total revenue and total cost
(dollars per hour)
A Monopoly’s Output and Price
Quantity (haircuts per hour)
Economic
profit = $12
42
TR
A Monopoly’s Output and Price
Economic
profit $12
MC
MR
0 1 2 3 4 5
10
14
20
Quantity (haircuts per hour)
Price and cost (dollars per hour)
D
ATC
Profit = $12
($4 x 3 units)
Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition
Single Price Monopoly and Competition Compared
Perfect Competition
a price taker
produce where mr = mc
p = mr = mc
no barriers to entry
Monopoly
monopoly influences its price
produce where mr = mc
p > mc; p > mc
barriers to entry
restricts output, charges a higher price
Single Price Monopoly and Competition Compared
S =MC
MR
Quantity
Price
D
PM
PC
QM
QC
Perfect
competition
Single price
monopoly: Higher
price and smaller
output
Inefficiency of Monopoly
Price
Quantity
0
D
QC
PC
MC
Perfect Competition
Consumer
surplus
Producer
surplus
Efficient
quantity
Inefficiency of Monopoly
Price
Quantity
PA
PM
0
D
MR
QM
QC
PC
Monopoly
Consumer
surplus
Deadweight
loss
Producer
surplus
MC
Monopoly’s
gain
Learning Objectives
Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency
Rent Seeking
The activity of trying to obtain a monopoly from which an economic profit can be made is called rent seeking.
The term rent includes consumer surplus, producer surplus, and economic profit.
Rent seeking occurs when a monopolist attempts to capture some of the consumer surplus for itself.
Rent Seeking
They attempt to do so by:
Buying a monopoly (ex. taxis)
Does not ensure an economic profit.
Creating a monopoly (ex. lobbying)
Very costly.
Rent Seeking Costs
ATC
Price
Quantity
PM
0
D
MR
QM
Monopoly
Consumer
surplus
MC
Rent seeking
costs exhaust
producer
surplus
Deadweight
loss
Learning Objectives
Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency
Price Discrimination
Price discrimination - selling a good or service at a number of different prices.
To be able to price discriminate, a monopoly must:
1. Identify and separate different buyer types
2. Sell a product that cannot be resold
How do these firms make a profit?
Price Discrimination
Consumer surplus
Price discrimination attempts to capture the consumer surplus for the monopoly.
Price Discrimination
Discriminating Among Units of a Good
Charging buyers different prices on each good bought (ex. bulk buying discounts)
Discriminating Among Individuals
Some people value additional units differently (ex. pizza)
Price Discrimination
Let’s look at how price discrimination, when used by a monopoly, can lead to higher profits — Global Air.
A Single Price of Air Travel
$48
million
MR
600
Passengers (thousands per year)
Price (dollars per trip)
D
0
5
8
10
15
20
300
900
1200
1500
1800
2100
MC
Consumer
surplus
Economic
profit
ATC
New Fair Structure
MR
600
Passengers (thousands per year)
Price (dollars per trip)
D
0
6
8
10
15
20
300
900
1200
1400
1800
2100
ATC
MC
Increased economic
profit from price
discrimination
1600
4
2
Perfect Price Discrimination
Global extracts the entire consumer surplus.
Perfect Price Discrimination
600
Passengers (thousands per year)
Price (dollars per trip)
D
0
6
8
11
15
20
300
900
1200
1400
1800
2100
ATC
MC
1600
4
2
Increase
in output
Increase in economic
profit from perfect
price discrimination
Efficiency and Rent Seeking with Price Discrimination
With perfect price discrimination, output increases to the point at which price equals marginal cost - where the marginal cost intersects the demand curve.
Output is identical to that of perfect competition.
Efficiency and Rent Seeking with Price Discrimination
Perfect price discrimination pushes consumer surplus to zero but increases producer surplus to equal the sum of consumer surplus and producer surplus in perfect competition.
Efficiency and Rent Seeking with Price Discrimination
Deadweight loss is zero.
Perfect price discrimination achieves efficiency.
Gains from Monopoly
Economies of Scale and Scope
Lowers average total cost and a greater range of goods produced
Incentives to Innovate
The attempt to apply knew knowledge in the production process and obtain a patent
Learning Objectives
Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency
Regulating a Natural Monopoly
Profit maximization
The Efficient Regulation
Marginal cost pricing rule
Average Cost Pricing
Average cost pricing rule
Regulating a Natural Monopoly
Profit maximization (cont.)
Suppose the natural gas company is not regulated and instead maximizes profit.
This outcome is fine for the gas company, but it is inefficient.
Regulating a Natural Monopoly
The Efficient Regulation
If the monopoly regulator wants to achieve an efficient use of resources, it must require the gas company to produce the quantity of gas that brings marginal benefits into equality with marginal costs.
A marginal cost pricing rule sets the price equal to marginal cost.
Regulating a Natural Monopoly
The Efficient Regulation (cont.)
The marginal cost pricing rule maximizes total surplus in the regulated industry.
The marginal cost pricing rule is efficient.
It leaves the natural monopoly incurring an economic loss.
Regulating a Natural Monopoly
MR
15
Quantity (millions of cubic feet per day)
Price and cost (cents per cubic foot)
0
3
4
10
18
20
30
ATC
Profit
maximizing
2
1
MC
Average
cost pricing
Marginal
cost pricing
Regulating a Natural Monopoly
Average Cost Pricing
Regulators almost never impose efficient pricing because of the consequences for the firm’s profit.
Instead, they compromise by permitting the firm to cover all its costs and to earn a normal profit.
Regulating a Natural Monopoly
Average Cost Pricing (cont.)
Pricing to cover cost and normal profit means setting price equal to average total cost - called an average cost pricing rule.
The firm earns a normal profit.
The outcome is inefficient, but less so than the unregulated profit maximizing outcome.
The End
1
2
3
4
5
6
7
8
10
Instructor Notes:
1) The demand curve for electric poser is D, and the average total cost curve is ATC.
2) Economies of scale exist over the entire ATC curve.
3) One firm can distribute 4 million kilowatt-hour at a cost of 5 cents a kilowatt-hour.
4) This same total output costs 10 a kilowatt-hour with two firms and 15 cents a kilowatt-hour with four firms.
5) So one firm can meet the market demand at a lower cost than two or more firms can, and the market is a natural monopoly.
12
14
15
16
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10
17
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10
18
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10
21
Instructor Notes:
The demand curve, D, and the marginal revenue curve, MR, are based on the numbers in the table and illustrate the calculation of marginal revenue when the price falls from $16 to $14.
22
27
Instructor Notes:
1) Over the range from 0 to 5 haircuts an hour, a price cut increases total revenue, so marginal revenue is positive, as shown by the blue bars.
2) Demand is elastic.
3) Over the range 5 to 10 haircuts an hour, a price cut decreases total revenue, so marginal revenues is negative, as shown by the red bars.
4) Demand is inelastic.
5) At 5 haircuts an hour, total revenue is maximized, and marginal revenue is zero.
6) Demand is unit elastic.
30
Instructor Notes:
1) The total revenue curve is shown above.
2) Total revenue is maximized where MR is zero--5 haircuts per hour.
31
32
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC).
33
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC).
34
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC).
35
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC).
36
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC).
37
Instructor Notes:
1) Profit is maximized when the price is $14 and 3 haircuts are sold.
2) Total revenue is $42, total cost is $30, and economic profit is $12 ($42 - $30).
41
Instructor Notes:
In this graph, economic profit equals total revenue (TR) minus total cost (TC) and is maximized at 3 haircuts an hour.
45
Instructor Notes:
1) In this related graph, economic profit is maximized when marginal cost (MC) equals marginal revenue (MR).
2) The price is determined by the demand curve (D) and is $14.
3) Economic profit, the blue rectangle, is $12--the profit per haircut ($4) multiplied by 3 haircuts.
60
Instructor Notes:
1) In perfect competition, the quantity QC is sold at the price PC.
2) Consumer surplus is the green triangle.
3) In long-run equilibrium, firms economic profits are zero and consumer surplus is maximized.
61
Instructor Notes:
1) A single-price monopoly, as shown in the graph, restricts output to QM and increases the price to PM .
2) Consumer surplus is the green triangle.
3) The monopoly takes the blue rectangle and creates a deadweight loss (the gray triangle).
47
63
64
48
49
50
51
52
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
52
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
52
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
52
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
