Principles of Economics

Ohio Wesleyan UniversityGoran Skosples

10. Monopoly

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LEARNING OBJECTIVES

Why do monopolies arise?

Why is MR < P for a monopolist?

How do monopolies choose their P and Q?

How do monopolies affect society’s well-being?

What can the government do about monopolies?

What is price discrimination?

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Introduction

A monopoly is a firm that is the sole seller of a product without close substitutes.

In this chapter, we study monopoly and contrast it with perfect competition.

The key difference: A monopoly firm has ____________, the ability to influence the market price of the product it sells. A competitive firm has no ___________.

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Why Monopolies Arise

The main cause of monopolies is _________ _______ – ______________________________.

Three sources of barriers to entry:

1. A single firm owns a key resource.

2. The gov’t gives a single firm the exclusive right to produce the good.

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Why Monopolies Arise3. _______ monopoly: a single firm can produce

the entire market Q at lower ATC than could several firms.

Q

Cost

ATC

Example: 1000 homes need electricity. Electricity

Economies of scale due to

huge FC

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Monopoly vs. Competition: Demand Curves

In a competitive market, the market demand curve slopes downward.

but the demand curve for any individual firm’s product is __________ at the market price.

The firm can increase Q without __________,

so _______ for the competitive firm.

P

Q

A competitive firm’s demand curve

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Monopoly vs. Competition: Demand Curves

A monopolist is the only seller, so it faces the ______ demand curve.

To sell a larger Q, the firm must ______ P.

Thus, MR P.

P

Q

A monopolist’s demand curve

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Moonbucks is the only seller of cappuccinos in town.

The table shows the market demand for cappuccinos.

Fill in the missing spaces of the table.

What is the relation between P and AR? Between P and MR?

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1.506

2.005

2.504

3.003

3.502

4.001

n.a.$4.500

MRARTRPQ

A C T I V E L E A R N I N G 1: A monopoly’s revenueA C T I V E L E A R N I N G 1: A monopoly’s revenue

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Moonbuck’s D and MR Curves

-3

-2

-1

0

1

2

3

4

5

0 1 2 3 4 5 6 7 Q

P, MR

$

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Understanding the Monopolist’s MR

Increasing Q has two effects on revenue:• The _______ effect:

More output is sold, which raises revenue• The _______ effect:

The price falls, which lowers revenue

To sell a larger Q, the monopolist must ______ the price on ___________________.

Hence, MR P

MR could even be negative if the price effect __________ the output effect

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Profit-Maximization

1. Find Q• Like a competitive firm, a monopolist maximizes

profit by producing the quantity where MR MC.

2. Set P• Once the monopolist identifies this quantity,

it sets the highest price consumers are willing to pay for that quantity.

• It finds this price from the D curve.

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Profit-Maximization

1. The profit-maximizing __ is where MR = MC.

2. Find __ from the demand curve at this __.

Quantity

Costs and Revenue

MR

D

MC

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The Monopolist’s Profit

As with a competitive firm, the monopolist’s profit equals

Quantity

Costs and Revenue

ATC

D

MR

MC

Q

P

ATC

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A Monopoly Does Not Have an S Curve

A competitive firm takes __ as given has a ______ curve that shows how its Q

depends on P

A monopoly firm is a “price-______,” not a “price-______” Q does not depend on __;

rather, Q and P are jointly determined by ___, ___, and _______________.

So there is ________________ for monopoly.

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Case Study: Monopoly vs. Generic Drugs

Patents on new drugs give a temporary monopoly to the seller.

When the patent expires, the market becomes competitive, generics appear.

MC

Quantity

Price

D

MR

The market for a typical drug

Why horizontal?

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The Welfare Cost of Monopoly

Recall: In a competitive market equilibrium, P MC and total surplus is ____________.

In the monopoly eq’m, P MR = MC• The value to buyers of an additional unit (P)

___________ the cost of the resources needed to produce that unit (MC).

• The monopoly Q is too ____ – could ________ total surplus with a ________ Q.

• Thus, monopoly results in a _______________.

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The Welfare Cost of Monopoly

Competitive eq’m:

quantity

P

total surplus is

Monopoly eq’m:

quantity

P

Quantity

Price

D

MR

MC

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Public Policy Toward Monopolies

1. Increasing competition with antitrust laws

2. Regulation

3. Public ownership

4. Doing nothing

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Price Discrimination Discrimination is the practice of treating people

differently based on some characteristic, such as race or gender.

Price discrimination is the business practice of selling the same good at different prices to different buyers.

The characteristic used in price discrimination is ________________________ : • A firm can increase profit by charging a higher

price to buyers with higher _______.

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Single Price Monopoly

Here, the monopolist charges the same price (PM) to all

buyers.

MC

Quantity

Price

D

MR

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Dual Price Monopoly

Here, the monopolist charges two different prices (P2 and P2) to

buyers.

A deadweight loss _______, but is _____ than in the case of single-price discrimination.

MC

Quantity

Price

D

MR

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Perfect Price Discrimination

Here, the monopolist produces the competitive quantity, but charges each buyer his or her WTP.

This is called perfect price discrimination.

The monopolist captures ___ CS.

MC

Quantity

Price

D

MR

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Price Discrimination in the Real World

In the real world, perfect price discrimination is not possible: • no firm knows every buyer’s _______• buyers do not announce it to sellers

So, firms divide customers into groups based on some observable trait that is likely related to WTP, such as age.

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Examples of Price Discrimination

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Maximum customers will pay for a movie:• college students, $10• senior citizens, $5

If P = $10: Qcollege = 10, Qsenior = 0

If P = $5: Qcollege = 10, Qsenior = 20

MC = 0 revenue = profit

How much should the theatre charge for a movie ticket? Should it price tickets to college students and senior citizens differently?

A C T I V E L E A R N I N G 2: Price discriminationA C T I V E L E A R N I N G 2: Price discrimination

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PricingProfit from 10

College StudentsProfit from 20 Seniors

Total Profit

Uniform, P = $5

Uniform, P = $10

Price discriminate

A C T I V E L E A R N I N G 2: AnswersA C T I V E L E A R N I N G 2: Answers

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CONCLUSION: The Prevalence of Monopoly

In the real world, pure monopoly is rare.

Yet, many firms have market power, due to • selling a unique variety of a product• having a large market share and few significant

competitors

In many such cases, most of the results from this chapter apply, including• markup of price over marginal cost• deadweight loss

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CHAPTER SUMMARY

A monopoly firm is the sole seller in its market. Monopolies arise due to barriers to entry, including: government-granted monopolies, the control of a key resource, or economies of scale over the entire range of output.

A monopoly firm faces a downward-sloping demand curve for its product. As a result, it must reduce price to sell a larger quantity, which causes marginal revenue to fall below price.

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CHAPTER SUMMARY

Monopoly firms maximize profits by producing the quantity where marginal revenue equals marginal cost. But since marginal revenue is less than price, the monopoly price will be greater than marginal cost, leading to a deadweight loss.

Policymakers may respond by regulating monopolies, using antitrust laws to promote competition, or by taking over the monopoly and running it. Due to problems with each of these options, the best option may be to take no action.

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CHAPTER SUMMARY

Monopoly firms (and others with market power) try to raise their profits by charging higher prices to consumers with higher willingness to pay. This practice is called price discrimination.