Lecture 20
Monopoly
Market structure
Market structures:
N
1
2
3-10
10-…
Name
A
pall
monopolized market - a single seller.
 Monopoly affects the price (has market power)
p( y)  10  y
 Takes
the price effect into account
 Today: choice without disctimination
Monopoly

What causes monopolies?
1. large fixed costs (Natural Monopoly)
2. a legal fiat (US Postal Service)
3. a patent (a new drug)
4. sole ownership of a good ( a toll highway)
5. formation of a cartel (OPEC)
Profit Maximization
 Secret
of happiness (FOC):
 ( y)  TR( y)  TC (y)
 Intuition:
the last unit gives the same
in terms of revenue as it costs
 Competitive firm
 Monopoly: MR not equal to price
Marginal Revenue and Price
 Competitive
firm
 Monopoly
p( y)  10  y
Profit of a Monopoly
 Profit
of the monopoly
 (y)  p(y) y  TC (y) 
 Suppose
 Total
p( y)  10  y
Revenue
 Marginal Revenue
y maximizing profit
 Secret
of happiness (FOC):
 ( y)  TR( y)  TC (y)
 Intuition:
the last unit gives the same
in terms of revenue as it costs
 Difference: MR not equal to price
y maximizing profit: geometry
p( y)  10  y
T C ( y )  0.5 y
M C ( y) 
MR( y) 
p
p 
*
y 
*
y
2
p( y)  10  y
Quiz
T C ( y )  0.5 y
M C ( y) 
MR( y) 
p
p 
*
y 
*
y
2
Pareto Efficiency




Competitive markets efficient
Is outcome Pareto Efficient when one
“trader” is big?
Loss of efficiency – deadweight loss
Total Potential Surplus
– competitive benchmark
– monopoly
Total Potential Surplus
p( y)  10  y

T C ( y )  0.5 y
Total Potential Surplus =Gains to trade
2
Competitive Benchmark
p( y)  10  y


T C ( y )  0.5 y
Competitive supply: p=MC
Consumer’s and Producers Surplus
2
Monopoly: Deadweight loss
p( y)  10  y

Monopoly
T C ( y )  0.5 y
2
Regulation of a Natural Monopoly
p( y)  10  y
TC ( y)  1  y
Regulating a Natural Monopoly
 So
a natural monopoly cannot be
forced to use marginal cost pricing.
Doing so makes the firm exit,
destroying both the market and any
gains-to-trade.
 Regulatory schemes can induce the
natural monopolist to produce the
efficient output level without exiting.