Roger LeRoy Miller
Economics Today
Chapter 24
Monopoly
Miller, Economics Today, © 2001 Addison Wesley Longman, Inc.
Introduction
The Central Selling Organization (CSO),
a marketing group based in London, sells about
70 percent of the world’s rough-cut diamonds each
year, collecting handling fees of about 10 percent.
Slide 24-2
Introduction
 The CSO is owned by South Africa's De
Beers, the world’s largest diamond mining
company.
 In any given year, the CSO sells between $4
and $5 billion in diamonds, making around
$400 million a year in profits.
 Why does the CSO withhold $4 to $5 billion
worth of uncut diamonds each year?
Slide 24-3
Learning Objectives
 Identify situations that can give rise
to monopoly
 Describe the demand and marginal
revenue conditions a monopolist faces
 Discuss how a monopolist determines
how much output to produce and
what price to charge
Slide 24-4
Learning Objectives
 Evaluate the profits earned
by a monopolist
 Understand price discrimination
 Explain the social cost of monopolies
Slide 24-5
Learning Objectives
 Definition of a Monopolist
 Barriers to Entry
 The Demand Curve a Monopolist Faces
 Elasticity and Monopoly
Slide 24-6
Chapter Outline
 Cost and Monopoly Profit Maximization
 Calculating Monopoly Profit
 On Making Higher Profits:
Price Discrimination
 The Social Cost of Monopolies
Slide 24-7
Did You Know That...
 From the Great Depression of the 1930s
until 1996, New York City kept the number
of taxicab licenses (called “medallions”) fixed
at 11,787?
 In 1996 bidders for 53 new medallions paid
an average of $177,000 for the right to sell
taxi services. Today medallions are valued
at more than $300,000.
 Why has there been such a big increase?
Slide 24-8
Definition of a Monopolist
 Monopolist
– A single supplier that comprises its entire
industry for a good or service for which
there is no close substitute
Slide 24-9
Definition of a Monopolist
 Monopolist
– May be large or small
 What do you think?
– Is Microsoft a monopolist?
Slide 24-10
Barriers to entry
 How to become a monopoly
– Create a barrier to entry and make
long-run economic profits by preventing
resources from entering your market
Slide 24-11
Barriers to Entry
 Ownership of resources without close
substitutes
– If you owned all the oil reserves,
who could enter the refining business?
– The Aluminum Company of America
(ALCOA) at one time owned 90%
of the world’s bauxite.
Slide 24-12
Barriers to Entry
 Problems in raising adequate capital
– Choose a product that requires
a substantial capital investment
– Why not enter the microprocessor
market and compete with Intel?
Slide 24-13
Barriers to Entry
 Economies of scale
– Low unit costs and prices drive out rivals
Slide 24-14
Barriers to Entry
 Natural Monopoly
– A monopoly that arises from the peculiar
production characteristics in an industry
– It usually arises when there are large
economies of scale
Slide 24-15
The Cost Curves that Might Lead
to a Natural Monopoly: The Case of Electricity
Figure 24-1
Slide 24-16
Barriers to Entry
 Legal or governmental restrictions
– Licenses, franchises, and certificates
of convenience
– Is the postal service still a monopoly?
• Consider
– UPS
– FedX
– Fax machines
– The Internet
Slide 24-17
International Example:
Will Mexico Ever Hang Up
on Its Telephone Monopoly?
 Telmex, the regulated Mexican
telephone monopoly, charges
Mexican businesses about $25 for a
call that would cost a U.S. business
about $5.
 Only about 10 percent of residents
of Mexico have telephone service.
Slide 24-18
Barriers to Entry
 Legal or governmental restrictions
– Patents
• Intellectual property
– Tariffs
• Taxes on imported goods
– Regulation
Slide 24-19
Barriers to Entry
 Cartels
– An association of producers in an industry
that agree to set common prices and
output quotas to prevent competition
Slide 24-20
The Demand Curve
a Monopolist Faces
 Monopolist’s demand = market demand
– Monopolist is the industry
Slide 24-21
The Demand Curve
a Monopolist Faces
 Recall
– In perfectly competitive markets:
• All firms combined create the industry supply
• Industry supply relative to market demand (D)
determines equilibrium price and quantity
• The industry faces the market demand
Slide 24-22
Demand Curves for the Perfect
Competitor and the Monopolist
Figure 24-2, Panels (a) and (b)
Slide 24-23
The Demand Curve
a Monopolist Faces
Monopoly
Perfect Competition
Single Seller
One of many sellers
Faces market demand
Perfectly elastic demand
(price takers)
Must lower price
to sell more
Must only produce more
to sell more
MR < P
All units sold for same
price (P = MR)
Slide 24-24
Marginal Revenue:
Always Less Than Price
Figure 24-3
Slide 24-25
Elasticity and Monopoly
 A monopoly is a single seller of a welldefined good or service with no close
substitutes.
 The more imperfect substitutes there
are, and the better these substitutes
are, the greater the price elasticity
of demand of the monopolist’s
demand curve
Slide 24-26
Elasticity and Monopoly
 Question
– If a monopoly raises price, what will
happen to quantity demanded?
 Hint
– Remember how consumers respond
to a change in price.
Slide 24-27
Cost and Monopoly
Profit Maximization
 Price Searcher
– A firm that must determine the priceoutput combination that maximizes profit
because it faces a downward-sloping
demand curve
Slide 24-28
Monopoly Costs,
Revenues, and Profits
Figure 24-4, Panel (a)
Slide 24-29
Monopoly Costs,
Revenues, and Profits
Figure 24-4, Panels (b) and (c)
Slide 24-30
Cost and Monopoly
Profit Maximization
 Why produce where marginal revenue
equals marginal cost?
– Producing past where MR = MC
• Incremental cost > Incremental revenue
– Producing less than where MR = MC
• Incremental revenue > Incremental cost
Slide 24-31
Maximizing Profits
Figure 24-5
Slide 24-32
Calculating Monopoly Profit
Figure 24-6
Slide 24-33
Monopolies:
Not Always Profitable
Figure 24-7
Slide 24-34
On Making Higher Profits:
Price Discrimination
 Price Discrimination
– Selling a given product at more than one
price, with the difference being unrelated
to differences in cost
Slide 24-35
On Making Higher Profits:
Price Discrimination
 Price Differentiation
– Establishing different prices for similar
products to reflect differences in marginal
cost in providing those commodities
to different groups of buyers
Slide 24-36
On Making Higher Profits:
Price Discrimination
 Necessary conditions for price
discrimination
– The firm must face a downward-sloping
demand curve
– The firm must be able to separate
markets at a reasonable cost
Slide 24-37
On Making Higher Profits:
Price Discrimination
 Necessary conditions for price
discrimination
– The buyers in the various markets
must have different price elasticities
of demand
– The firm must be able to prevent
resale of the product or service
Slide 24-38
On Making Higher Profits:
Price Discrimination
 Example
– Cheaper airfares for some,
really expensive fares for others
• Why can the airlines charge a business
traveler more than a vacation traveler
for the same seat?
• How can an airline distinguish between
a business traveler and a vacation traveler?
Slide 24-39
On Making Higher Profits:
Price Discrimination
Figure 24-8
Slide 24-40
The Social Cost of Monopolies
 Scenario
– Start with a perfectly competitive market
in long-run equilibrium
•
•
•
•
Pe: Qd = Qs
MR = MC
Pe = MC
Zero economic profits
Slide 24-41
The Social Cost of Monopolies
 Scenario
– Now, assume the industry is acquired
by one firm with no impact on cost.
Slide 24-42
The Effects
of Monopolizing an Industry
Figure 24-9, Panels (a) and (c)
Slide 24-43
Issues and Applications:
Trying to Open a Crack in the Diamond Cartel
 The DeBeers diamond cartel and its
Central Selling Organization (CSO)
restricts diamond sales each year
in an attempt to maximize its profits.
 DeBeers also buys diamonds
from non-cartel members.
 Between 1986 and 1998 diamond
prices rose by 50 percent.
Slide 24-44
Issues and Applications:
Trying to Open a Crack in the Diamond Cartel
 In 1998 the Russians followed by
British and Australian companies
began to sell “near-gem” quality
diamonds for lower prices and
diamond prices dropped by
over 20 percent.
 DeBeers kept control of “true-gem”
diamonds.
Slide 24-45
Issues and Applications:
Trying to Open a Crack in the Diamond Cartel
 Will the cartel be able to keep
its monopoly?
Slide 24-46
Web Links
 The following Web links appear in the
margin of this chapter in the textbook:
– http://www.uspto.gov
– http://www.loc.gov/copyright
– http://www.wtrg.com/opecshare.html
Slide 24-47
Summary Discussion
of Learning Objectives
 Why a monopoly can occur
– Barriers to entry
 Demand and marginal revenue
conditions faced by a monopolist
– The monopolist’s demand curve
is the industry demand curve
– Marginal revenue is less than price
Slide 24-48
Summary Discussion
of Learning Objectives
 How a monopolist determines
how much output to produce
and what price to charge
– Produce where marginal cost equals
marginal revenue
– Set price for that output on the demand
curve
Slide 24-49
Summary Discussion
of Learning Objectives
 A monopolist’s profits
– Price minus average total cost times
output equals profits (losses)
Slide 24-50
Summary Discussion
of Learning Objectives
 Price discrimination
– Selling at more than one price
with the price differences being unrelated
to differences in production costs
– Buyers with the more elastic demand
pay a lower price
Slide 24-51
Summary Discussion
of Learning Objectives
 Social cost of monopolies
– Price exceeds marginal cost
– The price is higher and output is lower
for a monopolist as compared
to a perfectly competitive industry
Slide 24-52
End of Chapter
Chapter 24
Monopoly