Chapter 12
MONOPOLY
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-2
Today’s lecture will:
• Summarize how and why the decisions
•
•
facing a monopolist differ from the
collective decisions of competing
firms.
Explain why MR = MC maximizes total
profit for a monopolist.
Determine a monopolist’s price,
output, and profit graphically and
numerically.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-3
Today’s lecture will:
• Show graphically the welfare loss from
•
•
•
monopoly.
Explain why a price-discriminating
monopolist will earn more profit than a
normal monopolist.
Explain why there would be no
monopoly without barriers to entry.
Discuss three normative arguments
against monopoly.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-4
Definition of Monopoly
• Monopoly is a market structure in
•
•
which one firm makes up the entire
market.
Barriers to entry into the market
prevent competition.
There are no close substitutes for the
monopolist’s product.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-5
Determinimg Equilibrium Price
and Quantity
Output Price
0
1
2
3
4
5
6
7
8
9
McGraw-Hill/Irwin
36
33
30
27
24
21
18
15
12
9
TR
MR
TC
MC
0
33
60
81
96
105
108
105
96
81
—
33
27
21
15
9
3
–3
–9
–15
47
48
50
54
62
78
102
142
196
278
—
1
2
4
8
16
24
40
56
80
ATC
Profit
48.00
25.00
18.00
15.50
15.60
17.00
20.29
24.75
30.89
–47
–15
10
27
34
27
6
–37
–102
–197
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-6
Equilibrium Price and Quantity
Price
$36
30
24
18
12
6
0
-6
-12
McGraw-Hill/Irwin
MC
The monopolist’s
price is $24
MR = MC at
approximately
4 units
D
1
2
3
4
5
6
7
8 9 10
MR
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-7
Comparison of Monopoly
and Pure Competition
MC
Monopolist price
$24 (MR=MC)
$36
Monopoly output
is lower and price
is higher than in
perfect
competition.
Competitive
Price $20.50
(P=MC)
24
20.50
12
D
0
1
2
3
4
5.17 6
7
8
MR
McGraw-Hill/Irwin
9
10
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-8
Finding a Monopolist’s Output,
Price, and Profit
Profit is P-ATC
(A-B) times total
output, QM.
Price
CM
Profit
Monopolist produces
output QM where MR=MC.
B
MR
0
McGraw-Hill/Irwin
QM
Monopolist charges
price PM from A on the
demand curve.
ATC
A
PM
MC
D
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-9
Breaking Even
MC
ATC
• Produce QM
where
MR = MC
PM
•Price (PM) = ATC
• Profit = 0
MR
0
McGraw-Hill/Irwin
QM
D
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-10
Minimizing Losses
MC
Price
CM
B
PM
A
ATC
• Produce QM,
where
MR = MC.
•Price (PM) < Cost (CM)
Loss
•Loss = CM PMBA
MR
0
McGraw-Hill/Irwin
QM
D
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-11
Welfare Loss
Price
•B and D:
welfare loss or
deadweight loss
MC
•C:
transfer from consumer
surplus to monopolist
PM
C
PC
D
•A: opportunity cost
B
A
0
McGraw-Hill/Irwin
QM
MR
QC
of
diverted resources
D
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-12
Price Discrimination
• Monopolist charges different prices to
•
different individuals.
 Consumers with less elastic demands
are charged higher prices.
 Consumers with more elastic demands
are charged lower prices.
Price discrimination increases output and
profits.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-13
Examples of Price
Discrimination
• Movie discounts to senior citizens and
•
•
•
children.
Airline discounts for Saturday night
stayovers.
Cars are seldom sold at list price.
Tracking consumer information and
pricing accordingly.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-14
Barriers to Entry
• Natural Ability
 A firm is better at producing the good
than anyone else.
• Economies of Scale
 Natural monopoly - a single firm can
produce at a lower cost than can two or
more firms.
• Government-Created Monopolies
 Patents, licenses, and franchises
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-15
Natural Monopoly
•One firm producing Q1 has average cost C1.
• If two firms share the market, each produces
Average Cost
Q1/2 and has average cost C2.
•Three firms each producing Q1/3 have
C3
average cost C3.
C2
C1
0
McGraw-Hill/Irwin
ATC
Q⅓
Q½
Q1
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-16
Natural Monopoly
•A natural monopolist produces QM and
charges PM and earns a profit.
Average Cost
Profit
•If the government regulates a competitive
PM
solution where P=MC, the monopolist
charges PC and produces QC for a loss..
CM
CC
PC
Loss
MR
0
McGraw-Hill/Irwin
QM
QC
ATC
MC
D
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-17
Normative Views of
Monopoly
• Monopolies are unjust because they
•
•
restrict freedom.
Monopolies transfer income from
“deserving” consumers to
“undeserving” monopolists.
Monopolies cause potential
monopolists to waste resources
trying to get monopolies.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-18
Government Policy and
Monopoly: AIDS Drugs
• A few companies have patents for AIDS
•
drugs that enable them to charge high
prices because demand is inelastic.
Policy Options
 Government regulation where price = marginal

cost benefits society, but discourages
research.
Government purchase of the patents and
allowing anyone to produce the drugs so their
price = marginal cost is expensive for
taxpayers.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-19
Summary
• Monopoly is a market structure,
•
•
protected by barriers to entry, in which a
single firm produces a product for which
there are no close substitutes.
A monopolist maximizes profit or
minimizes losses where MR=MC.
To determine a monopolist’s profit or
loss:
 Find output where MR=MC.
 Determine price and ATC at that output.
 Profit or loss = (P – ATC) * Q.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-20
Summary
• Monopoly output is lower and price is
•
•
higher than in competitive markets.
Because monopolies reduce output and
charge P > MC, monopolies create a
welfare loss for society.
A price-discriminating monopolist earns
more profit than a normal monopolist by
charging a higher price to those with less
elastic demand and a lower price to those
with more elastic demand.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-21
Summary
• In order to discriminate a monopolist
must:
 Identify and separate groups of customers
with different elasticities of demand.
 Limit their ability to resell its product
between groups.
• Three important barriers to entry are:



Natural ability
Increasing returns to scale
Government restrictions
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-22
Summary
• Natural monopolies exist in industries with
•
•
strong economies of scale, so it is more
efficient for one firm to produce the entire
output.
In a natural monopoly the competitive
outcome where P=MC results in losses.
Normative arguments against monopoly are:
 Monopolies are inconsistent with freedom.
 Distributional effects of monopoly are unfair.
 Monopolies encourage people to waste time and
money trying to get monopolies.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-23
Review Question 12-1 Given the following demand and cost
information, complete the table and find the profit-maximizing
price and output.
Output Price Total
Revenue
Marginal
Revenue
Marginal Average
Cost
Total Cost
Profit
-----
-----
$-10
______
18
_______
$7
$17
1
______
32
______
14
______
5
11
10
______
14
______
42
10
______
6
9.33
14
______
4
12
48
______
6
______
12
10
8
______
5
10
50
______
2
______
15
11
-5
______
0
$20
______
$0
1
18
18
______
2
16
3
McGraw-Hill/Irwin
-----
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
12-24
Review Question 12-2 Show the equilibrium output, price,
and profit from question 12-1 on a graph.
$20
Price
MC
MR = MC between
3 and 4 units, so the
monopolist maximizes
profit at Q = 3 and
P = $14
Profit = (P-ATC)*Q
Profit = (14-9.33)*3=$14
15
14
ATC
10
9.33
Profit = $14
D
5
MR
1
McGraw-Hill/Irwin
2
3
4
5
Quantity
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.