This is __
Microeconomics
This chapter is 1 of 7
chapters that make
..,. up 55°/o-70°/o of the
microeconomics
exam.
Monopol~
When one firm, like AT&T during the 1980s (the only
telephone carrier) or a firm that makes nuclear aircraft carriers,
is the sole producer of a good, it is by definition a monopoly in
the market for that good. The aim of this chapter is to develop
a model of monopoly that can be used to explain this behavior
and thereby help us understand how real-world monopolies
operate. We will show how a monopoly decides what price (P)
to charge its customers and what quantity (Q) to sell. Profit (TR
- TC) is the goal!
Page1
A Modelof a Monopoll'
A monopoly occurs when there is only one firm in an industry
selling a product for which there are no close substitutes.
Thus, implicit in the definition of monopoly are barriers to
entry ; other firms are not free to enter the industry. The
economist's model of a monopoly assumes that the monopoly
will choose a level of output that maximizes profits. The most
important difference when compared to a competitive market is
that a monopoly has market power and is therefore a pricemaker and not a price-taker. There is no one that can undercut
a monopoly's price, and what a monopoly does with its
production levels can vastly impact prices, all of which is at its
discretion. A monopoly has market power and maintains it by
having 1) economies of scale, 2) control of resources, 3)
government or legal barriers, and 4) superioriy in technology.
Page2
ShowingMarketPowerwith a Graph
Competitive firms view the market price (P) as essentially out
of its control. A firm's price is shown by the flat line in the
right graph and is thus the same regardless of how much the
firm produces. The monopoly sees a downward-sloping
market demand curve for its product, as shown in the left
graph. The downward-sloping demand seen by the monopoly
is the same as the market demand curve because the monopoly
is the only market supplier; it is the market.
Price
Price Equilibrium price ~Pe),
demand (D), marginal .
benefit (MB), and marginal
o em~nc1 cu rv e i s nm ,
revenue (MR) showing
rnarkcl
De mand cu rv e s l ope s
clow n , sh ow i 11
g mark e t
110
powe r.
power .
.,...__
__ T ----
D
perf ectJy elastic
D
Quantity
Page3
Quantity
Market vs, Firm
Price
Market
Firm
Socially optimal
and profit
maximizing point
and market
equilibrium (Me)
Socially optimal,
profit maximizing,
and allocatively
and productively
efficient point
Supply
Price
(S)
Equilibriu
price (Pe)....
and market
price line
Supply
(S)
P, D, MR,
and MB
Demand
(D)
,,,;,
Equilibrium
quantity (Qe)
Page4
Quantity
Equilibrium
quantity (Qe)
Quantity
DecliningMarginalRevenue
Marginal revenue (MR) is the change in revenue for a firm
from one more unit of output sold. Price (P) and marginal
revenue decline as the output of quantity rises. Marginal
revenue (MR) should always be less than the price (P) because
a monopoly has to reduce the price of the product to sell more.
Market
D e mand
To t al
Marginal
Margi n al
Revenue
Revenue
Cost
(TR)
•o
if
4
5
6
1 so•
140
130 •
120
11 O•
7
100
90
8
80
9
70
10
Page5
160
nO
0
150
280
390
480
550
600
630
640
630
600
(MC)
(MR)
Profits
- 70
•1 50
130
•l l 0
90
•70
50
30
10
- 10
- 30
84
94
l l4
148
196
26 l
35 1
481
656
9
71
5
10
20
196
296
366
402
404
369
289
149
- 56
34
48
65
90
130
1 75
AverageRevenue
We can also use average revenue (AR) to show that marginal
revenue (MR) is less than the price (P), except for the first unit
of output. Average revenue is defined as total revenue
divided by the quantity of output : AR = TR I_a_Average
revenue is equal to the price.
Market Demand
Quantity
Produced
Total
Marginal
and Sold
Price
Revenue
Revenue
(Q)
(P)
(TR)
(MR)
•o
0
0
150
150
280
390
130
l 10
Page6
150
2
140
3
4
130
120
480
90
5
1l 0
550
cl)
100
70
50
30
10
R
RO
lA9')
(MC)
Profits
9
~
196
_,..
1
90
Marginal
C2Je ~~ Cost
~iae.t0i~«
,·~
I St>
110
5
10
20
296
34
48
65
90
402
404
369
366
289
ComparingTotalRevenueand TotalCosts
At some level of production, total costs (TC) start to increase
more than total revenue (TR) increases, so that eventually
profits reach a maximum. When marginal cost (MC) becomes
greater than marginal revenue (MR), the profit-maximizing
quantity has already been surpassed. Remember MC==MRfor
monopolies, just like P(D)==MC(S)for competitive firms.
Market
Demand
Quantity
Produced
and Sold
Price
(Q)
(P)
0
l
160
150
2
140
3
130
120
1l 0
100
90
4
5
m
7
8
9
Page7
'1n't
Total
Marginal
Total
Marginal
Revenue
(TR)
Revenue
(MR)
Costs
(TC)
Cost
0
150
280
390
480
550
600
630
640
• 630
80
70
nO
-
600
(MC)
- 70
70
-
Profits
9
71
84
s
1 10
94
10
90
1 14
70
148
20
34
196
296
366
50
196
261
351
150
79
130
30
10
- 10
- 30
-
481
656
48
-6 5
90
130
l 75
~~~
289
149
- 56
ComparingTotalRevenueand TotalCosts-Questions
38. In the gr aph below TC i total co t and TR i
total reve nue.
$
TC
I
TR
G
0
At \Vhich leve l of output is pr ofit n1ax imi zed?
Page8
ComparingTotalRevenueand TotalCosts-Questions
38. In the gr aph below TC i total co t and TR i
total reve nue.
$
TC
I
TR
G
0
At \Vhich leve l of output is pr ofit n1ax imi zed?
Page9
EquatingMarginalCostsand MarginalRevenue
(cont.)
The monopoly should produce up to the level of production where
marginal cost equals marginal revenue: MC= MR . The marginal
revenue curve is plotted, along with the marginal cost curve. As the
quantity produced increases above very low levels, the marginal
cost curve slopes up and the marginal revenue curve slopes down.
The MR curve becoming negative shows that as TR continues to fall,
at some point MR will become negative. The MR curve must be
drawn to extend below $0, and where MR==O,total revenue (TR) is at
A Monopoly (showing profit)
its max.
Pric e
Marg in a l cost (MC) / S
Ave r age
tota l cost
(ATC)
Tot al
revenue
(TR)
Tot a l
costs
(TC)
. -........
1
,
MC= :
MR l.
':/
'
'
..
Demand
marginal
(D) /
benefit
Quantity
is m ax imi zed
Page10
(MB)
EquatingMarginalCostsand MarginalRevenue
(cont.)
Marginal revenue (MR) equals marginal cost (MC) at the level of output
where the two curves intersect. 5 is the profit-maximizing quantity.
$240 is the profit-maximizing price because that is what the price is at
when the quantity of 5 intersects with the demand (D) curve.
Price
A Monopoly
MC/S
:300
:280
2GO~
Monopoly _....A240
price (P)
Monopoly's
profit maximizing
/
point
220
200
~
160~
1 -10
(D/MB
0
59'
.
9
Monopoly quantity (Qe)
Page11
LO
20
Quantity
EquatingMarginalCostsand MarginalRevenue
(cont.)
Last, for the benefit of society and where a competitive firm
would have its profit maximizing point, the allocatively
efficient/socially optimal quantity is 9 and its price $200.
Profit Maximizing: A Monopoly vs. a Market
Price
:300
Monopoly
price (P)
:280
, 240
2
Go
~
220
MC/S
Monopoly's
profit
maximizing
./ point
:
I
Equilibrium_,.A 200 ------price (Pe)
1so
--i-------~--.-:
Market
equilibrium (Me) and
. profit maximization
160 ~
1 -10
(D/MB
0
-
;,
9
10
1 E5
Monopoly quantity (Q~) Equilibrium quantity (Qe)
Page12
20
Quantity
EquatingMarginalCostsand MarginalRevenue
(cont.)
At a production quantity of 5, the monopolist's economic profit
would be $200 because 5 x $240 (where the quantity intersects
the demand (D) curve, is $1,200, but the ATC curve is at a
quantity of 5 and at $200. $1,200 - $1,000==$200.
Profit Maximizing: A Monopoly vs. a Market
Price
:300
Monopoly
price (P)
:280
, 240
2
Go
MC/S
Monopoly's
profit
~
maximizing
./
point
ATC
220
Socially optimal,
profit maximizing,
and allocatively and
productively efficient
point
Equilibrium_,.A 200
price (Pe)
1so
160~
1 -10
(D/MB
0
-
;,
9
10
1 E5
Monopoly quantity (Q~) Equilibrium quantity (Qe)
Page13
20
Quantity
Equating Marginal Costsand MarginalRevenue-?s
1. \\ ' l1i 11 f tl1
1n n p Ii t
(
~
II
i11gi 11
arily lrt1 at a
pr fit-111aximizi 11gI v I of t1tpt1t.
Maroi11alr v 11t1 i
bttt r at r than pri
(B Margir1al r
11t1 i
bttt I
tha11pri .
(
Marginal r v r1t1 i
t a11I pri .
(D A rag t tal
ti
(E A rag varia I
Page14
qt1al t 1nar i11al
.
qttal t 1nar ir1al
qt1al t b th margir1al
rnir1i1niz d.
t i nli ni11liz d.
Equating Marginal Costsand MarginalRevenue-?s
1. \\ ' l1i 11 f tl1
1n n p Ii t
(
~
II
i11gi 11
arily lrt1 at a
pr fit-111aximizi 11gI v I of t1tpt1t.
Maroi11alr v 11t1 i
bttt r at r than pri
Margir1al r 11t1 i
bttt I
tha11pri .
(
Marginal r v r1t1 i
t a11I pri .
(D A rag t tal
ti
(E A rag varia I
<•
Page15
qt1al t 1nar i11al
.
qttal t 1nar ir1al
qt1al t b th margir1al
rnir1i1niz d.
t i nli ni11liz d.
MC = MR at a Monopolyvs. P = MC at a CompetitiveFirm
For monopolies that are not regulated, profit maximization
occurs at the demand line above the intersection of marginal
cost (MC) and marginal revenue (MR). They produce a
smaller quantity than possible and therefore have excess
capacity, and they charge more; they are inefficient and create
deadweight loss (DWL). For the competitive firm, marginal
cost (MC) is the price (P), which implies the condition of profit
maximization at a competitive firm: P == MC. Competitive
firms produce more but charge less; they can reach the socially
optimal quantity because they can be efficient.
Profit Maximizing;
Price
:JOO
A Monopoly vs. a Market
MC / S
Monopol y's
profit
ATC
l •IO
(D / MB
0
-
..
=>
Mo n opo ly quant ity (Qe)
Page16
,,,,,,.
9
-1_
10
E quilibrium
u c;
qu a nti ty ( Q e )
20
Quantit
y
MC = MR at a Monopolyvs. P = MC at a Competitive
Firm-Questions
UJ
u
~
Averag e Total Co st
Demand
Q UA NTITY
0
57 . If th e m ono po lis t is unr eg ul ate d. its pr o fitm ax imi z in g pri ce and output leve l wo uld lea d
to a d ea dw e ig ht loss e qu a l to area
(A)
(B)
(C)
(D)
(E )
Page17
RUY
RTY
RTW
TUY
uvw
MC = MR at a Monopolyvs. P = MC at a Competitive
Firm-Questions
UJ
u
~
Averag e Total Co st
Demand
0
Q UA NTITY
57 . If th e m ono po lis t is unr eg ul ate d. its pr o fitm ax imi z in g pri ce and output leve l wo uld lea d
to a d ea dw e ig ht loss e qu a l to area
(A) RUY
RTY
(C) RTW
( D ) TUY
(E ) uvw
e
Page18
MC = MR at a Monopolyvs. P = MC at a Competitive
Firm- Questions
8. Whict1 of the follo\\,ing i tnost likely to occur if a
ingle-price monopoli t i ~eplaced by a perfe tty
competitive market?
(A
(B
(C
(D
Price will increa e.
The deadweight lo will decree e.
Profit will increa e.
Output will decrea e.
(E Tt1e firtn co t curve will hift upward.
Page19
MC = MR at a Monopolyvs. P = MC at a Competitive
Firm- Questions
8. Whict1 of the follo\\,ing i tnost likely to occur if a
ingle-price monopoli t i ~eplaced by a perfe tty
competitive market?
(A
(It.
(C
(D
Price will increa e.
The deadweight lo will decree e.
Profit will increa e.
Output will decrea e.
(E Tt1e firtn co t curve will hift upward.
Page20
The GenericDiagramof a Monopolyand Its Profits
The marginal cost (MC) curve cuts through the average total
cost (ATC) curve at the lowest point on the average total cost
curve. Second, the marginal revenue (MR) curve is below the
demand curve over the entire range of production. Where MR
is "O" is the divider between the elastic range and inelastic
range of demand.
A Monopoly (showing profit)
Price
Margina l cost (MC) / S
Average
tota l cost
(ATC)
Total
revenue
(TR)
Total
costs
(TC)
emand (D) /
marginal benefit (MB)
Margina l
revenue (MR)
Quantity p'duced
\
MR = 0
and TR
is maximized
Page21
Quantity
The GenericDiagramof a Monopolyand Its Profits(cont.)
In the elastic range (> 1), consumers are sensitive to increases
in prices and will pay less of the increase the more the price
increases. In the inelastic range (<1), just the opposite.
A Monopoly (showing profit)
Price
Margina l cost (MC) / S
Average
tota l cost
(ATC)
Total
rev enue
(TR)
Total
costs
(TC)
Marginal
reven u e (MR)
Quantity
/'
produced
emand (D) /
marginal benefit (MB)
~ s::
\
MR = O
a nd TR
is max imized
Page22
Quantity
The GenericDiagramof a Monopolyand Its Profits1.s.
9. A ingle -price monopoli t i currently producing in
the inela tic portion of i market demand curve. In
order to maximize profit the monopoli t hould
change the price and output in which of the
following ways?
A
(B
(C
(D
(E
Page23
Price
Output
Increa e
Increa e
Increa e
Decrea e
Not change
[ncrea e
Oecrea e
Not change
[ncrea e
[ncrease
The GenericDiagramof a Monopolyand Its Profits1.s.
9. A ingle -price monopoli t i currently producing in
the inela tic portion of i market demand curve. In
order to maximize profit the monopoli t hould
change the price and output in which of the
following ways?
Price
A Increa e
Increa e
(C Increa e
(D Decrea e
(E Not change
c•
Page24
Output
[ncrea e
Oecrea e
Not change
[ncrea e
[ncrease
Microeconomics Do-Now
Please do this:
1. Showing a profit or a loss for the monopoly with
whatever numbers you choose, draw a graph that
includes both the profit maximizing/socially
optimal/allocatively efficient point for a competitive firm
and the profit maximizing point for a monopoly. Be sure
to include the MC and ATC curves and a sloping D and
MR curve. Remember that a monoply produces a lower
quantity (Q) and charges a higher price (P) than a
competitive or pure firm.
Page25
Determiningthe Monopoll''
s Profits
Profits are given by the difference between the area of two
rectangles, a total revenue (TR) rectangle and a total costs (TC)
rectangle.
A Monopoly and Its Profit
Price
f R$800- TC$
600==$200 profit
onopol
price (P) ".
Marginal cost (MC) I S
Average
total co t
(ATC)
Total
re enue
(TR)
$800
$600
Marginal
re enu (M R)
Quantit
Page26
/'
produced
..
•
~
\
MR = O
and TR
is maximized
emand (D) /
n1arginal benefit (lWB)
Quantity
Determiningthe Monopoll''
s Profits(cont.)
Is it possible for a monopoly to have negative profits, or
losses? In this case, the price (P) is below average total cost
(ATC), and therefore total revenue (TR) is less than total costs
(TC). Like a competitive firm, a monopoly with negative
profits will shutdown if the price is less than the average
variable cost (AVC). It will eventually exit the market if
negative profits persist.
Marginal cost
(MC) IS
Monopoly
price (P)
Total
(ATC)
Total
costs
and TR
is maximized
(TC)
(TR)
Demand (D) I
marginal
benefit(MBJ
Quantity
Qua nt ity pr o<l u cc, l
Page27
Average
total cost
Competition,Monopoly,and DeadweigbtT,oss
With a lower quantity produced by a monopoly , the sum of
consumer surplus (CS) and producer surplus (PS) is reduced.
This reduction in consumer plus producer surplus is called the
deadweight loss due (DWL) to monopoly. It is a quantitative
measure of the harm a monopol y causes the econom y.
Price
Thi.s am oun f of consu mer
surpl us i turn ed int o pr ofits .
--t
Monopoly
Ma rgina l cos t (.l/ C) for monopoly=
sum of th e marginal cost · for eac h
th e co mpe tit ive firm s= mar ket
suppl y curve for comp etiti\' e indu stry.
or
pr ice
Competit i\'C price
now PS
~
----~
Int ersec ti on of rnarkt· t demand and
ma rke t supply gi,·cs co mpe titi, ·c outpu t.
PS
MR= O
/
and TR
,I' is maximized
Intersec t ion of marg ina l
rev "nu e and mtug ina l cost
gh·PR mo no poly ouqrn t.
Demand (D) / marginal
benefit (MB)
Quantity
t\lonopo]y quantity
Page28