Monopoly
Chapter 9
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Introduction

This chapter examines how a market
controlled by a single producer behaves.
 What
price will a monopolist charge?
 How much will the monopolist produce?
 Are consumers better or worse off when only
one firm controls an entire market?
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Market Power

Market power is the ability to alter the
market price of a good or service.
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The Downward-Sloping
Demand Curve
Firms with market power confront
downward-sloping demand curves.
 Competitive firms face a horizontal
demand curve.

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Firm vs. Industry Demand
Price (per bushel)
The competitive firm
Demand facing
competitive firm
$13
The industry
$13
Market
demand
0
Quantity (bushels per day)
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0
Quantity
(thousands of bushels per day)
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Monopoly
The demand curve facing the monopoly
firm is identical to the market demand
curve for the product.
 Monopoly is a firm that produces the
entire market supply of a particular good or
service.

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Price and Marginal Revenue

A monopoly faces a different profit
maximizing situation than competitive
firms.
 Profit-maximization
rule – Produce at that
rate of output where MR = MC.
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Price and Marginal Revenue

Unlike competitive firms, marginal revenue
for a monopolist is not equal to price.
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Price and Marginal Revenue

Marginal revenue is the change in total
revenue that results from a one-unit
increase in the quantity sold.
Marginal Change in total revenue TR
=
=
q
revenue Change in quantity sold
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Price and Marginal Revenue
So long as the demand curve is downwardsloping, MR will always be less than price.
 The MR curve lies below the demand
(price) curve at every point but the first.

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Price and Marginal Revenue
Quantity
1
2
3
4
5
6
7
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Price
$13
12
11
10
9
8
7
Total
Revenue
$13
24
33
40
45
48
49
Marginal
Revenue
—
$11
9
7
5
3
1
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Price and Marginal Revenue
$14
A
B
Price (per basket)
12
C
D
b
10
E
c
8
F
G
Demand
(= price)
d
6
e
4
f
2
Marginal revenue
g
0
McGraw-Hill/Irwin
1
2
3
4
5
6
7
Quantity (baskets per hour)
8
9
10
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Profit Maximization
We need to find the intersection of
marginal cost and marginal revenue.
 This will give us the profit-maximizing rate
of output.
 Only one price is compatible with the profitmaximizing rate of output.

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Price or Cost (per basket)
Profit Maximization
$14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
McGraw-Hill/Irwin
Average
total cost
D
Profits
d
Demand
Marginal
cost
1
2
Marginal
revenue
3
4
5
6
7
Quantity (baskets per hour)
8
9
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Market Power at Work:
Computer Market Revisited

As an example, we’ll use a fictitious
company called Universal Electronics that
acquires an exclusive patent on the
production of microprocessors.
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Market Power at Work:
Computer Market Revisited

The patent functions as a barrier to entry.
 Barriers
to entry – Obstacles that make it
difficult or impossible for would-be producers
to enter a particular market, such as patents.
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Market Power at Work:
Computer Market Revisited

For comparison purposes, Universal is not
taking advantage of economies of scale.
 Economies
of scale – Reductions in minimum
average costs that come about through
increases in the size (scale) of plant and
equipment.
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The Production Decision
Like any producer, Universal wants to
produce at the rate that maximizes profits.
 Universal faces a production decision
concerning its many plants.

 Production
decision – The selection of the
short-run rate of output (with existing plant
and equipment).
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The Production Decision
Universal cannot have each of its factories
competing with each others – expanding
output and driving down prices.
 Instead, Universal will seek to coordinate
the production decisions of its plants.

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Marginal Revenue
Each Universal plant faces a downwardsloping demand curve, thus, the marginal
revenue no longer equals price.
 Only firms that confront a horizontal
demand curve equate marginal cost and
price.

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Reduced Output

The typical Universal plant will produce
fewer computers that would be produced
by a typical perfectly competitive firm.
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The Monopoly Price

The intersection of the marginal revenue
and marginal cost curves establishes the
profit-maximization rate of output.
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The Monopoly Price

The demand curve tells us how much
consumers are willing to pay for that
output.
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Initial Conditions in the
Monopolized Computer Market
$1200
W
C
1000
Average total cost
800
M
B
600
400
0
1200
Price (per computer)
Price (per computer)
1000
200
Monopoly outcome
Competitive
outcome
Marginal
cost
200 400
Demand
curve facing
single plant
Marginal revenue
of single plant
800
1200
Quantity (computers per month)
1600
800
600
Competitive
market supply
A
X
Market
demand
400
200
0
24,000
Quantity
(computers per month)
Monopoly Profits

Total profit equals average profit per unit
times the number of units produced.
Profit per unit = price – average total cost
Profit per unit = p – ATC
Total profits = profit per unit X quantity
Total profits = (p – ATC) X q
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Monopoly Profits

A monopoly receives larger profits than a
comparable competitive industry by
reducing the quantity supplied and pushing
prices up.
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Monopoly Profits: The Typical
Universal Plant
Marginal cost
Price (per computer)
$1200
W
Average total cost
C
1000
800
Profit
M
600
K
B
Demand curve
facing single plant
400
200
0
McGraw-Hill/Irwin
Marginal revenue of
single plant
200
400
600
800 1000 1200
Quantity (computers per month)
1400
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Monopoly Profits: The Entire
Company
Price (per computer)
Monopolist's equilibrium
$1100
$1000
T
MC
A
R
X
Competitive short-run
equilibrium
ATC
Competitive
long-run equilibrium
Monopoly
profit
V
U
MR
0
McGraw-Hill/Irwin
qM qC
Market demand
Quantity (computers per month)
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Barriers to Entry

Unless there are barriers to entry, high
monopoly profits tend to attract profithungry entrepreneurs into the market.
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Barriers to Entry

These profits will be maintained as long as
barriers to entry prevent any competitors
from entering the market.
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A Comparative Perspective on
Market Power

Outcomes differ under competitive and
monopoly conditions.
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Competitive Industry
High prices and profits signal consumers’
demand for more output.
 The high profits attract new suppliers.
 Production and supplies expand.

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Competitive Industry
Prices slide down the market demand
curve.
 A new equilibrium is established.
 Price equals marginal cost at all times.

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Competitive Industry

Throughout the process, there is great
pressure to reduce costs or improve
product quality.
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Monopoly Industry
High prices and profits signal consumers’
demand for more output.
 Barriers to entry are erected to exclude
potential competition.
 Production and supplies are constrained.

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Monopoly Industry
Prices don’t move down the market
demand curve.
 No new equilibrium is established.
 Price exceeds marginal cost at all times.

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Monopoly Industry

There is no squeeze on profits and thus no
pressure to reduce costs or improve
product quality.
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Monopoly Industry

Because monopoly markets do not tend
towards marginal cost pricing, consumers
do not get the mix of output that delivers
the most utility from available resources.
 Marginal
cost pricing – the offer (supply) of
goods at prices equal to their marginal cost.
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Political Power

A firm with considerable market power
likely to have significant political power as
well.
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The Limits to Power
Monopolists only have absolute control of
the quantity of output supplied to the
market.
 Monopolists must still contend with the
market demand curve.

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The Limits to Power

How strong a constraint that is depends on
the price elasticity of demand.
 Price
elasticity of demand – The percentage
change in quantity demanded divided by the
percentage change in price.
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The Limits to Power

The greater the price elasticity of demand,
the more a monopolist will be frustrated in
its attempts to establish both high prices
and high volume.
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Price Discrimination
A monopolist may be able to extract
greater profits by practicing price
discrimination.
 Price discrimination is the sale of an
identical good at different prices to different
consumers by a single seller.

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Entry Barriers

There are six barriers to entry.
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Entry Barriers

Patents – offers a producer 20 years of
exclusive rights to produce a particular
product.
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Entry Barriers

Monopoly franchises – governments also
create and maintain monopolies by giving
a single firm the exclusive right to supply a
particular good or service.
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Entry Barriers

Control of key inputs – a company may
lock out competition by securing exclusive
access to key inputs.
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Entry Barriers

Lawsuits – may be used to prevent new
companies from successfully entering an
industry.
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Entry Barriers

Acquisition – when all else fails, purchase
a potential competitor.
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Entry Barriers

Economies of scale – a monopoly may
persist because of cost advantages over
smaller firms
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Pros and Cons of Market Power

It is conceivable that monopolies could
benefit society.
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Research and Development
Because of their greater profits,
monopolists have a greater advantage in
pursuing research and development.
 They do not have a clear incentive to do
so.

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Entrepreneurial Incentives
Market power can be an incentive for
entrepreneurial activity.
 An innovator can make substantial profits
in a competitive market before the
competition catches up.

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Economies of Scale

If economies of scale exist, the monopolist
may attain much greater efficiency than a
large number of competitive firms.
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Economies of Scale

There is no guarantee that such
economies of scale will exist in a given
industry.
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Natural Monopolies

A natural monopoly is an industry in
which one firm can achieve economies of
scale over the entire range of market
supply.
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Natural Monopolies

Economies of scale act as a “natural”
barrier to entry.
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Natural Monopolies

Examples of natural monopolies include
local telephone services, local cable
services, and other local utility services.
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Natural Monopolies

While economically desirable, natural
monopolies may be abused.
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Contestable Markets

A contestable market is an imperfectly
competitive market subject to potential
entry if prices or profits increase.
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Contestable Markets
Contestable markets are characterized by
moderate barriers to entry.
 When potential profits reach a certain level
competitors are enticed to enter the
market.

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Structure vs. Behavior
The structure of monopoly is, in itself, not a
problem.
 If potential rivals force a monopolist to
behave like a competitive firm, then a
monopoly imposes no cost on consumers
or on society at large.

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Microsoft: Bully or Genius?

Concerning Microsoft, critics argue that
Microsoft:
 Charges
too much for its systems software.
 Suppresses substitute technologies.
 Bullies potential competitors.
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The AT&T Case
The federal government dismantled AT&T
in 1984.
 Prior to the break-up, AT&T supplied 96
percent of all long-distance service and
over 80 percent of local telephone service.

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The AT&T Case

The authority for the federal government to
break up monopolies lies in the three major
antitrust laws existing in the U.S.
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Antitrust Laws

Sherman Act (1890) – prohibits
“conspiracies in restraint of trade.
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Antitrust Laws

Clayton Act (1914) – principally aimed at
preventing the development of monopolies
by prohibiting price discrimination,
exclusive dealing agreements, certain
types of mergers, and interlocking boards
of directors among competing firms.
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Antitrust Laws

The Federal Trade Commission Act
(1914) – created the FTC to study industry
structures and behavior so as to identify
anti-competitive practices.
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The Microsoft Case

The antitrust accusations against Microsoft are:
 It thwarted competitors in operating systems
by erecting entry barriers, including exclusive
purchase agreements with computer
manufacturers.
 It used its monopoly position in operating
systems to gain an unfair advantage in the
applications market.
 It bought out its competitors.
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Microsoft’s Defense

In its defense, Microsoft asserted that:
 It
dominates the computer industry because it
produces the best products at attractive prices.
 The computer industry is highly contestable if
not perfectly competitive.
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The Verdict

A federal court concluded that Microsoft
abused its monopoly position in operating
systems.
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The Verdict

By limiting consumer choices and stifling
competition, Microsoft had denied
consumers better and cheaper information
technology.
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The Remedy
The trial judge suggested a structural
remedy, that Microsoft might have to be
broken into two companies to ensure
competition.
 The U.S. Department of Justice decided to
seek a behavioral remedy instead.

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Monopoly
End of Chapter 9
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