Chapter 10
Monopoly
(Part II)
© 2004 Thomson Learning/South-Western
What’s Wrong with Monopoly?

Profitability
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–

2
Monopoly power is the ability to raise price above
marginal cost.
Profits are the difference between price and
average cost.
In Figure 10.2, one firm earns positive
economic profits (a) while the other (b) earns
zero economic profits.
FIGURE 10.2: Monopoly Profits Depend on the Relationship
between the Demand and Average Cost Curves
Price
Price
MC AC
MC
AC
P*
P*=AC
AC
D
D
MR
0
Q*
Quantity
per week
(a) Monopoly with Large Profits
3
MR
0
Q*
Quantity
per week
(b) Zero-Profit Monopoly
What’s Wrong with Monopoly?
–

People may also be concerned that economic
profits go to the wealthy.
–
4
If monopoly rents accrue to inputs, the monopoly
may appear to not earn a profit.
However, as with the Navajo blanket monopoly, the
profits of the low-income Navajo are coming from
the more wealthy tourists.
APPLICATION 10.2: Who Makes Money
at Casinos?



5
U.S. casinos take in about $50 billion each year in
gross revenues.
In some markets, casinos operate quite
competitively…there are so many casinos in Las
Vegas that it is unlikely that any one of them has
much power to set prices monopolistically.
However, many other locales have adopted such
restrictions on the numbers and sizes of casinos that
owners of these casinos are able to capture
substantial monopoly profits.
Riverboat Gambling




6
A number of states on the Mississippi River
permit casino gambling only in riverboats.
One clear impact of the way that riverboat
gambling is regulated is to provide monopoly
rents to a number of different parties.
States are the primary beneficiaries – they
usually tax net profits from riverboats at more
than 30 percent.
The owners of riverboats also make monopoly
profits.
Indian Gaming




7
The Indian Gaming Regulatory Act of 1988 clarified
the relationship between state and the Indian tribes
living within their borders.
The Act made it possible for these tribes to offer
casino gambling under certain circumstances.
Since the passage of the Act, more than 120 tribes
have adopted some form of legalized gambling.
The distributional consequences of Indian gaming are
generally beneficial.
What’s Wrong with Monopoly

Distortion of Resource Allocation
–
Monopolists restrict their production to maximize
profits.

–
8
Since price exceeds marginal cost, consumers are willing
to pay more for extra output than it costs to produce it.
From societies point of view, output is too low as
some mutually beneficial transactions are missed.
Distortion of Resource Allocation


9
In Figure 10.3 the monopolist is assumed to
produce under conditions of constant marginal
cost.
Further, it is assumed that if the good where
produced by a perfectly competitive industry,
the long-run cost curve would be the same as
the monopolist’s.
Distortion of Resource Allocation



10
In this situation, a perfectly competitive industry
would produce Q* where demand equals longrun supply.
A monopolist produces at Q** where marginal
revenue equals marginal cost.
The restriction in output (Q* - Q**) is a
measure of the harm done by a monopoly.
FIGURE 10.3: Allocational and
Distributional Effects of Monopoly
Price D
MR
B
P**
MC ( =AC)
A
11
0
Q**
Quantity per week
Monopolistic Distortions and
Transfers of Welfare

The competitive output level (Q* in Figure 10.3)
is produced at price P*.
–
–
12
The total value to consumers is the area DEQ*0
Consumers’ pay P*EQ*0.
Consumer surplus is DEP*.
FIGURE 10.3: Allocational and
Distributional Effects of Monopoly
Price
D
MR
B
P**
P*
13
E
A
MC ( =AC)
0
Q**
Q*
Quantity per week
Allocational Effects

A monopolist would product Q** at price P**.
–
–
–
14
Total value to the consumer is reduced by the area
BEQ*Q**.
However, the area AEQ*Q** is money freed for
consumers to spend elsewhere.
The loss of consumer surplus is BEA which is often
called the deadweight loss from monopoly.
FIGURE 10.3: Allocational and
Distributional Effects of Monopoly
Price D
MR
B
P**
P*
15
E
A
MC ( =AC)
Value of
transferred
inputs
0
Q**
Q*
Quantity per week