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©Copyright 2017 by the UBC Real Estate Division
LESSON 8
Monopoly
Assigned Reading
1.
Mankiw, N. Gregory, et al. 2014. Principles of Microeconomics (6th Canadian Edition). Toronto:
Nelson Education Ltd.
Chapter 15: Monopoly
Recommended Reading
1.
Mankiw, N. Gregory, et al. 2014. Study Guide to Accompany Principles of Microeconomics
(6th Canadian Edition). Toronto: Nelson Education Ltd.
Chapter 15: Monopoly
Learning Objectives
After studying this lesson, students should be able to:
1.
identify the characteristics and sources of monopoly;
2.
analyze how a monopoly determines the quantity to produce and the price to charge to maximize
profits;
3.
show how a monopolist's demand and marginal revenue are different from a perfect competitor's;
4.
evaluate the efficiency of monopoly;
5.
identify some of the various public policies toward monopoly: competition law, regulation, public
ownership, and doing nothing;
6.
explain how and why a monopolist would charge different prices to different customers (price
discriminate);
7.
provide examples of price discrimination; and
8.
explain the difference in the effect on total surplus if the monopolist can or cannot price
discriminate.
Instructor's Comments
This lesson deals with imperfectly competitive market structures. In understanding any imperfectly
competitive market structure, it is essential to analyze the least competitive structure: monopoly. This
analysis is structured around several key questions: What are the cost conditions that give rise to monopoly?
How does a monopoly maximize its profit, and how do its output and price compare to those of a perfectly
competitive industry? Why is monopoly inefficient? What is the appropriate policy towards monopoly?
8.1
©Copyright 2017 by the UBC Real Estate Division
Lesson 8
A monopoly will occur in an environment where there is a complete absence of market competition, in
which the firm is a price maker. This lesson combines the previous cost analysis from Lesson 7 with a
downward-sloping demand curve for the individual firm's output. Profit maximization occurs where
marginal cost is equal to marginal revenue, but now pricing is along the firm's demand curve which is also
the market demand curve.
Some of the difficulties in regulating a monopoly are evident in the recent Microsoft case in the United
States. Microsoft was accused of being an illegal monopoly and using its monopoly position to restrain
trade. In particular, Microsoft was accused of using its control of the operating system market in order to
seize control of the web browser market from Netscape. The court sided with the government, finding that
Microsoft had in fact behaved illegally. Finding appropriate remedies and sanctions has posed a challenge.
The United States Justice Department offered a proposal to break Microsoft into two separate companies,
one responsible for the operating system and the other for applications. The most important application is
Microsoft Office. Currently, Microsoft's market share for both the operating system and Office is in the area
of 90%. Thus, the Justice Department's proposal amounts to splitting one monopoly into two monopolies.
Unless the two monopolies are more vulnerable to competition than one combined monopoly would be, this
remedy may, in fact, make the situation worse. In the current situation, Microsoft will restrain its pricing on
the operating system in order to increase demand for its applications. Similarly, it will restrain its pricing on
applications in order to increase demand for the operating system. This is a standard result when a monopoly
produces complementary goods. When the monopoly is broken-up, however, the price restraint may also
disappear. In this case, consumers may actually be forced to pay more as a result of the Justice Department's
proposal. Thus, attempts to loosen a monopolist's control of the market must take into account the effects
beyond just reducing control.
Potential monopolists in real estate markets face other challenges. The monopolists ability to control the
market depends on the absence of substitutes, which explains DeBeers's aggressive advertising campaign
outlined in the text to differentiate diamonds from other gems. In real estate, the supply of real estate from
existing buildings (the stock of real estate) or at other locations acts as a break on monopolist tendencies.
For instance, in a metropolitan area where one large developer controls all of the vacant land suitable for
development, the ability of consumers to buy existing units or for other developers to acquire existing
buildings and redevelop them acts to limit, though not to prevent, the ability of the large developer to
increase prices. If the developer is constructing a multi-building project, such as the Expo Lands
development by Concord Pacific on Vancouver's False Creek, any new building faces competition from
units in the buildings already constructed. Because every location is unique, any building has a certain
"local" monopoly power because it is the only supply at its precise location. However, because other
locations are imperfect substitutes, such as suburban office buildings and downtown office buildings, the
ability of a property owner to exploit this power by charging high rents is limited.
Another concept from this lesson that has direct application to real estate is the idea of barriers to entry. As
noted in the readings, competition will be imperfect whenever it is impossible to enter or exit the market
without a cost. Consider the case of real estate brokerage. This is a market where entry is restricted by
professional licensing requirements. Thus, there is an entry barrier. However, it is important to remember
that professional licensing requirements serve the important function of assuring customers of the expertise
of their brokers. Thus, although the readings imply that entry barriers are bad, that is not necessarily the
case. Although they may restrict competition, they may serve other useful roles.
8.2
©Copyright 2017 by the UBC Real Estate Division
Monopoly
Review and Discussion Questions
1.
Explain why a monopolist produces a lower output than a competitive industry produces, even
though both maximize profit by producing where MC = MR.
2.
What are the advantages and disadvantages of price discrimination for the monopolist and for
society as a whole?
3.
What are competition laws and what are their advantages and disadvantages for economic
efficiency?
4.
The chart below provides cost and revenue data for Tara's Greenhouse:
Quantity
0
1
2
3
4
5
6
7
8
9
FC
40
VC
0
30
50
58
64
70
80
94
114
144
TC
MC
P
25
24
23
22
21
20
19
18
17
16
TR
MR
AVC
(a)
Fill in the blanks.
(b)
Is this firm a competitive firm? How can you tell?
(c)
What price should Tara's Greenhouse charge and what output should it produce? What
profit or loss will result? Is this a long-run equilibrium? Explain.
THE NEXT TWO (2) QUESTIONS ARE BASED ON THE FOLLOWING INFORMATION:
The production and distribution of electric power traditionally has been treated as a natural monopoly subject
to government regulation of pricing.
5.
Explain clearly why this is so. Would this industry still be a natural monopoly without regulation?
6.
Recently, there has been a move to deregulate the power industry and allow competition among
producers, who could buy and sell electricity through a nationwide power grid similar to the
pipelines used to transport petroleum or natural gas. How would this affect the industry's status as a
natural monopoly?
7.
Describe a government-created monopoly. How is one created? Why might one be created? Give an
example.
8.
What is the defining characteristic of a natural monopoly? Give an example of a natural monopoly.
9.
Why might economists prefer private ownership of monopolies over public ownership of
monopolies?
8.3
©Copyright 2017 by the UBC Real Estate Division
Lesson 8
10.
Consider the delivery of mail. In general, what is the shape of the average total cost curve? How
might the shape differ between isolated rural areas and densely populated urban areas? How might
the shape have changed over time? Explain.
11.
A small town is served by many competing supermarkets, which have constant marginal cost.
12.
13.
(a)
Using a diagram of the market for groceries, show the consumer surplus, producer surplus,
and total surplus.
(b)
Now suppose that the independent supermarkets combine into one chain. Using a new
diagram, show the new consumer surplus, producer surplus, and total surplus. Relative to
the competitive market, what is the transfer from consumers to producers? What is the
deadweight loss?
For many years, both local and long-distance phone service has been provided by provincially
owned or regulated monopolies.
(a)
Explain why long-distance phone service was originally a natural monopoly.
(b)
Over the past two decades, technological developments have allowed companies to launch
communication satellites that can transmit a limited number of calls. How did the growing
role of satellites change the cost structure of long-distance phone service?
(c)
In response to these technological developments, some provinces have deregulated the longdistance market in Canada. Local phone service has remained regulated. Why might it be
efficient to have competition in long-distance phone service and regulated monopolies in
local phone service?
Rapper Drake has a monopoly of a scarce resource: himself. He is the only person who can produce
a Drake concert. Does this fact imply that the government should regulate the prices of his concerts?
Why or why not?
8.4
©Copyright 2017 by the UBC Real Estate Division
Monopoly
ASSIGNMENT 8
CHAPTER 15: Monopoly
Marks: 1 mark per question.
THE NEXT TWO (2) QUESTIONS ARE BASED ON THE FOLLOWING TABLE:
1.
Fixed Costs
(dollars)
Total Variable
Cost (dollars)
100
0
50
0
90
1
50
25
80
2
50
40
70
3
50
50
60
4
50
70
50
5
50
100
40
6
50
140
30
7
50
190
20
8
50
250
3 units.
4 units.
5 units.
6 units.
The profit-maximizing single-price monopolist's maximum profit is:
(1)
(2)
(3)
(4)
3.
Demanded
Output (units)
The profit-maximizing single-price monopolist should produce:
(1)
(2)
(3)
(4)
2.
Quantity Price
(dollars)
$100
$110
$120
$130
There are examples in the market in which the government helps firms create monopolies. Why
would they do this?
(1)
(2)
(3)
(4)
They only do this for Crown corporations to raise the government's revenue base.
The government wants the firm to produce and the firm will only produce if there is a
monopoly.
The firm that is granted a monopoly has an extraordinarily high average total cost.
Both (2) and (3) are true.
Assignment 8 continued on the next page
8.5
©Copyright 2017 by the UBC Real Estate Division
Lesson 8
4.
How does a monopoly differ from a firm in a competitive market?
A.
B.
C.
D.
(1)
(2)
(3)
(4)
5.
must sell to the government.
must sell in international markets.
must use its market power to force up the price of complementary products.
must lower its price.
The economic inefficiency of a monopolist can be measured by:
(1)
(2)
(3)
(4)
7.
A and C only
B only
B, C, and D only
None of the above.
In order to sell more of its product, a monopolist:
(1)
(2)
(3)
(4)
6.
the number of consumers who are unable to purchase the product because of its high price.
the deadweight loss.
the excess profit generated by monopoly firms.
the poor quality of service offered by monopolist firms.
Barriers to entry in a monopoly arise when:
A.
B.
C.
D.
(1)
(2)
(3)
(4)
8.
A monopolist is unable to set prices, while a firm in a competitive market is able to
set prices.
A monopoly has barriers to entry, while a firm in a competitive market does not
have barriers to entry.
A monopolist's demand curve equals the market demand curve, while a firm in a
competitive market's demand curve does not equal the market demand curve.
A monopolist has many substitutes, while a competitive firm does not have many
substitutes.
a key resource is owned by a single firm.
the government awards a firm the exclusive right to produce a product.
average total costs are always declining.
a firm faces perfectly elastic demand.
A or B only
C only
A, B, or C only
All of the above
Since natural monopolies have a declining average cost curve, regulating natural monopolies by
setting price equal to marginal cost would:
(1)
(2)
(3)
(4)
result in a less than optimal total surplus.
maximize producer surplus.
cause the monopolist to operate at a loss.
all of the above
Assignment 8 continued on the next page
8.6
©Copyright 2017 by the UBC Real Estate Division
Monopoly
THE NEXT TWO (2) QUESTIONS ARE BASED ON THE FOLLOWING GRAPH:
9.
A profit-maximizing monopolist will choose to produce
(1)
(2)
(3)
(4)
10.
(P5
(P5
(P4
(P3
– P2 ) × Q0
– P0 ) × Q0
– P1 ) × Q1
– P1 ) × Q2
Monopolists typically choose to use complex pricing schemes only if it results in:
(1)
(2)
(3)
(4)
12.
Q3
Q0
Q2
Q1
A profit-maximizing monopolist will have profit equal to:
(1)
(2)
(3)
(4)
11.
units of output.
decreased consumer surplus.
increased social welfare.
increased profits.
None of the above
When governments decide not to attempt to correct monopoly inefficiencies:
(1)
(2)
(3)
(4)
it is generally because the gain in total surplus is less than the cost of intervention in the market.
it is generally because they are unaware of the problems of monopolies.
they are assuming that competitive pressure in the market will resolve the problem without
intervention.
there is typically no evidence of deadweight loss from the monopoly.
End of Assignment 8
8.7
©Copyright 2017 by the UBC Real Estate Division
Lesson 8
13.
Why is there no supply curve for a monopoly?
(1)
(2)
(3)
(4)
14.
A monopolist has no choice over how much it supplies.
Supply curves are never required when determining price and quantity, for any type of producer.
Since a monopolist is a price setter, it is irrelevant to see how much will be produced at
different prices.
Both (1) and (3) are true.
Governments have typically responded to monopoly inefficiency by:
A.
B.
C.
D.
(1)
(2)
(3)
(4)
15.
can prevent firms from price discriminating.
arbitrage
fluctuating resource prices
high fixed costs
all of the above
Natural monopolies differ from other forms of monopoly because:
(1)
(2)
(3)
(4)
17.
A and D only
A, B, and C
B and C only
All of the above
Certain market forces such as
(1)
(2)
(3)
(4)
16.
regulating the behaviour of monopolies.
turning some private monopolies into public enterprises.
doing nothing at all.
forcing monopolists to go out of business.
they are generally not worried about competition eroding their monopoly position in the
market.
they are not subject to barriers to entry.
they are not regulated by government.
they generally do not make a profit.
Which of the following is not an example of price discrimination?
A.
B.
C.
D.
(1)
(2)
(3)
(4)
A restaurant charges different prices for the same meal, depending on whether it is
served at lunch or dinner.
A cell phone provider used to charge $50 for services for all customers. Now they
have a discount subsidiary that charges $30 for reduced services.
A ski resort offers a student discount on lift tickets.
A spa offers coupons on an online coupon website.
A only
B and D only
B, C, and D only
All of the above are examples of price discrimination
Assignment 8 continued on the next page
8.8
©Copyright 2017 by the UBC Real Estate Division
Monopoly
18.
In order to maximize profits, a monopoly will:
(1)
(2)
(3)
(4)
19.
If a regulated monopoly is unable to generate profits at the "marginal-cost pricing" regulated level
of production, then:
(1)
(2)
(3)
(4)
20.
the regulated monopolist will only exit the industry if they can make a profit.
the regulated monopolist should try to minimize losses in the long run.
the government should always purchase the monopoly.
it may make sense for the government to subsidize the monopolist.
All monopolies are associated with a form of
market outcomes.
(1)
(2)
(3)
(4)
___
20
set price and quantity where marginal revenue equals marginal cost.
set price and quantity where marginal revenue equals average total cost.
set quantity where marginal revenue equals marginal cost and price where quantity equals
the demand curve.
set quantity where demand equals marginal cost and price where marginal revenue equals
marginal cost.
; this provides a role for
to improve
entrepreneurial success, the invisible hand
market failure, government
cost failure, the invisible hand
social efficiency, government
Total Marks
End of Assignment 8
8.9
©Copyright 2017 by the UBC Real Estate Division