Lecture 10 In this chapter, look for the answers to

these questions:
Why do monopolies arise?
Why is MR < P for a monopolist?
Monopoly How do monopolies choose their P and Q?
How do monopolies affect societys well-being?
What can the government do about monopolies?
What is price discrimination?

Figure 1 The Four Types of Market Structure

Introduction
A monopoly is a firm that is the sole seller of a
Number of Firms?
product without close substitutes.
Many
firms In this chapter, we study monopoly and contrast
Type of Products? it with perfect competition.
One Few Differentiated Identical The key difference:
firm firms products products
A monopoly firm has market power, the ability
Monopolistic Perfect
to influence the market price of the product it
Monopoly Oligopoly Competition Competition sells. A competitive firm has no market power.
Tap water Tennis balls Novels Wheat
Cable TV Crude oil Movies Milk

2 3

Why Monopolies Arise Why Monopolies Arise

The main cause of monopolies is barriers 3. Natural monopoly: a single firm can produce
to entry other firms cannot enter the market. the entire market Q at lower ATC than could
several firms.
Three sources of barriers to entry:
Example: 1000 homes
1. A single firm owns a key resource. need electricity. Cost Electricity
E.g., DeBeers owns most of the worlds Economies of
diamond mines ATC is lower if scale due to
one firm services huge FC
2. The govt gives a single firm the exclusive right all 1000 homes $80
to produce the good. than if two firms $50 ATC
E.g., patents, copyright laws each service
Q
500 homes. 500 1000
4 5

1
Monopoly vs. Competition: Demand Curves
In a competitive market,
the market demand curve
slopes downward.
but the demand curve
for any individual firms
product is horizontal
at the market price.
Monopoly vs. Competition: Demand Curves
A monopolist is the only
seller, so it faces the
market demand curve.
A competitive firms A monopolists
demand curve To sell a larger Q, demand curve
P P
the firm must reduce P.
Thus, MR P.

The firm can increase Q D

without lowering P,
so MR = P for the D
competitive firm. Q Q

6 7

A C T I V E L E A R N I N G 1: A C T I V E L E A R N I N G 1:
A monopolys revenue Answers
Moonbucks is
Q P TR AR MR Q P TR AR MR
the only seller of Here, P = AR,
cappuccinos in town. 0 P4.50 n.a. same as for a 0 P4.50 P0 n.a.
$4
The table shows the 1 4.00 competitive firm. 1 4.00 4 $4.00
market demand for 3
2 3.50 Here, MR < P, 2 3.50 7 3.50
cappuccinos. whereas MR = P 2
3 3.00 for a competitive 3 3.00 9 3.00
Fill in the missing 1
spaces of the table. 4 2.50 firm. 4 2.50 10 2.50
0
What is the relation 5 2.00 5 2.00 10 2.00
between P and AR? 1
6 1.50 6 1.50 9 1.50
Between P and MR?
8 9

Moonbucks D and MR Curves Understanding the Monopolists MR

Increasing Q has two effects on revenue:
P, MR
The output effect:
P5
More output is sold, which raises revenue
4
Demand curve (P) The price effect:
3
The price falls, which lowers revenue
2
1 To sell a larger Q, the monopolist must reduce the
0
price on all the units it sells.
-1 MR Hence, MR < P
-2 MR could even be negative if the price effect
-3 exceeds the output effect
0 1 2 3 4 5 6 7 Q
(e.g., when Moonbucks increases Q from 5 to 6).
10 11

2
 Profit-Maximization Profit-Maximization
Like a competitive firm, a monopolist maximizes
profit by producing the quantity where MR = MC. Costs and
1. The profit- Revenue MC
Once the monopolist identifies this quantity, maximizing Q
it sets the highest price consumers are willing to is where P
pay for that quantity. MR = MC.
It finds this price from the D curve. 2. Find P from
the demand D
curve at this Q. MR

Q Quantity

Profit-maximizing output
12 13

Figure 4 Profit Maximization for a Monopoly

The Monopolists Profit
Costs and
2. . . . and then the demand
Revenue 1. The intersection of the Costs and
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost Revenue MC
curve determines the
B profit-maximizing
Monopoly quantity . . . As with a P
price ATC
competitive firm, ATC
Monopoly
profit
Average total cost the monopolists
A profit equals D
Average
total
Demand
(P ATC) x Q MR
cost Marginal
cost
Q Quantity
Marginal revenue

0 Q QMAX Q Quantity
14 15

Figure 9 Marginal-Cost Pricing for a Natural Monopoly

A Monopoly Does Not Have an S Curve
A competitive firm
Price
takes P as given
has a supply curve that shows how its Q depends
on P
A monopoly firm
Average total
cost Average total cost is a price-maker, not a price-taker
Loss
Regulated
Marginal cost
Q does not depend on P;
price
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
Demand

0 Quantity
So there is no supply curve for monopoly.
16 17

3
 Case Study: Monopoly vs. Generic Drugs The Welfare Cost of Monopoly
The market for Recall: In a competitive market equilibrium,
Patents on new drugs
Price a typical drug P = MC and total surplus is maximized.
give a temporary
monopoly to the seller. In the monopoly eqm, P > MR = MC
When the
PM The value to buyers of an additional unit (P)
patent expires, exceeds the cost of the resources needed to
the market PC = MC produce that unit (MC).
becomes competitive, D The monopoly Q is too low
generics appear. could increase total surplus with a larger Q.
MR
Thus, monopoly results in a deadweight loss.
QM Quantity
QC

18 19

The Welfare Cost of Monopoly Monopoly- Public Policy

Government responds to the problem of monopoly in one of four ways.
Making monopolized industries more competitive.
Competitive eqm: Regulating the behavior of monopolies.
Price Deadweight
quantity = QE Turning some private monopolies into public enterprises.
loss MC
Doing nothing at all.
P = MC Antitrust laws are a collection of statutes aimed at curbing monopoly
total surplus is P power and to promote competition; however, Philippines has weak
P = MC antitrust policy.
maximized Anti-trust policies in developed countries allow government to prevent
MC mergers, break up companies and prevent companies from performing
Monopoly eqm: activities that make markets less competitive.
D Philippine law mainly provides only for compensation for firms and
quantity = QM consumers that arise from anti-competitive behavior:
MR - Civil Code (RA 386) allows for compensation due to unfair
P > MC competition.
deadweight loss - RA 165 provides for recovery of losses arising from anti-
QM QE Quantity competitive behavior.
At the same time, many laws restrict competition in the country, i. e.
Constitutional prohibition for foreign ownership of firms in many
industries.
20 21

PC = MC maximizes total surplus:

When the demand curve is above the MC curve, willingness to pay for one more unit exceeds the cost of providing one more unit, so it is efficient to keep producing.

Public Policy Toward Monopolies Public Policy Toward Monopolies

Increasing competition with antitrust laws Public ownership
Examples: Sherman Antitrust Act (1890), Problem: Public ownership is usually less
Clayton Act (1914) efficient since no profit motive to minimize costs
Antitrust laws ban certain anticompetitive
because the losers will be the customers and taxpayers
Doing because
nothingthe losers will be the customers and taxpayers
practices, allow govt to break up monopolies.
The foregoing policies all have drawbacks,
Regulation so the best policy may be no policy.
Govt agencies set the monopolists price
For natural monopolies, MC < ATC at all Q,
so marginal cost pricing would result in losses.
If so, regulators might subsidize the monopolist
or set P = ATC for zero economic profit.
22 23

4
 Monopoly- Public Policy Price Discrimination
Government may regulate the prices that the monopoly charges.
The allocation of resources will be efficient if price is set to equal Discrimination is the practice of treating people
marginal cost.
In practice, regulators will allow monopolists to keep some of the differently based on some characteristic, such as
benefits from lower costs in the form of higher profit, a practice
that requires some departure from marginal-cost pricing. In the race or gender.
Philippines, as regulators have difficulty in assessing marginal
costs of monopolists, firms are allowed to charge through the Price discrimination is the business practice of
return on rate base pricing.
This occurs in the following sectors: energy (Energy Regulatory selling the same good at different prices to
Commission), water (Metropolitan Waterworks and Sewerage
System/ Local Water Utilities Administration), roads (Toll
different buyers.
Regulatory Board).
Rather than regulating a natural monopoly that is run by a private firm,
The characteristic used in price discrimination
the government can run the monopoly itself (e.g. the Philippine is willingness to pay (WTP):
government runs the Philippine Postal Corporation and the National
Power Corporation; but at very huge losses). A firm can increase profit by charging a higher
Governments have to balance arguments for and against price to buyers with higher WTP.
government ownership of monopolies
Government can do nothing at all if the market failure is deemed small
compared to the imperfections of public policies. 24 25

Perfect Price Discrimination vs. Perfect Price Discrimination vs.

Single Price Monopoly Single Price Monopoly
Here, the monopolist
Here, the monopolist Consumer
Price produces the Price
charges the same surplus Monopoly
competitive quantity,
price (PM) to all profit
Deadweight but charges each
buyers. PM loss buyer his or her WTP.
A deadweight loss This is called perfect
results. MC
price discrimination.
MC
Monopoly
profit D D
The monopolist
MR captures all CS MR
as profit.
QM Quantity Quantity
But theres no DWL. Q
26 27

Price Discrimination in the Real World Examples of Price Discrimination

In the real world, perfect price discrimination is Movie tickets
not possible: Discounts for seniors, students, and people
no firm knows every buyers WTP who can attend during weekday afternoons.
buyers do not announce it to sellers They are all more likely to have lower WTP
than people who pay full price on Friday night.
So, firms divide customers into groups
based on some observable trait Airline prices
that is likely related to WTP, such as age. Discounts for Saturday-night stayovers help
distinguish business travelers, who usually have
higher WTP, from more price-sensitive leisure
travelers.

28 29

5
 Examples of Price Discrimination
Discount coupons
People who have time to clip and organize
coupons are more likely to have lower income
and lower WTP than others.
Need-based financial aid
Low income families have lower WTP for
their childrens college education.
Schools price-discriminate by offering
need-based aid to low income families.
Examples of Price Discrimination
Quantity discounts
A buyers WTP often declines with additional
units, so firms charge less per unit for large
quantities than small ones.
Example: A movie theater charges P4 for
a small popcorn and P5 for a large one thats
twice as big.

30 31

CONCLUSION: The Prevalence of Monopoly

CHAPTER SUMMARY
In the real world, pure monopoly is rare.
Yet, many firms have market power, due to
selling a unique variety of a product
having a large market share and few significant
competitors
In many such cases, most of the results from
this chapter apply, including
markup of price over marginal cost
deadweight loss
A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry,
including: government-granted monopolies, the
control of a key resource, or economies of scale
over the entire range of output.
A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it must
reduce price to sell a larger quantity, which causes
marginal revenue to fall below price.

32 33

CHAPTER SUMMARY
Monopoly firms maximize profits by producing the
quantity where marginal revenue equals marginal cost.
But since marginal revenue is less than price, the
monopoly price will be greater than marginal cost, and MR decreases due to price effect
leading to a deadweight loss.
Policymakers may respond by regulating monopolies,
using antitrust laws to promote competition, or by taking
over the monopoly and running it. Due to problems with
each of these options, the best option may be to take no
action.
Monopoly firms (and others with market power) try to
raise their profits by charging higher prices to consumers
with higher willingness to pay. This practice is called
price discrimination.

34