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Chapter 24
Monopoly
Introduction
States have various licensing requirements for
individuals who wish to practice specific professions.
For example, Ohio requires a $100 license fee to
become a kick boxer. Other states mandate specific
education requirements for interior designers.
What are the economic effects of these and other legal
requirements for entry into a profession?
Chapter 24 will explore the answer to this question.
Copyright 2014 Pearson Education, Inc. All rights reserved.
24-2
Learning Objectives
Identify situations that can give rise to monopoly
Describe the demand and marginal revenue
conditions a monopolist faces
Discuss how a monopolist determines how much
output to produce and what price to charge
Evaluate the profits earned by a monopolist
Understand price discrimination
Explain the social cost of monopolies
24-3
Chapter Outline
Definition of a Monopolist
Barriers to Entry
The Demand Curve a Monopolist Face
Elasticity and Monopoly
Cost and Monopoly Profit Maximization
Calculating Monopoly Profit
On Making Higher Profits: Price
Discrimination
The Social Cost of Monopolies
24-4
Did You Know That ...

Private hospitals are among the most profitable
companies in the U.S.?
A common characteristic among the most
profitable private hospitals is that they are all the
only large, full-service hospitals located within the
regions surrounding the cities in which they are
based.
In this chapter, you will learn the reasons for
substantial profits earned by a monopoly, a
business that is the only seller.
24-5
Definition of a Monopolist
Monopolist
A single supplier of a good or service for which
there is no close substitute
The monopolist therefore constitutes the entire
industry
24-6
Barriers to Entry
Question
How does a firm obtain monopoly power?
Answer
Barriers to entry that allow the firm to make
long-run economic profits
Barriers to entry are restrictions on who can
start as well as stay in business.
24-7
International Example: The Canadian

Wheat Monopoly
In Canada, the Canadian Wheat Board is the
only entity permitted by law to sell the
wheat produced by the countrys farmers.
It purchases the harvest from all farmers
and then acts as the sole supplier.
This is an example of monopoly.
24-8
Barriers to Entry (cont'd)

Barriers to entry include:
Ownership of resources without close substitutes
Economies of scale
Legal or governmental restrictions
24-9

Ownership of resources without close
substitutes
The Aluminum Company of America (ALCOA) at
one time owned most of of the worlds bauxite
24-10

Economies of scale
Low unit costs and prices drive out rivals
The largest firm can produce at the lowest
average total cost
24-11

Natural Monopoly
A monopoly that arises from the peculiar
production characteristics in an industry
It usually arises when there are large economies
of scale
One firm can produce at a lower average cost
than can be achieved by multiple firms
24-12
Figure 24-1 The Cost Curves That Might Lead

to a Natural Monopoly
24-13

Licenses, franchises, and certificates of
convenience
Examples include
Electrical utilities
Radio and television broadcasting
24-14
Policy Example: Waging Economic War on

Childrens Lemonade Stands
Some children who become entrepreneurs by
opening a neighborhood lemonade stand find
themselves confronted with law-enforcement
officials requiring payment of a license fee.
Typically, these children give up the lemonade
business and search for other income-generating
opportunities in the neighborhood.
24-15

Patents
Intellectual property
Tariffs
Taxes on imported goods
Regulation
Government enforcement of safety and quality
24-16
The Demand Curve a Monopolist

Faces
The monopolist faces the industry demand
curve because the monopolist is the entire
industry
24-17

Faces (cont'd)
Recall that under perfect competition
Firm faces perfectly elastic demand curve, it is a
price taker
The forces of supply and demand establish the
price per unit
Marginal revenue, average revenue, and price
are all the same
24-18

Faces (cont'd)
Marginal revenue equals the change in total
revenue due to a one-unit change in the
quantity produced and sold
24-19

Faces (cont'd)
Perfect competition versus monopoly
The perfect competitor doesnt have to worry
about lowering price to sell more
In a purely competitive situation, the firm
accounts for a small part of the market
It can sell its entire output, whatever that may be, at
the same price
24-20

Faces (cont'd)
Perfect competition versus monopoly
The more the monopolist wants to sell, the lower
the price it has to charge on the last unit sold
To sell the last unit, the monopolist has to lower
the price because it is facing a downward sloping
demand curve
24-21
Figure 24-2 Demand Curves for the Perfect

Competitor and the Monopolist
24-22

Faces (cont'd)
Monopoly
Perfect Competition
Single seller
Many sellers
Faces entire
industry demand
Faces perfectly
elastic demand
Must lower price

to sell more
Must produce more

to sell more
Not all units sold for

same price (MR < P)
All units sold for same

price (P = MR)
24-23
Elasticity and Monopoly

The monopolist faces a downward-sloping
demand curve (its average revenue curve)
That means that it cannot charge just any
price with no changes in quantity (a
common misconception) because,
depending on the price charged, a different
quantity will be demanded
24-24
Figure 24-3 Marginal Revenue: Always

Less Than Price
24-25
Elasticity and Monopoly (cont'd)

Question
If a monopoly raises price, what will happen to
quantity demanded?
Hint
Remember how consumers respond to a change
in price
24-26

Recall
A monopolist is a single seller of a well-defined
good or service with no close substitute
Think of some imperfect substitutes.
The demand curve slopes downward because

individuals compare marginal satisfaction to cost
24-27

After all, consumers have limited incomes
and unlimited wants
The market demand curve, which the
monopolist alone faces in this situation,
slopes downward because individuals
compare the marginal satisfaction they will
receive to the cost of the commodity to be
purchased
24-28
Costs and Monopoly Profit

Maximization
We assume profit maximization is the goal
of the pure monopolist, just as it is for the
perfect competitor
24-29

Maximization (cont'd)
Perfect competitor has only to decide on the
profit-maximizing output rate because price
is given
The perfect competitor is a price taker
For the pure monopolist, we must seek a

profit-maximizing price output combination
The monopolist is a price searcher
24-30

Price Searcher
A firm that must determine the price-output
combination that maximizes profit because it
faces a downward-sloping demand curve
24-31

We can determine the profit-maximizing
price-output combination with either of two
equivalent approaches:
By looking at total revenues and total costs
or
By looking at marginal revenues and marginal
costs
24-32

Total revenues-total costs approach
Maximize the positive difference between total
revenues and total costs
Marginal revenue-marginal cost approach

Profit maximization will also occur where
marginal revenue equals marginal cost
24-33

Question
Why produce where marginal revenue equals
marginal cost?
Answer
This is where the greatest positive difference
between total revenue and total cost occurs
24-34
Figure 24-4 Monopoly Costs,

Revenues, and Profits, Panel (a)
24-35
Figure 24-4 Monopoly Costs, Revenues, and

Profits, Panels (b) and (c)
24-36

Producing past where MR = MC
Result is that incremental cost will exceed
incremental revenue
Producing less than where MR = MC

The monopolist is not maximizing profits through
this approach either
24-37
Figure 24-5 Maximizing Profits
24-38
Cost and Monopoly Profit Maximization

(contd)
Real-World Informational Limitations
Price searching by a less-than perfect competitor
is a process
A monopolist can only estimate the actual
demand curve and make an educated guess
when it sets its profit-maximizing profit
For the perfect competitor, price is given already
by the intersection of market demand and supply
24-39
Example: Trial and Error Yields Profits

from Monopoly Time in the Air
Since the late 2000s, airlines have been taking
advantage of their position as monopoly sellers
during the duration of flights.
In addition to charging for checked bags, snacks,
and pillows, some airlines are now experimenting
with fees for more comfortable seats.
Other airlines offer travel concierge services that
assist passengers with booking items in their
destination cities.
As monopoly providers, airlines are searching for
prices that will maximize profits.
24-40
Calculating Monopoly Profit

Monopoly profit is given by the shaded area
in Figure 24-6, which is equal to total
revenues (P Q) minus total costs
(ATC Q)
24-41
Figure 24-6 Monopoly Profit
24-42
Calculating Monopoly Profit (cont'd)

No guarantee of profits
The term monopoly conjures up the notion of a
greedy firm ripping off the public
If ATC is everywhere above AR, or demand
No price-output combination allows the monopolist to
cover costs
24-43
Figure 24-7 Monopolies: Not Always

Profitable
24-44
Policy Example: The U.S. Rail Monopoly that

Subsists on Taxpayer Handouts
Amtrak has a near-monopoly on U.S. intercity rail
service. Nevertheless, it continues to suffer
economic losses.
To keep passenger rail lines operating, the federal
government provides a subsidy to cover Amtraks
losses.
So even though Amtrak charges loss-minimizing
prices, the revenues generated from passenger
fares are less than total costs.
24-45

Discrimination
Price Discrimination
Selling a given product at more than one price,
with the difference being unrelated to
differences in cost
24-46

Discrimination (cont'd)
Price Differentiation
Establishing different prices for similar products
to reflect differences in marginal cost in
providing those commodities to different groups
of buyers
24-47

Discrimination (cont'd)
Necessary conditions for price
discrimination
1. The firm must face a downward-sloping demand
curve
2. The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with
predictably different elasticities of demand
3. The firm must be able to prevent resale of the
product or service
24-48
Example: Why Students Pay Different Prices to

Attend College
Out-of-pocket tuition rates for any two college
students can differ by considerable amounts, even if
the students happen to major in the same subjects
and enroll in many of the same courses.
The reason for this is that colleges offer students
diverse financial aid packages depending on their
financial need.
To document their need for financial aid, students
must provide detailed information about family
income and wealth. This information helps the
college determine the prices that different families
are most likely to be willing and able to pay, so that
it can engage in price discrimination.
24-49
Figure 24-8 Toward Perfect Price Discrimination in

College Tuition Rates
24-50

Comparing monopoly with perfect
competition
Lets assume a monopolist comes in and buys up
every single perfect competitor
Notice the monopolist produces a smaller
quantity and sells at a higher price
24-51

(cont'd)
Comparing monopoly with perfect
competition
Monopolists raise the price and restrict
production compared to a perfectly competitive
situation
Consumers pay a price that exceeds the
marginal cost of production and resources are
misallocated in such a situation
24-52
What If . . . Governments protect local retailers

from big-box retailers such as Wal-Mart and
Target?
When local activists succeed in opposing the

opening of a new retailer, they also serve to
protect local stores from competition.
This means that local sellers can charge
prices higher than what would prevail under
perfect competition.
24-53
Figure 24-9 The Effects of Monopolizing

an Industry
24-54
You Are There: Seeking Higher Rents from

Souvenir Vendors in Atlanta
For the past 20 years, Stanley Hambrick and Larry
Miller have been paying an annual rent of $250 to
operate a vending stand at Turner Field, where
they sell baseball souvenirs and T-shirts.
Now, Atlanta has granted monopoly rights for the
vending space to a property-management
company. Rental rates now range from $500 per
month to $1,600 per month, depending on the
location of the vending stand.
Vendors now face monopoly rents as much as 77
times higher than what they used to pay.
24-55
Issues & Applications: The U.S. Occupational

License Explosion
In states across the land, licensing rules

have been expanding with each passing
year.
Table 24-1 on the next slide lists some of
the occupations that require licenses in at
least a few U.S. states.
24-56
Table 24-1 Selected Occupations Requiring

Licenses in Some U.S. States
24-57
Issues & Applications: The U.S.

Occupational License Explosion (contd)
To obtain an occupational license, people
typically must pay a fee and engage in a
period of study. These licenses create
monopoly profits for incumbents already
established in the profession.
After controlling for other determinants of
incomes, economists have found licensing
requirements can boost incomes by 15
percent.
24-58
Summary Discussion of Learning

Objectives (cont'd)
Why a monopoly can occur
Barriers to entry
Demand and marginal revenue conditions

faced by a monopolist
Because the monopolist constitutes the entire
industry, it faces the entire market demand
curve.
Marginal revenue is less than price.
24-59

Objectives (cont'd)
How a monopolist determines how much
output to produce and what price to charge
Seeks to maximize its economic profits
Produces where marginal revenue equals
marginal cost
Charges maximum price for the amount of
output where MR = MC
24-60

Objectives (cont'd)
A monopolists profits
Profit earned by monopolist is equal to the
difference between the price it charges and its
average production cost times the amount of
output it produces and sells.
Monopolist typically earns positive economic
profits.
24-61

Objectives (cont'd)
Price discrimination
Selling at more than one price with the price
differences being unrelated to differences in
production costs.
Monopolist sells some of its output at higher
prices to consumers with less elastic demand.
24-62

Objectives (cont'd)
Social cost of monopolies
Price exceeds marginal cost.
The price is higher and output is lower for a
monopolist as compared to a perfectly
competitive industry.
24-63
Appendix G: Consumer Surplus in a

Perfectly Competitive Market
Given the market clearing price that

prevails in the perfectly competitive market,
consumer surplus is:
the difference between the total amount that
consumers would have been willing to pay and
the total amount that they actually pay
24-64
Figure G-1 Consumer Surplus in a Perfectly

Competitive Market
24-65
Appendix G: How Society Loses from

Monopoly
Deadweight Loss
The portion of consumer surplus that no one in
society is able to obtain in a situation of
monopoly
No one in society, not even the monopoly, can
obtain this deadweight loss
24-66
Appendix G: How Society Loses from

Monopoly (contd)
As a result of monopoly, consumers are

worse off in two ways:
The monopoly profits that result constitute a
transfer of a portion of consumer surplus away
from consumers to the monopolist
The failure of the monopoly to produce as many
units as would have been produced under
perfect competition eliminates consumer surplus
that otherwise would have been a benefit to
consumers
24-67
Figure G-2 Losses Generated by Monopoly
24-68

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Chapter 24

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Did You Know That ...

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

Copyright 2014 Pearson Education, Inc. All rights reserved.

International Example: The Canadian

Copyright 2014 Pearson Education, Inc. All rights reserved.

Barriers to Entry (cont'd)

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Barriers to Entry (cont'd)

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Barriers to Entry (cont'd)

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Barriers to Entry (cont'd)

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Figure 24-1 The Cost Curves That Might Lead

Copyright 2014 Pearson Education, Inc. All rights reserved.

Barriers to Entry (cont'd)

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Policy Example: Waging Economic War on

Copyright 2014 Pearson Education, Inc. All rights reserved.

Barriers to Entry (cont'd)

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The Demand Curve a Monopolist

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The Demand Curve a Monopolist

Copyright 2014 Pearson Education, Inc. All rights reserved.

The Demand Curve a Monopolist

Copyright 2014 Pearson Education, Inc. All rights reserved.

The Demand Curve a Monopolist

Copyright 2014 Pearson Education, Inc. All rights reserved.

The Demand Curve a Monopolist

Copyright 2014 Pearson Education, Inc. All rights reserved.

Figure 24-2 Demand Curves for the Perfect

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The Demand Curve a Monopolist

Must lower price

Must produce more

Not all units sold for

All units sold for same

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Elasticity and Monopoly

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Figure 24-3 Marginal Revenue: Always

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Elasticity and Monopoly (cont'd)

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Elasticity and Monopoly (cont'd)

The demand curve slopes downward because

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Elasticity and Monopoly (cont'd)

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Costs and Monopoly Profit

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Costs and Monopoly Profit

For the pure monopolist, we must seek a

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Costs and Monopoly Profit

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Costs and Monopoly Profit

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