Chapter 12

1
Laugher Curve
The First Law of Economics:
For every economist, there exists an
equal and opposite economist.
The Second Law of Economics:
They're both wrong.

2
Introduction
Monopoly is a market structure in which a
single firm makes up the entire market.
Monopolies exist because of barriers to entry
into a market that prevent competition.

3
Introduction
Legal barriers, such as patents, prevent
others from entering the market.

■ Sociological barriers – entry is

prevented by custom or tradition.

4
Introduction
Natural barriers – the firm has a unique
ability to produce what other firms can’t
duplicate.

■ Technological barriers – the size of the

market can support only one firm.

5
The Key Difference Between
a Monopolist and a Perfect
Competitor
For a competitive firm, marginal revenue
equals price.
For a monopolist it does not.
The monopolist takes into account the fact
that its production decision can affect price.

6
The Key Difference Between
a Monopolist and a Perfect
Competitor
A competitive firm is too small to affect the
price.

■ It does not take into account the effect of

its output decision on the price it receives.

7
The Key Difference Between
a Monopolist and a Perfect
Competitor
A competitive firm's marginal revenue is the
market price.

■ A monopolistic firm’s marginal revenue is

not its price – it takes into account that its
output decision can affect price.

8
A Model of Monopoly
How much should the monopolistic firm
choose to produce if it wants to maximize
profit?

9
The Monopolist’s Price and
Output Numerically
The first thing to remember is that marginal
revenue is the change in total revenue that
occurs as a firm changes its output.

10
The Monopolist’s Price and
Output Numerically
When a monopolist increases output, it lowers
the price on all previous units.

■ As a result, a monopolist’s marginal

revenue is always below its price.

11
The Monopolist’s Price and
Output Numerically
In order to maximize profit, a monopolist
produces the output level at which marginal
cost equals marginal revenue.

■ Producing at an output level where

MR > MC or where MR < MC will
yield lower profits.

12
13
The Monopolist’s Price and
Output Graphically
The marginal revenue curve is a graphical
measure of the change in revenue that occurs
in response to a change in output.
It tells us the additional revenue the firm will
get by expanding output.

14
MR = MC Determines the
Profit-Maximizing Output
If MR > MC, the monopolist gains profit by
increasing output.
If MR < MC, the monopolist gains profit by
decreasing output.
If MC = MR, the monopolist is maximizing
profit.

15
The Price a Monopolist Will
Charge
The MR = MC condition determines the
quantity a monopolist produces.
The monopolist will charge the maximum
price consumers are willing to pay for that
quantity.
That price is found on the demand curve.

16
The Price a Monopolist Will
Charge
To determine the profit-maximizing price
(where MC = MR), first find the profit
maximizing output.

17
Price MC
Monopolist
$36 price
30
24
18
12
6 D
0
6 1 2 3 4 5 6 7 8 9 10
12 MR

18
Comparing Monopoly and
Perfect Competition
Equilibrium output for both the monopolist
and the competitor is determined by the MC
= MR condition.

19
Comparing Monopoly and
Perfect Competition
Because the monopolist’s marginal revenue is
below its price, price and quantity will not be
the same.

■ The monopolist’s equilibrium output is less

than, and its price is higher than, for a firm
in a competitive market.

20
Price MC
Monopolist
$36 price
30
24 Competitive price
18
12
6 D
0
6 1 2 3 4 5 6 7 8 9 10
12 MR

21
Profits and Monopoly
Draw the firm's marginal revenue curve.
Determine the output the monopolist will
produce by the intersection of the MC and MR
curves.

22
Profits and Monopoly
Determine the price the monopolist will
charge for that output.

■ Determine the average cost at that level

of output.

23
Profits and Monopoly
Determine the monopolist's profit (loss) by
subtracting average total cost from average
revenue (P) at that level of output and
multiply by the chosen output.

24
Profits and Monopoly
The monopolist will make a profit if price
exceeds average total cost.

■ The monopolist will make a normal return

if price equal average total cost.
■ The monopolist will incur a loss if price is
less than average total cost.

25
A Monopolist Making a
Profit
A monopolist can make a profit.

26
Price MC

ATC
PM A
Profit
CM B

MR D
0 QM Quantity

27
A Monopolist Breaking
Even
A monopolist can break even.

28
Price MC
ATC

PM

MR D
0 QM Quantity

29
A Monopolist Making a
Loss
A monopolist can make a loss.

30
Price MC ATC

CM B
Loss A
PM

MR D
0 QM Quantity

31
The Welfare Loss from
Monopoly
People’s purchase decisions don’t reflect the
true cost to society because monopolies
charge a price higher than marginal cost.

32
The Welfare Loss from
Monopoly
The marginal cost of increasing output is
lower than the marginal benefit of increasing
output.

33
The Welfare Loss from
Monopoly
The welfare loss of a monopolist is
represented by the triangles B and D.

■ The welfare loss is often called the

deadweight loss or welfare loss triangle.

34
 Price
MC

PM
C D
PC
B
A
MR D
0 QM QC Quantity
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All 35
Rights Reserved.
The Price-Discriminating
Monopolist
Price discrimination is the ability to charge
different prices to different individuals or
groups of individuals.

36
The Price-Discriminating
Monopolist
In order to price discriminate, a monopolist
must be able to:

● Identify groups of customers who have

different elasticities of demand;
● Separate them in some way; and
● Limit their ability to resell its product
between groups.

37
The Price-Discriminating
Monopolist
A price-discriminating monopolist can
increase both output and profit.

■ It can charge customers with more

inelastic demands a higher price.
■ It can charge customers with more elastic
demands a lower price.

38
Price Discrimination Occurs
in the Real World
Movie theaters give senior citizens and child
discounts.
All airline Super Saver fares include Saturday
night stopovers.
Automobiles are seldom sold at their sticker
price.
Theaters have midweek special rates.

39
Price Discrimination Occurs
in the Real World
Retail tire stores run special sales about half
the time.

■ Restaurants generally make most of their

profit on alcoholic drinks and just break
even on food.
■ College-town stores often give students
discounts.

40
Barriers to Entry and
Monopoly
Monopolies exist because of some barrier to
entry.
Barrier to entry – a social, political, or
economic impediment that prevents firms
from entering the market.

41
Barriers to Entry and
Monopoly
If there were no barriers to entry, profit-
maximizing firms would always compete away
monopoly profits.

42
Barriers to Entry and
Monopoly
Three important barriers to entry are natural
ability, increasing returns to scale, and
government restrictions.

43
Natural Ability
One firm may be more efficient than other
firms because it is better at producing a good
than those other firms making it.

44
Natural Ability
The public views “just monopolies” as those
which accrue to the firm because of the firm’s
ability.

45
Economies of Scale
If significant economies of scale are possible,
it is inefficient to have two producers.
If each produced half of the output, neither
could take advantage of economies of scale.

46
Economies of Scale
A natural monopoly is an industry in which
one firm can produce at a lower cost than can
two or more firms.

47
Economies of Scale
A natural monopoly will occur when indivisible
set up costs are so large that average total
costs fall within the range of potential output.

48
Economies of Scale
There is no welfare loss in the natural
monopoly situation.

■ There can actually be a welfare gain

because a single firm is so much more
efficient than several firms producing the
good.

49
Average Cost

C3
C2
C1 ATC

0 Q⅓ Q½ Q1 Quantity

50
 PM
Average Cost

Profit
CM

CC Loss ATC
PC MC
MR D
0 QM QC Quantity

51
Government Restrictions
Monopolies can be created by government.

52
Normative Views of
Monopoly
The public generally views monopolies the
way the Classical economists did – they
consider them unfair and wrong.

53
Normative Views of
Monopoly
The public accepts patents which are a type
of government-created monopoly.

● Patent – a legal protection of a

technical innovation that gives the
person holding the patent a monopoly
on using that innovation for a specified
period of time.

54
Normative Views of
Monopoly
The public does not like the distributional
effects of monopoly.

■ They believe that it transfers income from

“deserving” consumers to “undeserving”
monopolists.

55
Normative Views of
Monopoly
It is possible for the well-financed and the
well-connected to garner government favors.

■ The public prefers that firms do

“productive” things rather than lobby for
government favors.

56
Government Policy and
Monopoly: AIDS Drugs
The patents for AIDS drugs are owned by a
small group of pharmaceutical companies.
They can charge a very high price for a drug
that costs little to produce.

57
Government Policy and
Monopoly: AIDS Drugs
What, should the government do?

● Should it force the producer to charge a

price equal to its marginal cost.
● Doing so would create a significant
disincentive for drug companies to do
further research on other life-
threatening diseases.

58
Government Policy and
Monopoly: AIDS Drugs
The government could buy the patents.

● Payment would come from increased

taxes and would be quite expensive.
● The cost of regulation would drop, but it
would raise the question as to which
patents the government should buy.

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End of Chapter 12

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