2. The Monopoly Market Structure
What is a monopoly exactly?
A monopoly is a market structure characterized by:
A single seller
A unique product
Impossible entry into the market
Under a monopoly, the consumer has only one choice.
Thus, they can either buy from the producer or not
consume
There are no close substitutes.
3. A Single Seller
One single firm IS the industry.
Local monopolies are more commonly observed in the
real-world than national monopolies.
Examples
4.
5. Unique Products
Why do Monopolists have unique products?
Absence of close substitutes
6. Impossible Entry
Barriers to Entry are high
It is different or impossible for a new firm to enter an industry
due to:
Ownership of Vital Resources
Legal Barriers
Economies of Scale
7. Ownership of Vital Resources
A seller can create its own barrier to entry if it owns a
significant portion of a key resource required for the
production of the good or service.
In practice, monopolies rarely arise for this reason. The
market for most resources is national or even
international, and ownership of most resources is
dispersed among a large number of people and nations.
Example
8. Legal Barriers
Legal barriers to entry are the source of most present-
day monopolies.
Entry into the market or competition within the market
are restricted by the granting of a public franchise,
government license, patent, or copyright.
Examples:
9. Economies of Scale
Monopolies can emerge in time naturally because of the
relationship between average cost and the scale of the
operation.
This is called “natural monopolies”
Def: A natural monopoly is an industry in which the LRAC of
production declines throughout the entire market.
Natural monopoly provides an economic argument for
regulated public utilities.
10. Economies of Scale
When this happens a single firm can supply the entire
market demand at a lower cost than two or more
smaller firms.
Markets characterized by economies of scale often
become competitive over time because of technological
advances or because of natural growth in the size of the
market.
11. SOURCES OF MONOPOLY
Economies of Scale
The cost to distribute 4 million
kilowatt hours of electric power is
5 cents a kilowatt-hour with one
seller in the market, or . . .
10 cents a kilowatt-hour with two
sellers, or . . .
15 cents a kilowatt-hour with four
sellers.
Because of economies of scale, one
seller can meet the market demand
at a lower average cost than two or
more sellers.
12. Price and Output Decisions for a Monopolist
The demand curve for a monopolist differs from the
competitive firm because the monopolist is a price maker
not taker.
Def: A price maker is a firm that faces a downward sloping
demand curve.
13. More Demand and some Marginal Revenue
Demand and Marginal Revenue
They are both negatively-sloped
Demand
Market demand is negatively-sloped. The monopolist faces
a tradeoff between price and quantity sold.
To obtain a higher price, the monopolist must lower
quantity. Or, if it wants to sell a larger quantity, it must
lower price.
14. MONOPOLY EQUILIBRIUM
Demand and Marginal Revenue
Marginal revenue is less than price
The marginal revenue curve is negatively-sloped but lies below the
demand curve at each quantity: MR<P at all Q.
21. MONOPOLY EQUILIBRIUM
Example: Demand and Marginal Revenue
The marginal revenue curve is negatively-sloped and lies below the
demand curve. Marginal revenue is less than price at each quantity.
22. MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist
The diagram shows the
monopolist’s
• average total cost (ATC),
• marginal cost (MC),
• demand (D),
• and marginal revenue (MR).
The monopolist maximizes profits
or minimizes losses by producing
the quantity at which marginal
revenue equals marginal cost.
23. MONOPOLY EQUILIBRIUM
Profit Maximization by a
Monopolist
The equilibrium quantity is 3
haircuts per hour where MR=MC,
and
the equilibrium price is $14, shown
by the demand at the quantity 3.
The ATC of 3 haircuts is $10.
Because P>ATC at the equilibrium
quantity, the monopolist earns a
profit of $4 per haircut or $12 per
hour.
23 Monopoly
24. MONOPOLY EQUILIBRIUM
Profit Maximization by a Monopolist: Numerical Example
The data in the table below verify that 3 haircuts per hour maximizes the
monopolist’s profit.
25. MONOPOLY EQUILIBRIUM
Short-Run and Long-Run Equilibrium
When a monopolist incurs short-run losses
However, if a monopolist incurs economic losses in the short-
run, it exits the market in the long-run. The long-run equilibrium
quantity is zero.
26. MONOPOLY EQUILIBRIUM
Short-Run and Long-Run Equilibrium
When a monopolist earns short-run profits
27. Price Discrimination
The monopolist may charge different prices to
consumers to maximize profits.
Def: Price discrimination occurs when a seller charges
different prices for the same product that are not justified by
cost differences.
Selling a good or service at a number of different prices where
the price differences do not reflect differences in cost but instead
reflect differences in consumers’ price elasticities of demand.
However, specific conditions must be met before the
seller can act in this way.
28. Conditions for Price Discrimination
The seller must be a price maker and therefore face a
downward-sloping demand curve
The seller must be able to segment the market
distinguishing between consumers willing to pay different
prices
It must be impossible or too costly for customers to
engage in arbitrage
29. How can a producer price discriminate
Discriminating among groups of consumers
Different prices for consumers with different elasticities. The market is
segmented based on some easily distinguished characteristic of
consumers—age, for example.
Discriminating among units of a good
The seller charges the same prices to all consumers but offers
each consumer a lower price for a larger number of units
bought—volume discounts, for example.
30. Price Discrimination with Two Groups of Consumers
(a) (b)
per unit
Dollars
Dollars per unit
$3.00
LRAC, MC $1.50
LRAC, MC
1.00 1.00
MR D MR’ D’
0 400 Quantity per period 0 500 Quantity per period
A monopolist facing two groups of consumers with different demand elasticities may be
able to practice price discrimination to increase profit or reduce loss. With marginal cost
the same in both markets, the firm charges a higher price to the group in panel (a), which
has a less elastic demand than group in panel (b).
31. Is Price Discrimination Unfair
There is nothing evil or illegal about economic price
discrimination. It simply means charging different
prices for the same good or service unrelated to
differences in cost.
Price discrimination is common in all markets other
than perfectly competitive markets.
32. Is Price Discrimination Unfair
What are its effects:
Increase seller’s profit, at least in the short run
Enhance economic efficiency
Conserve on scarce resources.
Many buyers benefit because they are now paying a lower
price
Example: Movie Theatres- senior citizen and college students
discounts
33. How does it increase the sellers profits
Increases seller’s profits
By observing different elasticities for the consumers the
following can happen
Reduce the price for buyers with elastic demand will increase TR
Increase the price for buyers with inelastic demand will increase
TR
When the total quantity is not changing, then costs are not
changing, but revenues are profits are HIGHER
34. What about efficiency
Enhances economic efficiency
We know that under a monopoly the output is under-
produced. But price discrimination can fix this
underproduction of the good
A price-discriminating monopolist is able to sell a larger
quantity than a single-price monopolist by reducing price
only on the additional units sold, not on all units sold.
Because the problem with monopoly is underproduction,
increasing quantity enhances efficiency. The sum of
producer and consumer surplus is higher in a monopoly
market with price discrimination than in a market with a
single-price monopolist.
35. MONOPOLY AND COMPETITION
Competitive Equilibrium
The market demand curve is D.
The market supply curve is S.
The competitive market
equilibrium is where quantity
demanded equals quantity supplied.
The competitive equilibrium
quantity is QC and the equilibrium
price is PC.
36. MONOPOLY AND COMPETITION
Monopoly Equilibrium
The competitive market supply
curve, S, is the monopolist’s
marginal cost curve, MC.
The monopolist’s marginal revenue
curve is MR.
The monopolist’s equilibrium
quantity is QM where marginal
revenue equals marginal cost. The
equilibrium price is PM , shown by
the demand at QM.
37. MONOPOLY AND COMPETITION
Competitive and Monopolistic Equilibrium
Monopoly quantity is lower and price is higher
Amonopolist supplies a smaller quantity than a competitive market
would supply at a higher price.
The higher price allows a monopolist to earn positive long-run
economic profits.
38. MONOPOLY AND COMPETITION
Economic Consequences of Monopoly
The absence of competition results in
• Inefficiency and deadweight loss
• Redistribution of wealth
39. MONOPOLY AND COMPETITION
Efficiency of Competitive
Equilibrium
The competitive equilibrium price,
PC, brings consumers’ marginal
benefit into equality with
producers’ marginal cost.
Therefore, the competitive
equilibrium quantity, QC, is
efficient. The sum of consumer
surplus and producer surplus is
maximized.
40. MONOPOLY AND COMPETITION
Inefficiency of Monopoly
Marginal benefit in the monopoly
equilibrium (equals to the
monopoly equilibrium price, PM)
exceeds marginal cost.
Therefore, the monopoly
equilibrium quantity, QM, is
inefficient because of
underproduction. Monopoly results
in a deadweight loss.
42. MONOPOLY AND COMPETITION
Monopoly Redistributes Wealth
The deadweight loss of monopoly
arises from a net loss in both
consumer and producer surplus
compared with the competitive
equilibrium.
In addition to the net loss in the
total surplus, monopoly also
redistributes some of the remaining
surplus from consumers to the
monopolist.
