Unit 8: Monopoly

Instructor: Nguyen Tai Vuong

School of Economics and Management
Hanoi University of Science and Technology

Objectives
In this unit, look for the answers to these questions:
• Why do monopolies arise?
• Why is MR < P for a monopolist?
• How do monopolies choose their P and Q?
• How do monopolies affect society’s well-being?
• What can the government do about monopolies?
• What is price discrimination?

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Introduction
• A monopoly is a firm that is the sole seller of a product without
close substitutes.
• In this chapter, we study monopoly and contrast it with perfect
competition.
• The key difference:
A monopoly firm has market power, the ability to influence the
market price of the product it sells. A competitive firm has no
market power.

Why Monopolies Arise

The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s diamond mines

2. The govt gives a single firm the exclusive right to produce the
good.
E.g., patents, copyright laws

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Why Monopolies Arise
3. Natural monopoly: a single firm can produce the entire market
Q at lower ATC than could several firms.

Example: 1000 homes need

electricity. Cost Electricity
Economies of
ATC is lower if one firm scale due to
services all 1000 homes huge FC
than if two firms each $80
service 500 homes. $50 ATC
Q
500 1000
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Monopoly vs. Competition: Demand Curves

In a competitive market, the market
demand curve slopes downward.
but the demand curve for any A competitive firm’s
individual firm’s product is horizontal demand curve
P
at the market price.
The firm can increase Q without
lowering P,
D
so MR = P for the competitive firm.

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Monopoly vs. Competition: Demand Curves
A monopolist is the only seller,
so it faces the market demand
A monopolist’s
curve.
demand curve
P
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P.

D
Q

ACTIVE LEARNING 1: A monopoly’s revenue

Moonbucks is the only seller
of cappuccinos in town. Q P TR AR MR

The table shows the market 0 $4.50 n.a.

demand for cappuccinos. 1 4.00
Fill in the missing spaces of 2 3.50
the table.
3 3.00
What is the relation
between P and AR? 4 2.50
Between P and MR? 5 2.00
6 1.50

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 Answers

Here, P = AR, Q P TR AR MR
same as for a competitive firm.
0 $4.50
Here, MR < P, whereas MR = P
for a competitive firm. 1 4.00
2 3.50
3 3.00
4 2.50
5 2.00
6 1.50

Moonbuck’s D and MR Curves

P, MR
$5
4
Demand curve (P)
3
2
1
0
-1 MR
-2
-3
0 1 2 3 4 5 6 7 Q

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Understanding the Monopolist’s MR
• Increasing Q has two effects on revenue:
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers revenue
• To sell a larger Q, the monopolist must reduce the price on all
the units it sells.
• Hence, MR < P
• MR could even be negative if the price effect exceeds the output
effect
(e.g., when Moonbucks increases Q from 5 to 6).

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Profit-Maximization
• Like a competitive firm, a monopolist maximizes profit by
producing the quantity where MR = MC.
• Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to pay for that
quantity.
• It finds this price from the D curve.

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Profit-Maximization
1. The profit-maximizing Q
is where Costs and
MR = MC. Revenue MC

2. Find P from P
the demand curve at this
Q.

D
MR

Q Quantity

Profit-maximizing output
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The Monopolist’s Profit

Costs and
Revenue MC

As with a competitive firm, P

ATC
the monopolist’s ATC
profit equals
(P – ATC) x Q D
MR

Q Quantity

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A Monopoly Does Not Have an S Curve
A competitive firm
 takes P as given
 has a supply curve that shows how its Q depends on P
A monopoly firm
 is a “price-maker,” not a “price-taker”
 Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.
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Case Study: Monopoly vs. Generic Drugs

Patents on new drugs give a The market for
Price a typical drug
temporary monopoly to the
seller.
PM
When the patent expires,
the market
becomes competitive, PC = MC
generics appear. D
MR

QM Quantity
QC

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The Welfare Cost of Monopoly
• Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
• In the monopoly eq’m, P > MR = MC
• The value to buyers of an additional unit (P)
exceeds the cost of the resources needed to produce that unit
(MC).
• The monopoly Q is too low –
could increase total surplus with a larger Q.
• Thus, monopoly results in a deadweight loss.

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The Welfare Cost of Monopoly

Competitive eq’m:
Price Deadweight
quantity = QE loss MC
P = MC
P
total surplus is P = MC
maximized
MC
Monopoly eq’m: D
quantity = QM
MR
P > MC
deadweight loss QM QE Quantity

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Public Policy Toward Monopolies
• Increasing competition with antitrust laws
• Examples: Sherman Antitrust Act (1890), Clayton Act (1914)
• Antitrust laws ban certain anticompetitive practices, allow
govt to break up monopolies.
• Regulation
• Govt agencies set the monopolist’s 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.

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Public Policy Toward Monopolies

• Public ownership
• Example: U.S. Postal Service
• Problem: Public ownership is usually less efficient since no
profit motive to minimize costs
• Doing nothing
• The foregoing policies all have drawbacks,
so the best policy may be no policy.

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Price Discrimination
• Discrimination is the practice of treating people differently based
on some characteristic, such as race or gender.
• Price discrimination is the business practice of selling the same
good at different prices to different buyers.
• The characteristic used in price discrimination
is willingness to pay (WTP):
• A firm can increase profit by charging a higher price to buyers with higher
WTP.

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Perfect Price Discrimination vs. Single Price Monopoly

Here, the monopolist
charges the same price Consumer
Price
(PM) to all buyers. surplus

A deadweight loss results. Deadweight

PM loss

MC
Monopoly
profit D
MR

QM Quantity

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Perfect Price Discrimination vs. Single Price Monopoly
Here, the monopolist produces
the competitive quantity, but Price
charges each buyer his or her Monopoly
WTP. profit

This is called perfect price

discrimination.
MC
The monopolist captures all CS
as profit. D
But there’s no DWL. MR

Quantity
Q
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Price Discrimination in the Real World

• In the real world, perfect price discrimination is not
possible:
• no firm knows every buyer’s WTP
• buyers do not announce it to sellers
• So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.

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Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday night.
Airline prices
Discounts for Saturday-night stayovers help distinguish business
travelers, who usually have higher WTP, from more price-sensitive
leisure travelers.

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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 children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.

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Examples of Price Discrimination
Quantity discounts
A buyer’s WTP often declines with additional units, so firms
charge less per unit for large quantities than small ones.
Example: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s twice as big.

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CONCLUSION: The Prevalence of Monopoly

• 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

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SUMMARY
• 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.
• 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, 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.

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