Chapter 25: Monopoly

ECON 152 – PRINCIPLES OF MICROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2

Definition of a Monopolist

MonopolistA single supplier of a good or service for

which there is no close substitute

3

The source of monopolyA barrier to entry that allows the firm to make

long-run economic profits

Barriers to Entry

4

Ownership of resources without close substitutes If you owned all the oil reserves, who could

enter the refining business?The Aluminum Company of America (ALCOA)

at one time owned 90 percent of the world’s bauxite.

Barriers to Entry

5

Problems in raising adequate capitalChoose a product that requires a substantial

capital investmentWhy not enter the microprocessor market and

compete with Intel?

Barriers to Entry

6

Economies of scaleLow unit costs and prices drive out rivalsThe largest firm can produce at the lowest

average total cost

Barriers to Entry

7

Natural MonopolyA monopoly that arises from the peculiar

production characteristics in an industry It usually arises when there are large

economies of scale

Barriers to Entry

8Figure 25-1

LAC

LMC

Kilowatts of Electricity per Time Period

Pric

e pe

r K

ilow

att

The Cost Curves that Might Lead to a Natural Monopoly: The Case of Electricity

9

Legal or governmental restrictionsLicenses, franchises, and certificates of

convenience Is the postal service still a monopoly?

Consider UPS FedEx Fax machines The Internet

Barriers to Entry

10

Legal or governmental restrictionsPatents

Intellectual propertyTariffs

Taxes on imported goodsRegulation

Barriers to Entry

11

CartelsAn association of producers in an industry

that agree to set common prices and output quotas to prevent competition

Barriers to Entry

12

Recall In perfectly competitive markets:

All firms combined create the industry supply Industry supply relative to market demand (D) determines

equilibrium price and quantity The industry faces the market demand

The Demand Curvea Monopolist Faces

Monopolist’s demand = market demandMonopolist is the industry

13

Demand Curves for the Perfect Competitor and the Monopolist

Figure 25-3, Panels (a) and (b)

d = D

Q

Panel (b)

Demand If Individual SupplierIs the Only Supplier in a

Pure Monopoly

d

q

Panel (a)

Demand If Individual Supplier Is inPerfect Competition

Pric

e pe

r U

nit

Pric

e pe

r U

nit

14

MonopolyPerfect Competition

Single Seller

Faces market demand

Must lower price to sell more

MR < P

One of many sellers

Perfectly elastic demand (price takers)

Must only produce moreto sell more

All units sold for same price (P = MR)

Comparing Perfect Competition and Monopoly

15Figure 25-4

P1

MR = area A – area B

Quantity of Electricity perTime Period

Q + 1Q

P2

Area A (+)Gain

Area B (–)

Loss

Demand curve = AR curve

D

Pric

e of

Ele

ctri

city

Marginal Revenue: Always Less Than Price

16

A monopoly is a single seller of a well-defined good or service with no close substitutes.

The more imperfect substitutes there are, and the better these substitutes are, the greater the price elasticity of demand of the monopolist’s demand curve

Elasticity and Monopoly

17

Price Maker (Searcher)A firm that must determine the price-output

combination that maximizes profit because it faces a downward-sloping demand curve

Cost and MonopolyProfit Maximization

18Figure 25-5, Panel (a)

Monopoly Costs,Revenues, and Profits

19Figure 25-5, Panels (b) and (c)

Monopoly Costs,Revenues, and Profits

Profit-maximizingrate of output

MC = MR

MR

D

MC

1514131211109876543210

1

2

3

4

5

6

Panel (c)

10

9

8

7

Output per Time Period

Losses

Maximumprofit

TR

Losses

1514131211109876543210

10

20

30

40

50

60

Panel (b)

100

90

80

70

Output per Time Period

Pric

e,

Ma

rgin

al C

ost

s, a

nd

Ma

rgin

al R

eve

nu

e p

er

Un

it ($

)

To

tal C

ost

s a

nd

To

tal R

eve

nu

e (

$)

TC

20

Why produce where marginal revenue equals marginal cost?Producing past where MR = MC

Incremental cost > Incremental revenue

Producing less than where MR = MC Incremental revenue > Incremental cost

Cost and MonopolyProfit Maximization

21Figure 25-6

Maximizing Profits

MC

Quantity per Time Period

D

Pric

e, M

argi

nal C

ost,

and

Mar

gina

l Rev

enue

per

Uni

t

MRQ1

B

A

Qm

Pm

Q2

FC

22Figure 25-7

Calculating Monopoly Profit

131211109876543210

1

2

3

4

5

6

18

17

16

15

14

13

12

11

10

9

8

7

Output per Time Period

MC

D

MR

ATC

Qm

Pm

Pric

e,

Ma

rgin

al R

eve

nu

e,

an

d C

ost

pe

r u

nit

($)

Monopolyprofit

23Figure 25-8

Monopolies: Not Always Profitable

Losses

MR

Pm

C 1

Qm

D

ATC

MC

Output per Time Period

Pric

e, M

arg

inal

Rev

enu

e, a

nd C

ost

per

unit

A

24

Price Discrimination (Illegal)Selling a given product at more than one

price, with the difference being unrelated to differences in cost

On Making Higher Profits: Price Discrimination & Differentiation

Price Differentiation (Legal)Establishing different prices for similar

products to reflect differences in marginal cost in providing those commodities to different groups of buyers

25

Necessary conditions for price discrimination The firm must face a downward-sloping demand

curve The firm must be able to separate markets at a

reasonable cost The buyers in the various markets must have

different price elasticities of demand The firm must be able to prevent resale of the

product or service

On Making Higher Profits: Price Discrimination

26

Original ScenarioStart with a perfectly competitive market in

long-run equilibrium MR = MC Pe = MC (marginal cost pricing) Zero economic profits

The Social Cost of Monopolies

27

New Scenario: Now, assume the industry is acquired by one firm with no impact on cost.

End with a monopoly in long-run equilibrium MR = MC Higher prices since Pe > MC Lower quantity Potential positive economic profits

The Social Cost of Monopolies

28

The Effects of Monopolizing an Industry

MCm

Pm

Qm

D

S = MC

Panel (b)

MR

Quantity per Time Period

D

S = ΣMC

Panel (a)

Quantity per Time Period

Pric

e, M

arg

inal

Rev

enu

e, a

ndM

argi

nal C

ost

per

Uni

t

Pric

e pe

r U

nit

Pe

Qe

E

Before and after scenarios:

Chapter 25: Monopoly

ECON 152 – PRINCIPLES OF MICROECONOMICS

Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.