1. THE NATURE OF MONOPOLY Learning Objectives 1.Define monopoly and the relationship between price setting and monopoly power. 2.List and explain the.

1. THE NATURE OF MONOPOLY

Learning Objectives1. Define monopoly and the relationship between price setting and

monopoly power.2. List and explain the sources of monopoly power and how they

can change over time.3. Define what is meant by a natural monopoly.

• Monopoly refers a firm that is the only producer of a good or service for which there are no close substitutes and for which entry by potential rivals is prohibitively difficult.

• A price setter is a firm that sets or picks price based on its output decision.

• Monopoly power is the ability to act as a price setter.

1.1 Sources of Monopoly Power

• Barriers to entry are a characteristic of a particular market that block the entry of new firms in a monopoly market.

• Economies of scale lead to natural monopoly which is a firm that confronts economies of scale over the entire range of outputs demanded in its industry.

• Location• Sunk costs are expenditures that have already been made and that cannot be recovered.• Restricted ownership of raw materials and inputs• Government restrictions• Network effects involve situations where products become more useful the larger the number of

users of the product.

1.1 Sources of Monopoly Power

ATC1

ATC2

LRAC

D

24020

One firm producing 240 units can do so at

lower cost than twelve firms producing 20

units each.

One firm producing 240 units can do so at

lower cost than twelve firms producing 20

units each.

Twelve firms each produces 20 units.Twelve firms each produces 20 units.

2. THE MONOPOLY MODEL

Learning Objectives1. Explain the relationship between price and marginal revenue

when a firm faces a downward-sloping demand curve.2. Explain the relationship between marginal revenue and

elasticity along a linear demand curve.3. Apply the marginal decision rule to explain how a monopoly

maximizes profit.

2.1 Monopoly and Market Demand

P3

P2

Q1

P1

P

Qq

D

d

S

MC

Q2 Q3

Demand

Additional units sold only by

lowering price

Additional units sold only by

lowering price

Price takerPrice taker

2.2 Total Revenue and Price Elasticity

• EQUATION 2.1

– The following demand schedule is based on the above equation.

– Total revenue is calculated as TR = P*Q

Price $10 9 8 7 6 5 4 3 2 1 0

Quantity 0 1 2 3 4 5 6 7 8 9 10

Total revenue $0 9 16 21 24 25 24 21 16 9 0

PQ 10

2.2 Total Revenue and Price Elasticity

DemandInelastic range

Elastic range

Elastic range

Price $10 9 8 7 6 5 4 3 2 1 0

Quantity 0 1 2 3 4 5 6 7 8 9 10

Total revenue $0 9 16 21 24 25 24 21 16 9 0

Unit elasticUnit elastic

Total revenueTotal revenue

Inelastic range

2.3 Demand and Marginal Revenue

When marginal revenue is… then demand is…• positive price elastic• negative price inelastic• zero unit price elastic

2.3 Demand and Marginal Revenue

Price $10 9 8 7 6 5 4 3 2 1 0

Quantity 0 1 2 3 4 5 6 7 8 9 10

Total revenue $0 9 16 21 24 25 24 21 16 9 0

Marginal revenue $9 7 5 3 1 -1 -3 -5 -7 -9

Marginal revenue

Demand

2.4 Monopoly Equilibrium: Applying the Marginal Decision Rule

MC

Qm

PmPm

Qm

G

Demand

MR

E

Demand

Marginal cost

G

E

MR

ATC

Monopoly profitMonopoly profit

FATCm

3. ASSESSING MONOPOLY

Learning Objectives1. Explain and illustrate that a monopoly firm produces an output that is less than the efficient

level and why this results in a deadweight loss to society.2. Explain and illustrate how the higher price that a monopoly charges, compared to an

otherwise identical perfectly competitive firm, transfers part of consumer surplus to the monopolist and raises questions of equity.

3. Considering both advantages and disadvantages, discuss the potential effects that a monopoly may have on consumer choices, price, quality of products, and technological innovations.

4. Discuss the public policy responses to monopoly.

3.1 Efficiency, Equity, and concentration of Power

Pm

Qm

G

DemandMR

R MC

CPC

Consumer surplus transferred to the

monopoly firm

Consumer surplus transferred to the

monopoly firm

Deadweight loss of reducing output from the

competitive to the monopoly level

Deadweight loss of reducing output from the

competitive to the monopoly level

QC

3.1 Efficiency, Equity, and concentration of Power

3.2 The Fragility of Monopoly Power

• Monopoly power can be a fleeting thing.• Potential for profit invites competition.• Technological change and the pursuit of profits create

challengers for the monopolist.• Competitors seek to make the monopolists market

contestable.