CHAPTER 8 Monopoly 1 Part Two: Microeconomics of Product Markets Slides prepared by Bruno Fullone, George Brown College ©2010 McGraw-Hill Ryerson Ltd.
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CHAPTER 8
Monopoly
1
Part Two: Microeconomics of Product Markets
Slides prepared by Bruno Fullone,
George Brown College ©2010 McGraw-Hill Ryerson Ltd.
Chapter 8
2
In this chapter you will learn:
8.1 The characteristics of monopoly
8.2 About output and price determination in monopoly
8.3 About the economic effects of monopoly
8.4 Why a monopolist prefers to charge different prices in different markets
8.5 The choices facing governments that regulate monopolies
8.6 About the deadweight loss associated with monopoly
8.1 Monopoly
3 LO 8.1
Characteristics:
• Single Seller
• No Close Substitutes
• Price-Maker
• Blocked Entry
• Nonprice competition
Examples of Monopoly
LO 8.1 4
Quantity (millions)
$20
15
10
0 50 100 200
ATC
D
If ATC declines over the
entire market demand,
least-cost production is
realized only if
there is one producer - a
natural monopoly
Barriers to Entry –
Figure 8-1 Economies of Scale
Avera
ge
tota
l co
st
per
un
it
5 LO 8.1
Barriers to Entry
Economies of Scale
Legal Barriers to Entry: Patents
and Licences
Ownership or Control of Essential
Resources
Pricing and Other Strategic
Barriers to Entry
6 LO 8.1
Monopoly Demand
Three basic assumptions:
Monopoly status is secured
Firm is not governmentally
regulated
Firm charges the same price for
all units
7 LO 8.1
Monopoly Demand 1. Marginal revenue is less than
price
Illustrated…
Table 8-1 Revenues and Costs
(1) Quantity
Of Output
(2) Price
(Average Revenue)
(3) Total
Revenue (1) X (2)
(4) Marginal Revenue
(5) Average
Total Cost
(6) Total Cost (1) X (5)
(7) Marginal
Cost
(8) Profit (+)
or Loss (-)
0
1
2
3
4
5
6
7
8
9
10
$172
162
152
142
132
122
112
102
92
82
72
$0
162
304
426
528
610
672
714
736
738
720
$162
142
122
102
82
62
42
22
2
-18
$190.00
135.00
113.33
100.00
94.00
91.67
91.43
93.75
97.78
103.00
$100
190
270
340
400
470
550
640
750
880
1030
$90
80
70
60
70
80
90
110
130
150
$-100
-28
+34
+86
+128
+140
+122
+74
-14
-142
-310
Revenue Data Cost Data
] ] ] ] ] ] ] ] ] ]
] ] ] ] ] ] ] ] ] ]
Can you See Profit Maximization? 8
LO 8.1
9
P
Q
D
132
When price decreases
from $142 to $132, one
more unit is sold…
Gain = $132
$142
1 2 3 4 5 6
Revenue will increase by $132
with the extra unit sold
Price and Marginal Revenue in Monopoly
Figure 8-2
LO 8.1
10 1 2 3 4 5 6
P
Q
D
but revenue loss
= $10 X 3 units
Loss = $30
When price decreases
from $142 to $132, one
more unit is sold…
Gain = $132 Marginal revenue
= $132-30
= $102 < $132 (price)
132
$142
11 LO 8.1
Monopoly Demand
1. Marginal revenue is less than
price
2. The monopolist is a price-
maker
3. The monopolist sets prices in
the elastic region of demand
Illustrated…
LO 8.1 12
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q
To
tal re
ven
ue
Pri
ce
per
un
it
200
150
200
50
750
500
250 TR
D
Inelastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q
MR
Elastic
TR
Demand, MR, and TR for a Monopolist
Figure 8-3
13 LO 8.2
8.2 Output and Price Determination
Cost Data
assume competitive factor markets
MR=MC Rule
Illustrated …
LO 8.2 14
AT
C
T
C
$1
00
$1
90
19
0
13
5
27
0
11
3
34
0
10
0
40
0
94 47
0
92 55
0
91 64
0
94 75
0
98 88
0
10
3
10
30
Q P T
R
0 $1
72
$
0
1 16
2
16
2
2 15
2
30
4
3 14
2
42
6
4 13
2
52
8
5 12
2
61
0
6 11
2
67
2
7 10
2
71
4
8 92 73
6
9 82 73
8
10 72 72
0
MR
$16
2
142
122
102
82
62
42
22
2
-18
MC
$90
80
70
60
70
80
90
110
130
150
]
]
]
]
]
]
]
]
]
]
Table 8-1
produce?
produce?
produce?
produce?
LO 8.2 15
AT
C
T
C
$1
00
$1
90
19
0
13
5
27
0
11
3
34
0
10
0
40
0
94 47
0
92 55
0
91 64
0
94 75
0
98 88
0
10
3
10
30
Q P T
R
0 $1
72
$
0
1 16
2
16
2
2 15
2
30
4
3 14
2
42
6
4 13
2
52
8
5 12
2
61
0
6 11
2
67
2
7 10
2
71
4
8 92 73
6
9 82 73
8
10 72 72
0
Profit
or loss
$-100
-28
+34
+86
+128
+140
+122
+74
-14
-142
-310
MR
$16
2
142
122
102
82
62
42
22
2
-18
MC
$90
80
70
60
70
80
90
110
130
150
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
]
Profit
Maximization
Choice
Same results as TR – TC Rule
LO 8.2 16
Q
D
MR
200
175
150
125
100
75
50
25 0 1 2 3 4 5 6 7 8 9 10
P
Profit Maximization by a Monopolist
MC Find q
MR = MC Figure 8-4
LO 8.2 17
MC
$122= Pm
Find p
Q
D
MR
200
175
150
120
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
P Profit Maximization by a Monopolist
Price, costs
and revenue
per unit
LO 8.2
18
MC Find ATC
Q
D
MR
200
175
150
120
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
ATC $122= Pm
$94=ATC Profit
Profit
=(p - ATC) X q
=(122-94) X 5
=140
Profit Maximization by a Monopolist Price, costs
and revenue
per unit
19 LO 8.2
Output and Price Determination
Cost Data
assume competitive factor markets
MR=MC Rule
No Monopoly Supply Curve
20 LO 8.2
Output and Price Determination
Misconceptions About Monopoly
Pricing
Not the highest price
Total, not unit, profit
Possibility of Losses by
Monopolist
Illustrated…
LO 8.2
21
MC
Loss
Q
D
MR
P
ATC
Qm
Pm
A
V
AVC
MR = MC
The Loss-Minimizing Position of a Monopolist
Figure 8-5
Price, costs
and revenue
per unit
LO 8.3 22
8.3 Economic Effects of Monopoly
•Price, Output, and Efficiency
•inefficient relative to a purely
competitive industry
•Pm > MC
•Pm > minimum ATC
Illustrated …
LO 8.3
23
Q
P
D
Pc
Qc
S = MC
P=MC=minimum ATC
Figure 8-6 Inefficiency of Monopoly
Price and
output if the
industry were
competitive
LO 8.3 24
Q
P
D
MR
Pc
Qc
Pm
Qm
S = MC
Monopolist
will sell fewer
units at a
higher price
than in pure
competition
Inefficiency of Monopoly
MR = MC a
b
c
Efficiency loss in
triangle area abc
LO 8.3 25
Economic Effects of Monopoly
• Income Transfer – monopoly owners enriched at the expense of
consumers
• Cost Complications
Economies of Scale – simultaneous consumption
– network effects
X-Inefficiency
Illustrated…
LO 8.3 26
Avera
ge t
ota
l cost
per
unit
Quantity
Average
Total Cost
Q2
Inefficient internal operation
leads to higher-than-necessary
costs
Figure 8-7 X-Inefficiency
ATC2
X' ATCX'
Q1
X ATCX
ATC1
27 LO 8.3
Economic Effects of Monopoly
Cost Complications
Economies of Scale
simultaneous consumption
network effects
X-Inefficiency
Rent-Seeking Expenditures
Technological Advance
28 LO 8.3
Assessment and Policy Options
Legitimate concerns
Three policy options:
1. Charges under Canada’s
anticombines laws
2. Regulate prices and operations
of natural monopolies
3. Ignore monopolies which are
unsustainable over the long term
LO 8.4 29
• Charging maximum price customer will pay
• Charging customer one price for 1st set
purchased and lower price for subsequent
units
• Charging some customers one price, others
another
8.4 Price Discrimination
LO 8.4 30
Illustrated…
• Necessary Conditions.…
– Monopoly Power
– Market Segregation
– No Resale
• Examples
– Airlines
– Theatres, golf courses
– Coupons
– International trade
Price Discrimination
LO 8.4 31
Q
D MRb
MC = ATC
P
Qb
Pri
ce a
nd
Co
sts
Pb
(a) Small Businesses
Price Discrimination-Different Groups of Buyers
Figure 8-8
LO 8.4
32
Q
D MRs
MC = ATC
P
Qs
Pri
ce a
nd
Co
sts
Ps
(b) Students
Price Discrimination-Different Groups of Buyers
LO 8.5 33
8.5 Regulated Monopoly
• Natural monopolies traditionally have
been subject to rate (price) regulation
– e.g., natural gas distributors, regional
telephone companies, electricity suppliers
• Trend to deregulation where possible
– e.g., long distance telephone
LO 8.5 34
Regulated Monopoly
• May be desirable to maintain but regulate a natural monopoly
• Types of regulation include:
– Socially optimal price where P = MC
– Fair-return price where P = ATC
Illustrated…
LO 8.5 35
Q
D MR
MC
ATC
P
Unregulated
monopoly price M
Qm
Pri
ce a
nd
Co
sts
Pm
Regulated Monopoly – Socially Optimal
Socially Optimal Price
Price = MC
Qr
Pr LOSS
Allocatively efficient
BUT
Subsidy required
Figure 8-9
LO 8.5 36
Q
D MR
MC
ATC
P Fair Return Price
Price = ATC
f
M
Qm Qr Qf
Pri
ce a
nd
Co
sts
Pm
Pr
Pf
r FIRM BREAKS EVEN
still some underallocation
Regulated Monopoly – Fair Return
37
LO 8.5
Dilemma of Regulation
Setting price at P = MC
firm earns losses
Setting price at P = ATC
still some underallocation of resources
Regulation can improve outcomes
38
LO 8.6
8.6 Monopoly and Deadweight Loss
Net loss of consumer and producer
surplus is deadweight loss
Monopolist also loses producer
surplus, but gains producer surplus at
the expense of consumer surplus
Consumers lose consumer surplus
LO 8.6 39
Q
P
D=MB
Pc
Qc
S = MC
Consumer
surplus
Producer
surplus
Efficient
output
Outcomes with
pure competition
Monopoly and Deadweight Loss
Figure 8-10
LO 8.6 40
Q
P
D=MB
MR
Pc
Qc
Pm
Qm
S = MC
Consumer
surplus
Producer
surplus
Monopoly’s
gain B
C
Outcomes with
pure monopoly
Deadweight
loss
Monopoly and Deadweight Loss
41
Chapter 8
The Last Word: De Beers Diamonds
66 years of monopoly pricing
Independent producers went along
Mid-2000 abandoned attempt to control supply of diamonds
New discoveries
Independent producers withdrew
Political considerations
New strategy
“The diamond supplier of choice”
Chapter 8 42
Chapter 8 Summary 8.1 Characteristics of Monopoly
8.2 Output and Price Determination in a Monopoly MR = MC
8.3 Economic Effects of Monopoly
8.4 Price Discrimination and Monopoly
8.5 Regulated Monopoly Socially optimal price or fair-return price
8.6 Monopoly and Deadweight Loss
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