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
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.