CHAPTER
10
MONOPOLY
MICROECONOMICS
Roger A. Arnold • Thirteenth Edition
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10-1 The Theory of Monopoly
10-2 Monopoly Pricing and Output Decisions
10-3 Perfect Competition and Monopoly
10-4 The Case Against Monopoly
10-5 Price Discrimination
2
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10-1 The Theory of Monopoly (1 of 3)
• Monopoly: A theory of market structure based on three
assumptions: There is one seller, it sells a product that has no
close substitutes, and the barriers to entry are extremely high
• 10-1a Barriers to Entry: A Key to Understanding Monopoly
• Public Franchise: A firm’s government-granted right that
permits the firm to provide a particular good or service and
that excludes all others from doing so
• Natural Monopoly: The condition in which economies of
scale are so pronounced that only one firm can survive
3
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10-1 The Theory of Monopoly (2 of 3)
• 10-1a Barriers to Entry: A Key to Understanding Monopoly (cont)
• Legal Barriers: These include public franchises, patents, and
government licenses
• Economies of Scale: In some industries, low average total
costs are obtained only through large-scale production; if new
entrants are to compete, they must enter on a large scale, but
this is risky and costly; If economies of scale are so
pronounced that only one firm can survive, the firm is called a
natural monopoly
• Exclusive Ownership of a Necessary Resource: Existing firms
may be protected from the entry of new firms by the exclusive
ownership of a resource needed to enter the industry
4
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10-1 The Theory of Monopoly (3 of 3)
• 10-1b What is the Difference Between a Government
Monopoly and a Market Monopoly?
• When high barriers take the form of public franchises,
patents or government licenses, competition is legally
prohibited (this is a government monopoly)
• When high barriers take the form of economies of scale or
exclusive ownership of a resource result in a monopoly,
competition is not legally prohibited (this is a market
monopoly)
5
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10-2 Monopoly Pricing and Output Decisions (1 of
5)
• Price Searcher: A seller that has the ability to control, to
some degree, the price of the product it sells
• The monopolist is a price searcher
• 10-2a The Monopolist’s Demand and Marginal Revenue
• In the theory of monopoly, the monopoly firm and the
industry are the same
• So, the demand curve for the monopoly firm is the market
demand curve, which is downward sloping
• Because such a curve posits an inverse relationship between
price and quantity demanded, more is sold at lower prices
than at higher prices, ceteris paribus
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EXHIBIT 1
The Dual Effects of a Price Reduction on Total Revenue
7
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10-2 Monopoly Pricing and Output Decisions (2 of
5)
• 10-2b The Monopolist’s Demand Curve and Marginal Revenue
Curve Are Not the Same
• In the theory of monopoly, the firm’s demand curve is not the
same as its marginal revenue curve but rather lies above its
marginal revenue curve (Ex 2)
• 10-2c Price and Output for a Profit-Maximizing Monopolist
• The monopolist that seeks to maximize profit produces the
quantity of output at which MR=MC, and charges the highest
price per unit at which this quantity of output can be sold (Ex
3)
• The profit-maximizing price may be the loss-minimizing
price; monopoly profits and losses are illustrated in Exhibit 4
8
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EXHIBIT 2
Demand Curve and Marginal Revenue Curve
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EXHIBIT 3
The Monopolist’s Profit-Maximizing Price and Quantity of Output
10
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EXHIBIT 4
Monopoly Profits and Losses
11
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10-2 Monopoly Pricing and Output Decisions (3 of
5)
• 10-2d Comparing the Demand Curve in Perfect Competition with
the Demand Curve in Monopoly
• The perfectly competitive firm is a price taker; it has no control
over the price
• The monopoly firm is a price searcher; it has some control
over the price
• What determines whether a firm is a price-taker or a price-
searcher is the demand curve it faces
• The perfectly competitive firm faces a horizontal demand
curve; it can sell at only one price, which is determined by the
market
• The monopoly firm faces a downward-sloping demand curve; it
can sell at different prices and searches for the best price
12
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10-2 Monopoly Pricing and Output Decisions (4 of
5)
• 10-2e If a Firm Maximizes Revenue, Does it Automatically
Maximize Profit Too?
• Profit is the difference of total revenue (TR) and total cost
(TC)
• Because TC is the sum of total fixed costs (TFC) and total
variable costs (TVC) we can rewrite our profit equation as:
• Maximizing profit is the same as maximizing total revenue
under one condition: TVC=0; then TVC falls out of our
profit equation, and we are left with:
13
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10-2 Monopoly Pricing and Output Decisions (5 of
5)
• 10-2e If a Firm Maximizes Revenue, Does it Automatically
Maximize Profit Too? (cont)
• A rise in TR will automatically increase profit by the same
amount
• Now, suppose TVC is not zero; we return to our profit
equation:
• Let TR=$100 and TFC=$40, but this time TVC=$20
• What happens?
• Profit maximization is the same as revenue maximization
only when there are no variable costs (i.e., when TVC = $0)
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10-3 Perfect Competition and Monopoly (1 of 2)
• 10-3a Price, Marginal Revenue, and Marginal Cost
• There are two key differences between perfect competition
and monopoly
• 1. For the perfectly competitive firm, P=MR; for the
monopolist, P>MR; the perfectly competitive firm’s demand
curve is its marginal revenue curve; the monopolist’s demand
curve lies above its marginal revenue curve
• 2. The perfectly competitive firm charges a price equal to its
marginal cost; the monopolist charges a price greater than its
marginal cost; that is:
– Perfect competition: P=MR and P=MC
– Monopoly: P>MR and P>MC
15
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10-3 Perfect Competition and Monopoly (2 of 2)
• 10-3b Monopoly, Perfect Competition, and Consumers’
Surplus
• A monopoly firm differs from a perfectly competitive firm
in terms of how much consumers’ surplus buyers receive
(Exhibit 5)
• 10-3c Monopoly or Nothing?
• From a consumer’s perspective, perfect competition seems
a better choice than monopoly because it provides more
output and a lower price; in short, there is more consumer
surplus
• But sometimes, the choice is between monopoly and
nothing (Exhibit 6)
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EXHIBIT 5
Monopoly, Perfect Competition, and Consumers’ Surplus
17
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EXHIBIT 6
Monopoly or Nothing?
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10-4 The Case Against Monopoly (1 of 3)
• 10-4a The Deadweight Loss of Monopoly
• Deadweight Loss of Monopoly: The net value (the value
of buyers over and above the costs to suppliers) of the
difference between the competitive quantity of output
(where P=MC) and the monopoly quantity of output (where
P>MC); the loss due to not producing the competitive
quantity of output
• Exhibit 7 shows demand, marginal revenue, marginal cost,
and average total cost curves
• For simplicity’s sake, assume that the product is produced
under constant cost conditions, so that marginal cost equals
long-run average total cost
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EXHIBIT 7
Deadweight Loss and Rent Seeking as Costs of Monopoly
20
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10-4 The Case Against Monopoly (2 of 3)
• 10-4b Rent Seeking
• Rent Seeking: Actions of individuals and groups that spend
resources to influence public policy in the hope of
redistributing (transferring) income to themselves from
others
• If the market is monopolized, part of the consumers’ surplus
that is lost to buyers becomes profits for the monopolist
(Exhibit 8)
• The other part is the deadweight loss of monopoly
identified by the deadweight loss triangle (DCB)
21
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10-4 The Case Against Monopoly (3 of 3)
• 10-4c X-Inefficiency
• X-Inefficiency: The increase in costs, due to the
organizational slack in a monopoly, resulting from the
absence of competitive pressure to push costs down to their
lowest possible level
22
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10-5 Price Discrimination (1 of 5)
• Price Discrimination: A price structure in which the seller
charges different prices for the product it sells and the price
differences do not reflect cost differences
• 10-5a Types of Price Discrimination
• Perfect Price Discrimination: A price structure in which
the seller charges the highest price that each consumer is
willing to pay for the product rather than go without it
• Second-Degree Price Discrimination: A price structure in
which the seller charges a uniform price per unit for one
specific quantity, a lower price for an additional quantity,
and so on
23
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10-5 Price Discrimination (2 of 5)
• 10-5a Types of Price Discrimination
• Third-Degree Price Discrimination: A price structure in
which the seller charges different prices in different markets
or charges different prices to various segments of the
buying population
• 10-5b Why a Monopolist Wants to Price Discriminate
• A perfectly price-discriminating monopolist receives the
maximum price for each unit of the good it sells; a single-
price monopolist does not
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10-5 Price Discrimination (3 of 5)
• 10-5c Conditions of Price Discrimination
• Arbitrage: Buying a good at a low price and selling it for a
higher price
• For a monopolist to price discriminate, the following
conditions must hold:
– 1. the seller must exercise some control over price; that is, it
must be a price searcher
– 2. the seller must be able to distinguish among buyers who are
willing to pay different prices
– 3. Reselling the good to other buyers must be impossible or too
costly; arbitrage must not be possible
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10-5 Price Discrimination (4 of 5)
• 10-5e (sic) Moving to P=MC Through Price Discrimination
• When the perfectly price-discriminating monopolist
produces the quantity of output at which MR=MC, it
automatically produces the quantity at which P=MC
• The perfectly price-discriminating monopolist and the
perfectly competitive firm both exhibit resource allocative
efficiency (Exhibit 8)
26
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EXHIBIT 8
Comparison of a Perfectly Competitive Firm, a Single-Price Monopolist,
and a Perfectly Price-Discriminating Monopolist
27
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10-5 Price Discrimination (5 of 5)
• 10-5f Coupons and Price Discrimination
• Third-degree price discrimination is sometimes employed
by means of cents-off coupons
• One of the conditions of price discrimination is that the
seller must be able to distinguish among customers who are
willing to pay different prices; if you were a seller, how
would you find out?
• Many sellers place cents-off coupons in newspapers and
magazines for people who place a relatively low value on
their time
• People who place a relatively high value on their time are
not willing to spend it clipping and sorting coupons
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