Imperfect

Competition
Monopoly
Monopoly – Introduction
• A market structure where one single firm constitutes an entire industry
and no close substitutes exist for consumers.
• For practical purposes, one firm with a very high market share is considered a
monopoly
• Monopolies are price makers – Since there is no competition, monopolies
can charge any price
• They are both industry and firms simultaneously
• E.g. US Postal Service, electricity and garbage collection company, Saudi
Aramco, Google, Youtube, Facebook, Anheuser Busch
Popular Monopolist cases
• From Mid-1990s until 2004, US
Department of Justice prosecuted
Microsoft Corporation for including
Internet Explorer as default web
browser with its operating system

• In 2015, a US federal court tossed out

antitrust charges that Google had an
agreement with mobile device makers
to set Google as the default search
engine
Types of Monopoly
• Natural Monopoly: where barriers to entry are something other than
legal prohibition
• Legal Monopoly: where laws prohibit (or severely limit) competition
Natural Monopoly
1. Economies of Scale: A firm that becomes very
large may gain significant production
advantages over its rivals by being able to
produce with lower costs
• Competitors cannot compete as they may have higher
production costs
• Market has room for only one producer
• Demand curve intersects LRAC at 5,000 planes a year
in the adjoining diagram
• A competitor with a capacity to produce 4,000 planes
will have too high costs
• A competitor with a capacity of 8,000 planes will have
lower costs but cannot sell all of them
• Economies of scale are large relative to quantity
demanded in market
Natural Monopoly - continued
2. Control of physical resource (Geography
is the barrier to entry): A firm may
control the resources required for
production of a product.
• Historical example ALCOA – the
Aluminum Company of America –
controlled most of supply of bauxite
that is used to produce Aluminum
• DeBeers – controls majority of global
diamond production
Legal Monopoly
3. Government Power (Government is the barrier to entry):
Government may give sole production rights to a single firm
• May states or cities have laws or regulations that allow households
a choice of only one electric company, water company and
garbage collection company
• Government allows producers to become regulated monopolies to
insure that customers have an appropriate amount of these
products or services
• E.g. US Postal Service is the only organization that is legally
allowed to deliver first-class mail
• Water Company, Firefighters, The Army
Legal Monopoly
4. Copyrights / Patents (Technology or Common use is barrier to
entry): Government grants sole production rights of a product to
single firm such as new medical drugs
• A patent gives the inventor exclusive legal right to make, use, or
sell the innovation for a limited time
• Copyright is a form of protection provided by laws of US for
original works of authorship
• E.g. Microsoft, Intel
Intimidating Potential Competition
• Predatory Pricing: Firm uses the threat of sharp price cuts to discourage
competition
• E.g. A large airline that provides most of flights between two cities. A
new small start-up airline decides to offer service between these two
cities
• Large airline immediately slashes prices to the bone
• New airline is not able to sell any tickets or make money and goes out of business
• Large airline raises prices as soon as new airline goes out of business
• Large advertising budgets could also discourage new entrants
• E.g. Coke and Pepsi – a new entrant will need a big advertising budget to
compete with firmly established firms
Good news…
1. Only one graph because the firm IS the industry.
2. The cost curves are the same
3. The MR= MC rule still applies
4. Shut down rule still applies
Demand and Marginal Revenue in a Monopoly
• Monopolies (and all imperfectly competitive
firms) have a down-sloping demand curves with P
MR < D
• Which means, to sell more a firm must lower its
price
• Marginal Revenue doesn’t equal the Price
• A monopolist perceives its demand curve to be
same as market’s demand curve D

• When MR curve falls below x-axis, MR is negative MR Q

and is in the inelastic range of demand curve
• Monopolist does not produce in inelastic range
 Demand and MR in Monopoly

Price Qd TR MR
• Based on table on right, MR < P (demand $6 0 $0 -
curve) $5 1 $5 $5
• If monopoly wants to sell more product, it $4 2 $8 $3
must lower price for all units sold, resulting $3 3 $9 $1
in MR falling faster than price
$2 4 $8 ($1)
$1 5 $5 ($3)
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10

15
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9

16
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$8 $8 $8

17
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$7 4 28 4
$8 $8 $8
$7 $7 $7 $7

18
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$7 4 28 4
$8 $8 $8
$6 5 30 2
$7 $7 $7 $7
$6 $6 $6 $6 $6

19
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$7 4 28 4
$8 $8 $8
$6 5 30 2
$7 $7 $7 $7 $5 6 30 0
$6 $6 $6 $6 $6
$5 $5 $5 $5 $5 $5

20
Why is MR less than Demand? P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$7 4 28 4
$8 $8 $8
$6 5 30 2
$7 $7 $7 $7 $5 6 30 0
$6 $6 $6 $6 $6 $4 7 28 -2

$5 $5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $4
21
Why is MR less than Demand? P Qd TR MR
$11 0 - -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$7 4 28 4
$8 $8 $8
$6 5 30 2
$7 $7 $7 $7 $5 6 30 0
$6 $6 $6 $6 $6 $4 7 28 -2

$5 $5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $4
22
Why is MR less than Demand? P Qd TR MR
$11 0 - -
$10 1 10 10
$10
$9 2 18 8
$9 $9 $8 3 24 6
$8 $8 MR
$8 IS LESS THAN $7 4 28 4
$6 5 30 2
$7 $7 $7 $7 PRICE $5 6 30 0
$6 $6 $6 $6 $6 $4 7 28 -2

$5 $5 $5 $5 $5 $5
$4 $4 $4 $4 $4 $4 $4
Calculating
Marginal
Revenue
To sell more a firm must lower its price. What happens to
Marginal Revenue?
Price Quantity Total Marginal
Demanded Revenue Revenue
$6 0
$5 1
$4 2
$3 3
$2 4
$1 5

Does the Marginal Revenue equal the price?

To sell more a firm must lower its price. What happens to
Marginal Revenue?
Price Quantity Total Marginal
Demanded Revenue Revenue
$6 0 0
$5 1 5
$4 2 8
$3 3 9
$2 4 8
$1 5 5

Does the Marginal Revenue equal the price?

26
To sell more a firm must lower its price. What happens to
Marginal Revenue?
Price Quantity Total Marginal
Demanded Revenue Revenue
$6 0 0 -
$5 MR1 DOESN’T
5 5
$4
EQUAL
2
PRICE
8 3
$3 3 9 1
$2 4 8 -1
$1 5 5 -3

Draw Demand and Marginal Revenue Curves

Plot the Demand, Marginal Revenue, and Total
Revenue Curves
P
$15

10

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
TR
$64

40

20

Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Demand and Marginal Revenue Curves
What happens to TR when MR hits zero?
P
$15

10

5
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
TR
$64 MR
40
Total Revenue is
at it’s peak when
20 MR hits zero
TR
Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Elastic vs. Inelastic Range of
Demand Curve
 Elastic and Inelastic Range
P Elastic Inelastic
Total Revenue Test $15
If price falls and TR
increases then 10

demand is elastic.
5
D
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
TR A monopoly
$64 MR will only
Total Revenue Test
If price falls and 40 produce in
TR falls then the elastic
demand is inelastic.
20 range
TR
Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Maximizing Profit
What output should this monopoly produce?
MR = MC
How much is the TR, TC and Profit or Loss?
P
$9 MC
ATC
8
7 Profit =$6
6
5 D
4
3
2 MR
1 2 3 4 5 6 7 8 9 10 Q
Conclusion: A monopolist produces where MR=MC, but
charges the Qprice consumers are willing to pay identified
by the demand curve.
P
$9 MC
ATC
8
7
6
5 D
4
3
2 MR
1 2 3 4 5 6 7 8 9 10 Q
 What if costs are higher?
How much is the TR, TC, and Profit or Loss?
MC
P ATC
$10
9 AVC
8
7
D
6
5 TR= $90
4 TC= $100
MR
3 Loss=$10
6 7 8 9 10 Q
 TR= $70
Identify and Calculate: TC= $56
Profit/Loss= $14
Profit/Loss per Unit= $2
P MC

$10 ATC
9
8
D
7
6
5 MR
4
1 2 3 4 5 6 7 8 9 10 Q 36
Monopoly - profits
• Like all profit-maximizing firms, a
monopolist determines price and
output at MR = MC
• Profit-maximizing quantity = 5
• Price = $5
• Total Revenue = ?
• Total cost = ?
• Total profit = ?
• Profit per unit = ?
Are Monopolies
Efficient?

38
Monopolies vs. Perfect Competition
P S = MC

CS
In perfect competition,
Ppc CS and PS are
PS maximized.

Q
Qpc 39
Monopolies vs. Perfect Competition
P S = MC

At MR=MC,
Pm A monopolist will
produce less and
Ppc
charge a higher price

D
MR
Q
Qm Qpc 40
Monopolies vs. Perfect Competition
Where is CS S = MC
P and PS for a
monopoly?
CS
Pm Total surplus falls.
Now there is
PS DEADWEIGHT
LOSS

Monopolies underproduce and over D

charge, decreasing CS and
MR
increasing PS.
Q
Qm 41
Are Monopolies Productively Efficient?
Does Price = Min ATC? No. They are not
producing at the lowest
cost (min ATC)
P
$9 MC
ATC
8
7
6
5 D
4
3
2 MR
1 2 3 4 5 6 7 8 9 10 Q 42
Are Monopolies Allocatively Efficiency?
Does Price = MC? No. Price is greater.
The monopoly is under
producing.
P
$9 MC
ATC
8
7
6

Monopolies are NOT efficient!

5
4
D

3
2 MR
1 2 3 4 5 6 7 8 9 10 Q 43
Monopolies are inefficient because they…
1. Charge a higher price
2. Don’t produce enough
• Not allocatively efficiency
3. Produce at higher costs
• Not productively efficiency
4. Have little incentive to innovate

Why?
Because there is little external pressure to be efficient
44
Monopolies and Efficiency
• Aside from PC, none of other market structures is productively or
allocatively efficient, leading to a misallocation of resources

• Allocative efficiency: is producing exact amount of output that

society wants, where P = MC. Monopolies produce where P > MC so
they are not allocatively efficient

• Productive efficiency: is when products are produced at lowest

possible cost where P = minimum ATC. Monopolies produce were P >
ATC so they are not productively efficient
 Natural Monopoly
One firm can produce the socially optimal quantity
at the lowest cost due to economies scale.
P
It is better to have only
one firm because ATC is
falling at socially
optimal quantity
MC
ATC

MR D
Qsocially optimal Q 46
2007 FRQ #1
2007 FRQ Answers
Monopoly and Efficiency

• A monopoly is good for a

monopolist but it is generally bad for
consumers and society as a whole

Deadweight loss will always be below the demand curve, above

marginal cost, and to right of profit-maximizing quantity
 Monopoly graph with perfectly elastic slope of
cost curves

• Adjoining figure shows MC, AC and

LRAC cost curves with same perfectly
elastic slope
Practice questions
1. Profit-maximizing quantity?
2. Price at profit-maximizing quantity?
3. Economic profit at profit-maximizing quantity?
4. Deadweight loss at profit-maximizing quantity?
5. Consumer surplus at profit-maximizing quantity?
6. Below what price is MR negative and in the inelastic range of demand?
7. At what quantity is there unit elasticity?
8. At profit-maximizing quantity, are there economies of scale,
diseconomies of scale or constant returns to scale?
9. What is allocatively efficient quantity?
10. What is consumer surplus at allocatively efficient quantity?
Solution
1. 10, where MR = MC
2. $5
3. $20
4. $10
5. $10
6. $4 as below this MR is negative. A monopolist will always produce
on the elastic portion of the demand curve or >= $4
7. 15; MR is zero at that quantity
8. Constant returns to scale, as LRATC is flat. When LRATC is declining,
it is economies of scale; increasing, it is diseconomies of scale
9. 20 where P = MC
10. $40
Regulating
Monopolies

53
Why Regulate?
Why would the government regulate a
monopoly?
1. To keep prices low
2. To make monopolies efficient

How do they regulate?

•Use Price controls: Price Ceilings
•Why don’t taxes work?
•Taxes reduce supply and that’s the problem 54
Where should the government place the price
ceiling?
1.Socially Optimal Price
P = MC (Allocative Efficiency)

OR
2. Fair-Return Price (Break–Even)
P = ATC (Normal Profit)
55
 Regulating Monopolies
Where does the firm produce if it is
P
unregulated?
MC

Pm ATC

D
MR

Qm Q 56
 Regulating Monopolies
PriceOptimal
Socially Ceiling at Socially Optimal
= Allocative Efficiency
P
MC

Pm ATC
Pso

D
MR

Qm Qso Q 57
 Regulating Monopolies
Price Ceiling
Fair Return meansatnoFair Returnprofit
economic
P
MC

Pm ATC
Pso
Pfr
D
MR

Qm Qso Qfr Q 58
 Regulating Monopolies
Unregulated
Socially
P
Optimal MC
Fair
Return
Pm ATC
Pso
Pfr
D
MR

Qm Qso Qfr Q 59
Regulation of Monopolies
• Firms such as water or electricity providers have very high fixed
costs
• Have high barriers to entry
• One firm can serve at lower costs than several firms

• Government allows such companies to operate as monopolies

• Due to fear of high prices and poor quality and service, Government
regulates their operations
• Goal is to increase efficiency and reduce deadweight loss
Regulating Monopolies – Socially optimal pricing
• Socially optimal pricing: Monopoly
is forced to allocatively efficient
pricing
• P = MC
• Socially optimal will likely be below
the ATC of production which could
force a firm out of business (or a
large subsidy from taxpayers)
• ATC is continually falling due to
economies of scale in a natural
monopoly
• Marginal cost of serving an
additional customer will be minimal
Regulating Monopolies – Fair-return pricing
• Fair-return pricing: Monopoly is
allowed to break even i.e. earn a
normal profit and cover its implicit
and explicit costs
• P = ATC
• This price is higher than socially
optimal price but less than what an
unregulated monopoly will charge
(while trying to maximize profits)
• ATC is continually falling due to
economies of scale in a natural
monopoly
• Marginal cost of serving an additional
customer will be minimal
Unregulated Monopoly
• Unregulated monopoly is not
regulated by Government
• Produces at profit-maximizing
quantity of MR = MC
• Underproduces and overcharges
• ATC is continually falling due to
economies of scale in a natural
monopoly
• Marginal cost of serving an
additional customer will be minimal
Regulating a Natural Monopoly
What happens if the government sets a price ceiling
to get the socially optimal quantity?
P
The firm would make a
loss and would require a
subsidy
MC

Pso
ATC

MR D
Qsocially optimal Q 64
Price
Discrimination

65
Price Discrimination
Definition:
Practice of selling the same products to
different buyers at different prices
Examples:
•Airline Tickets (vacation vs. business)
•Movie Theaters (child vs. adult) or
(afternoon show vs evening show)
•All Coupons (spenders vs. savers)
•Tolls on highway during rush hour 66
PRICE DISCRIMINATION
• Price discrimination seeks to charge each consumer what they are willing
to pay in an effort to increase profits
• Those with inelastic demand are charged more than those with elastic

Requires the following conditions:

1. Must have monopoly power - Firm is a price maker – it has a pricing strategy
that looks to charge a higher price and realize more profits
2. Must be able to segregate the market based on different price elasticities’
relative elastic demand
– Consumers with elastic demand have more choices of substitute products
– Those with relatively inelastic demand have less sensitivity to price of a particular
product since they have fewer substitute choices
3. Consumers must NOT be able to resell product
4. Price differences are not based on cost differences
 P Qd TR MR
$11 0 0 -
 Results of Price P Qd TR MR
Discrimination $11 0 0 -
$10 1 10 10
$10

69
 Results of Price P Qd TR MR
Discrimination $11 0 0 -
$10 1 10 10
$10
$9 2 19 9
$10 $9

70
 Results of Price P Qd TR MR
Discrimination $11 0 0 -
$10 1 10 10
$10
$9 2 19 9
$10 $9 $8 3 27 8
$10 $9 $8

71
 Results of Price P Qd TR MR
Discrimination $11 0 0 -
$10 1 10 10
$10
$9 2 19 9
$10 $9 $8 3 27 8
$7 4 34 7
$10 $9 $8
$10 $9 $8 $7

72
 Results of Price P Qd TR MR
Discrimination $11 0 0 -
$10 1 10 10
$10
$9 2 19 $9
$10 $9 $8 3 27 $8
$7 4 34 $7
$10 $9 $8
$6 5 40 $6
$10 $9 $8 $7 $5 6 45 $5
$10 $9 $8 $7 $6 $4 7 49 $4

$10 $9 $8 $7 $6 $5
$10 $9 $8 $7 $6 $5 $4
73
 P Qd TR MR
$11 0 0 -
$10 1 10 10
$10
$9 2 19 $9
$10 $9 $8 3 27 $8
WHEN PRICE$7 4 34 $7
$10 $9 $8
DISCIMINATING,
$6 5 40 $6
$10 $9 $8 $7 MR = D$5 6 45 $5
$10 $9 $8 $7 $6 $4 7 49 $4

$10 $9 $8 $7 $6 $5
$10 $9 $8 $7 $6 $5 $4
74
 Regular Monopoly vs.
Price Discriminating Monopoly
P
MC

Pm
ATC

MR
Qm Q 75
A perfectly discriminating monopoly can charge
each person differently so the
Marginal Revenue = Demand
P
MC

ATC

MR
Q 76
A perfectly discriminating can charge each person
differently so the Marginal Revenue = Demand
Identify the Price, Profit, CS, and DWL
P
MC

ATC

D =MR

Qnm Q 77
A perfectly discriminating can charge each person
differently so the Marginal Revenue = Demand
Identify the Price, Profit, CS, and DWL
P
MC

ATC

D =MR
Price Discrimination results in several
prices, more profit, no CS, and a higher
socially optimal
Q
quantity Q
nm 78
Characteristics of a Monopoly
• One firm selling a unique product
• The demand curve is downsloping with
MR < D
• High barriers to entry
• Firm is a “price-maker”
• Economic profits in the long run
• Not allocatively efficient (P > MC)
• Not Productively efficient (P > minimum
ATC)