1. Principles of Microeconomics Chapter 15
Monopoly

2. Fundamental Causes of Monopoly
Barriers to Entry cause Monopoly Power
Resource Restrictions:
Monopoly has sole ownership of a key resource in production
Gov’t created Monopolies
Monopoly is granted exclusive rights to produce or sell a good
Natural Monopolies
One firm can provide the good at a lower cost than two or more firms

3. Pricing and Production Decisions
A monopoly firm has complete price control because they are the sole provider of the good
Considered a Price Maker
Monopoly firm – still faces a downward sloping demand curve
To sell more = must lower the price
Price: determined by firm
Quantity: determined by demand

4. Monopoly Production Decisions
Consider the market for diamonds where DeBeers has a monopoly. It is deciding how much to sell and at what price.
Where will it gain positive revenue?
What price should it set and where should it produce to maximize profits?
What will be the size of its profits at this point?
Plot the price, MR, and MC on a graph. Indicate the profit max point of production and the price the monopoly will set.
Price
Quantity TR TC MR MC
2000
25,000
1800
100
180,000
100,000
1600
200
320,000
190,000
1400
300
420,000
290,000
1200
400
480,000
400,000
1000
500
500,000
525,000

5. Monopoly Production Decisions
Monopoly can set the price anywhere below $2000 and gain positive revenue
Optimal point of production?
Need to consider profit maximization
MR = MC
If MR > MC: Increase profits by increasing Qs
If MR < MC: Increase profits by decreasing Qs

6. Monopoly Production Decisions
Price
Quantity TR MR TC MC
Profit
Change Profit
2000 -
25,000
-25,000
1800
100
180,000
100,000
750
80,000
105,000
1600
200
320,000
1400
190,000
900
130,000
50,000
300
420,000
1000
290,000
1200
400
480,000
600
400,000
1100
-50,000
500
500,000
525,000
1250
-105,000
Optimal Point of Production: MR = MC P = 1400; Q = 300

7. Application Reflection
Why does this matter?
Even though it has control over prices, a monopoly can only set as high a price as demand will allow.
It will determine the optimal production point based on where MR = MC
Once it has determined production quantity, it will assign a price based on demand
What’s the most important takeaway?
Even with complete price control, monopoly firms must consider the demand for their product when setting the price
They are still profit maximizing – so they produce where MR = MC
A monopoly can gain positive economic profits in both the long run and short run
MUDDIEST POINT?

8. Profits for a Monopoly
Profits = TR – TC = (P x Q) – (ATC x Q) = Q (P – ATC) Profits = 300 (1400 – 966) ATC = 290,000 / 300 = 966

9. Welfare Costs of a Monopoly
Since monopolies set prices and quantities at MR = MC and MR ≠ P – the monopoly outcome is socially inefficient.
Total surplus would be maximized at P = D = MC
D = MC  Socially Efficient Outcome
MR = MC  Profit Max Outcome

10. Difference between Monopoly Outcome and Socially Efficient Outcome  Deadweight loss

11. Application 2
Based on market research, Company A finds out the following information on demand and production costs of its new good:
Demand: P = 1000 – 10Q
Total Revenue: TR = 1,000 Q - 10 Q2
Marginal Revenue: MR = 1,000 – 20 Q
Marginal Cost: MC = Q
What is the price and quantity that maximize profits?
What is the price and quantity that maximize social welfare?
Draw the diagram and calculate the deadweight loss.

12. Application Reflection
Why does this matter?
Here we can quantify and graph the difference between the monopoly firm’s optimal decision and the optimal point for society as a whole
For society – consumers are better off where D = MC because the buyer’s value of the last unit produced is exactly equal to the cost of producing it. But this point is a loss for a monopoly
Monopolies will always produce less than socially optimal and charge a higher price
What’s the most important takeaway?
Quantifying deadweight loss based on the difference between monopoly outcome and socially efficient outcome
Monopoly will never produce at socially efficient point on its own because it will incur losses there
But society incurs deadweight loss from the monopoly outcome
MUDDIEST POINT?

13. Ways to Regulate Monopoly Power
Increase competition with Antitrust Laws
Regulate natural monopolies to bring price as close to socially efficient point as possible
Public Ownership  Government takes over
Do nothing: Cost to regulation > Benefit of regulating

14. Key Takeaways
Monopolies are the least competitive market structure but they still depend on demand to set prices and profit maximizing quantities
There are social costs to monopoly power, including deadweight loss
There are many harmless and harmful examples of monopoly power in the world today.