1. Chapter 9
Monopoly
© 2006 Thomson/South-Western

2. Barriers to Entry Sole supplier of a product with no close substitutes
Barriers to entry restrictions on the entry of new firms into an industry
Legal restrictions
Economies of scale
Control of an essential resource

3. Legal Restrictions
Patents award an inventor the exclusive right to produce a good or service for 20 years
Provide the stimulus to turn an invention into a marketable product, a process called innovation
Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service

4. Exhibit 1: Economies of Scale$
Monopoly emerges when a firm experiences economies of scale as reflected by the downward-sloping, long-run average cost curve t i n u r e p t s o C
Long-run
average cost
Quantity per period

5. Economies of Scale
Market demand is not great enough to permit more than one firm to achieve sufficient economies of scale
A single firm will emerge from the competitive process as the sole seller in the market.

6. Control of Essential Resources
Control over some nonreproducible resource critical to production
Professional sports teams
Alcoa was the sole U.S. maker of aluminum for a long period of time because it controlled the supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade

7. Demand, Average and Marginal Revenue
De Beers controls the entire diamond market and suppose they can sell three diamonds a day at $7,000 each  total revenue of $21,000
Total revenue divided by quantity is the average revenue per diamond which is also $7,000  monopolist’s price equals the average revenue per diamond

8. Exhibit 2: Loss or Gain from Selling One More Unit
By selling another diamond, De Beers gains the revenue from the sale of the 4th diamond
To sell the 4th unit, De Beers must sell all four diamonds for $6,750 each, sacrificing $250 on each of the first three diamonds that could have been sold for $7,000 each
The loss in revenue from the first three units is $750
The net change in total revenue from selling the 4th diamond is $6,750 - $750 = $6,000
$7,000
LOSS
6,750 G A I N
Price per Diamond
D = Average
revenue 3 4
1 - carat diamonds per day

9. Exhibit 3: Revenue Schedule
As De Beers expands output, total revenue increases until quantity reaches 15 diamonds when total revenue tops out
For all units of output except the first, marginal revenue is less than price and the gap widens as the price declines because the loss from selling all diamonds at the lower price increases

10. Exhibit 4: Monopoly Demand and Marginal and Total Revenue
(a) Demand and Marginal Revenue
Total revenue is maximized when marginal revenue equals zero
When demand is elastic, a decrease in price increases total revenue  marginal revenue is positive
When demand is inelastic, a decrease in price reduces total revenue  marginal revenue is negative
Elastic
$ per diamond
Unit elastic
$3,750
Inelastic
Marginal revenue
D = Average revenue
1-carat diamonds
per day
(b) Total Revenue
$60,000
Dollars
Total revenue
1-carat diamonds
per day

11. Firm’s Costs and Profit Maximization
Monopolist can choose either the price or the quantity, but choosing one determines the other
Because the monopolist can select the price that maximizes profit, we say the monopolist is a price maker
More generally, any firm that has some control over what price to charge is a price maker

12. Exhibit 5: Short-Run Revenues and Costs for the Monopolist
Short-run Costs and Revenue for a Monopolist
Price Marginal Marginal Average Total
Diamonds (average Total Revenue Total Cost Total Cost Profit or
per day revenue) revenue (MR = Cost ( MC = (ACT = Loss =
(Q) (p) (TR = Q x p) TR / Q) (TC) TC / Q) TC/Q) TR - TC
(1) (2) (3) =(1) x (2) (4) (5) (6) (7) (8)
0 $7, $15, $15,000
, $7, $7, , ,750 $19, ,250
, ,500 7, ,500 3, , ,000
, ,000 6, ,500 3, , ,500
, ,000 6, ,000 2, , ,000
, ,500 5, ,000 2, , ,500
, ,500 5, ,500 1, , ,000
, ,000 4, ,750 1, , ,250
, ,000 4, ,250 1, , ,750
, ,500 3, ,250 2, , ,250
, ,500 3, ,000 2, , ,500
, ,000 2, ,250 3, , ,750
, ,000 2, ,000 4, , ,000
, ,500 1, ,500 6, , ,000
, ,500 1, ,000 9, , ,500
, , , , , ,500
, , , , , ,000
, , , , , ,500
Profit-maximizing monopolist produces that quantity where total revenue exceeds total cost by the greatest amount  $12,500 per day when output is 10 units per day. Total revenue is $52,500 and total cost is $40,000
MR = MC at this same level of output

13. Exhibit 6: Monopoly Costs and Revenue
(a) Per-Unit Cost and Revenue
Marginal cost
The intersection of the two marginal curves at point e in panel (a) indicates that profit is maximized when 10 diamonds are sold.
ATC of $4,000 is identified by point b: the average profit per diamond equals the price of $5,250 minus the ATC of $4,000 = $1,250 – the economic profit is the equal to $1,250 * 10 units sold = $12,500
In panel (b), the firm’s profit or loss is measured by the vertical distance between the TR and TC: profit is maximized where 10 diamonds are produced per day
Average total cost
Dollars per unit a
$5,250
Profit b
4,000 e
D = Average revenue MR 10 16 32
Diamonds per day
(b) Total Cost and Revenue
Total cost
Maximum
profit
$52,500
Total dollars
40,000
Total revenue
15,000
Diamonds per day

14. Exhibit 7: The Monopolist Minimizes Losses in the Short Run
Marginal revenue equals marginal cost at point e.
At quantity Q, price p (at point b) is less than average total cost (at point a)
The monopolist suffers a loss.
But the monopolist will continue to produce rather than shut down in the short run because price exceeds average variable cost (at point c).
Marginal cost a
Average total cost
Dollars per unit
Loss b p
Average variable cost c e
Demand = Average revenue
Marginal revenue
Quantity per period Q

15. Long-Run Profit Maximization
If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run
A monopolist that earns economic profit in the short-run may find that profit can be increased in the long run by adjusting the scale of the firm
Conversely, a monopoly that suffers a loss in the short run may be able to eliminate that loss in the long run by adjusting to a more efficient size

16. Exhibit 8: Perfect Competition and Monopoly
Equilibrium in perfect competition is at point c, where market demand and supply intersect to yield price pc and quantity Qc
Monopolist maximizes profit by equating MR with MC: point b and price pm and output Qm
Consumer surplus is shown by the shaded triangle ampm m pm
Dollars per unit b c pc
Sc = MC = ATC
D = AR
MRm Qm Qc
Quantity per period

17. Exhibit 8: Perfect Competition and Monopoly
Consumer surplus under perfect competition is the large triangle acpc while under monopoly it shrinks to the smaller triangle ampm
Consumer surplus has been reduced by more than the profit triangle
Consumers have also lost the triangle mcb – the deadweight loss of monopoly – allocative inefficiency arising from the higher price and reduced output m p m
Dollars per unit b c p
Sc = MC = ATC c
D = AR
MRm Qm Qc
Quantity per period

18. Why the Welfare Loss Might Be Lower
If economies of scale are extensive enough, a monopolist may be able to produce output at a lower cost per unit than could competitive firms, thus costs may be lower than under competition
Monopolists may, in response to public scrutiny and political pressure, keep prices below what the market could bear
A monopolist may keep the price below the profit maximizing level to avoid attracting new competitors

19. Why the Welfare Loss Might Be Higher
If resources must be devoted to securing and maintaining a monopoly position, monopolies may involve more of a welfare loss that simple models suggest
Efforts devoted to securing and maintaining a monopoly position are largely a social waste because they use up scarce resources but add nothing to output

20. Why the Welfare Loss Might Be Higher
Activities undertaken by individuals or firms to influence public policy to directly or indirectly redistribute income to them are called rent seeking
Without competition, monopolists may become inefficient
Monopolists are criticized for being slow to adopt the latest production techniques, develop new products, and for generally lacking innovation

21. Price Discrimination
Charging difference prices to different customers when the price differences are not justified by differences in cost
Conditions:
Demand curve must slope downward – the firm has some market power and control over price
At least two groups of consumers for the product, each with a different price elasticity of demand
Ability, at little cost, to charge each group a different price for essentially the same product
Ability to prevent those who pay the lower price from reselling the product to those who pay the higher price

22. Exhibit 9: Price Discrimination
At a given price, price elasticity of demand (panel b, elastic) is greater than in panel a (inelastic).

23. Perfect Price Discrimination
If a monopolist could charge a different price for each unit sold, the firm’s marginal revenue curve from selling one more unit would equal the price of that unit
the demand curve would become the marginal revenue curve
A perfectly discriminating monopolist charges a different price for each unit of the good

24. Exhibit 10: Perfect Price Discrimination
A perfectly discriminating monopolist would maximize profits at point e, where MR = MC a t i n u r
P r o f i t e p
Long-run
average cost
= marginal cost e s r c a l l o D
D = Marginal
revenue Q
Quantity per period