1. 7 Monopoly Define what a monopoly is.
Explain why price exceeds marginal revenue in monopoly.
Describe how a monopoly sets output and price.
Illustrate how monopoly and competitive outcomes differ.
List the pros and cons of monopoly structures.
We will revisit these learning objectives at the end of the chapter.
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2. CHAPTER 7
The goal of this chapter is to examine how a market controlled by a single producer—a monopoly—behaves.
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3. Market power over price and quantity. The firm is the industry.
MONOPOLY STRUCTURE
A monopoly is one firm that produces the entire market supply of a particular good or service.
Barriers to entry.
Market power over price and quantity.
The firm is the industry.
The firm’s demand curve is the market demand curve.
If another firm entered this industry, it would no longer be a monopoly. The monopolists’ demand curve is downward-sloping since the monopolist is the industry.
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4. Monopolists do not maximize profit where price equals marginal cost.
MONOPOLY STRUCTURE
Monopolists do not maximize profit where price equals marginal cost.
For perfectly competitive firms:
Price = MR because it is a price taker.
Profit maximizing rule is MR = MC.
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5. A monopolist can sell additional output only if it reduces prices.
MONOPOLY STRUCTURE
Because monopolists face a downward sloping demand curve, marginal revenue is not constant.
Marginal revenue is the change in total revenue from a unit increase in quantity.
A monopolist can sell additional output only if it reduces prices.
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6. Marginal revenue is always less than price for a monopolist.
MONOPOLY STRUCTURE
Marginal revenue is always less than price for a monopolist.
Quantity
Price
Total Revenue
Marginal Revenue A 1 B 2 C 3 D 4 E 5 F 6 G 7
X $ = $13
$11 9 7 5 3 1
X $ =
X $ =
X $ =
X $ =
X $ =
X $ =
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7. MR curve is always below the demand curve.
MONOPOLY STRUCTURE
MR curve is always below the demand curve.
$14 A
Marginal revenue is less than price for a monopoly. 13 B 12 C 11 D b 10 E 9 c F 8 G
Demand (price charged by monopolist)
PRICE (per pound) 7 d 6
The MR curve decreases twice as fast as the demand curve. 5 e 4 3 f 2
Marginal revenue 1 g 1 2 3 4 5 6 7 8 9 10
QUANTITY (pounds of fish per hour)
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8. MONOPOLY BEHAVIOR
A monopolist maximizes profits by producing a rate of output where MR = MC.
A monopolists identifies the price corresponding to this output using the demand curve.
Demand curve indicates highest price consumers are willing to pay for a specific quantity of output.
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9. MONOPOLY BEHAVIOR A monopolist’s production decisions are:
Output by setting MR = MC.
Price using the demand curve.
$14
Average Total cost 13 12 11 D 10
Profit per unit = p – ATC 9
Total profit 8
Total profit = (p – ATC) x q
PRICE OR COST (per pound) d 7
Point D is where MR = MC, the profit-maximizing quantity.
Follow this quantity up to the demand curve to identify the profit-maximizing price.
The difference between P and ATC is per unit profits.
The area of the white rectangle represents the profit.
Note that monopolists do not minimum costs. 6
Demand 5 4
MR = MC 3
Marginal Cost 2
Marginal revenue 1
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QUANTITY (pounds of fish per hour)

10. The profit maximization rule of setting MR = MC applies to all firms.
MONOPOLY BEHAVIOR
The profit maximization rule of setting MR = MC applies to all firms.
A monopoly firm produces an output where MC = MR (< p).
A perfectly competitive firm produces an output where MC = MR (= p).
MC = MR (< p) for all imperfectly competitive firms.
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11. MONOPOLY BEHAVIOR
A monopolist produces less output and charges a higher price than a competitive industry.
Average 13
total cost 12
Monopolist price of $10 and output of 4.
Competitive price of $9 and output of 5. 11 D 10 E 9 8
MC = p
PRICE OR COST (per pound) 7 d
MC = MR 6
Demand 5 4 3
Marginal 2
cost
Marginal 1
revenue 1 2 3 4 5 6 7 8 9
QUANTITY (pounds of fish per hour)
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12. Monopolists earn positive profits due to complete barriers to entry.
Barriers to entry are obstacles making it difficult or impossible for firms to enter the market.
Positive profit requires the restriction of output through limiting the number of firms in the industry.
Examples of barriers to entry include patents, legal harassment, exclusive licensing, bundled products, and government franchises. Barriers to entry act to limit the number of firms entering an industry.
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13. PATENT PROTECTION Several barriers exist that prohibit entry.
Patent: Exclusive rights to an innovation
Legal harassment: Sue potential entrants.
Exclusive license: Contract restricting factors of production.
Bundling products: Selling complementary products.
Government franchise: Exclusive production right.
A patent gives a firm the sole right to produce a good for a certain number of years. Polaroid’s patents forced Kodak out of the instant-photography business.
Lengthy legal battles are so expensive that the threat of legal action may deter entry into a monopolized market. Monopolists usually have the financial power to press lawsuits like this.
The lack of a license can be a significant barrier to entry, unless a firm wishes to operate illegally.
Bundled products serve as a barrier to entry, causing the customer to purchase unwanted goods in order to acquire the good they want. You want ESPN on cable, but, to get it, you must also pay for the Oprah Winfrey Network and Country Music Network, which you may not want. Bundling products makes it difficult for competitors to sell their products profitably. Microsoft bundles software applications with its Windows operating systems (although the European Union required Microsoft to offer alternatives to consumers).
A monopoly granted by a government license. These include local power, telephone, and cable TV companies. Another example is the U.S. Postal Service, which has a monopoly in providing first-class mail. Technology is rapidly eliminating monopolies like this. Skype versus the phone company; DirecTV versus the cable company, etc.
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14. A monopolist prohibits entry of new firms, keeping price high.
COMPARATIVE OUTCOMES
A monopoly’s market power allows it to change the way the market responds to consumer demands.
A monopolist prohibits entry of new firms, keeping price high.
A perfectly competitive firm cannot prohibit entry of new firms, price tends to fall.
If the monopolist can keep newcomers out, they focus on the profit-maximizing quantity. Competitive firms will have new entries and must cater to the customer for fear they might go to a competitor.
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15. High price and profit signal consumers’ demand for more output.
COMPARATIVE OUTCOMES
High price and profit signal consumers’ demand for more output.
In a competitive industry:
High profit attract new suppliers.
Production and supply expand.
Price falls.
Economic profit squeezed to zero.
Pressure to innovate to keep ahead.
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16. High price and profit signal consumers’ demand for more output.
COMPARATIVE OUTCOMES
High price and profit signal consumers’ demand for more output.
In a monopoly industry:
Barriers to entry prohibit competition.
Production and supply constrained.
Price remains high.
Economic profit remains.
No pressure to innovate.
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17. Market power is not solely concentrated with monopolists.
NEAR MONOPOLIES
Market power is not solely concentrated with monopolists.
Two or more firms may rig the market to replicate monopoly outcomes and profits.
A near monopoly is when multiple firms work together to try to act like a monopolist.
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18. Duopoly: Two firms dominate market.
NEAR MONOPOLIES
Three significant industry structures provide firms with some market power.
Duopoly: Two firms dominate market.
These firms set price and output even if other firms are present.
May engage in price wars.
May engage in price fixing.
A duopoly is two firms in a market, while an oligopoly is a few firms, usually three or more. In monopolistic competition many firms each strive to have a monopoly on their own brand image but must still contend with competing brands.
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19. Oligopoly: Several firms dominate the market.
NEAR MONOPOLIES
Oligopoly: Several firms dominate the market.
Goods are close substitutes.
May collude to control price or output.
May engage in price wars.
Relay on clever advertising to persuade consumers to their product.
Barriers to entry are high.
Examples include airlines such as Delta, United, and other large carriers. There are some smaller regional airlines. Loyalty programs are big and advertising attempts to persuade travelers to fly with a certain airline.
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20. Monopolistic competition: Many firms selling a differentiated product.
NEAR MONOPOLIES
Monopolistic competition: Many firms selling a differentiated product.
No one firm has complete market power.
Contend with competing brands.
Each has monopoly power on their brand.
Few barriers to entry.
Examples include restaurants, cereal, clothing, shoes, and service industries.
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21. WHAT GETS PRODUCED
Firms with market power alter the output of goods and services in specific ways.
Less is produced
Sold at higher price.
The result is fewer workers are needed and fewer customers purchase the products, but producer make profits.
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22. RESEARCH AND DEVELOPMENT
In principle, monopolies have a greater ability to pursue research and development.
Have profits to invest in expensive R&D.
No incentive to improve products.
Continue to make profits by maintaining market power.
Monopolies have no clear incentive for invention and innovation.
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23. ENTREPRENEURIAL INCENTIVES
In principle, monopolies potentially drive entrepreneurial activities.
However:
Positive profit by innovation is not exclusive to monopoly industry.
Innovators in perfect competition have the ability to earn large profits.
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24. Firm could use its size to achieve greater efficiency.
ECONOMIES OF SCALE
One firm producing all output may benefit consumers if lower costs are achieved at higher output rates.
Economies of scale are present if average costs fall as the size (scale) of plant and equipment increases.
Firm could use its size to achieve greater efficiency.
Monopolists will grow as large as needed to produce the profit-maximizing quantity. Any start-up trying to compete must necessarily start small and at higher costs.
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25. Large monopolist may not achieve greater efficiency.
NATURAL MONOPOLY
A natural monopoly is an industry in which one firm can achieve economies of scale over the entire range of market supply.
Large monopolist may not achieve greater efficiency.
Consumers may not benefit if monopolist doesn’t lower prices.
A natural monopoly achieves economies of scale “naturally,” and it makes sense to have only one producer of the good. Examples of natural monopolies include local telephone, cable, and utility services.
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26. CONTESTABLE MARKETS
A monopolist earning large profits entices potential rivals to enter the market.
A contestable market is an imperfectly competitive industry subject to potential entry if prices or profits increase.
How contestable a market is depends not so much on its structure as it does on its barriers to entry.
A contestable market in which competitors will compete for the customer’s business. Monopoly is not a contestable market.
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27. STRUCTURE VERSUS BEHAVIOR
If potential rivals force a monopolist to behave like a competitive firm, then a monopoly imposes no cost on consumers.
Potential rivals must have a reasonable chance to enter the market and reduce the monopoly’s market power.
Potential competition can force a monopoly to change its ways. The advent of satellite-delivered TV caused land-based cable systems to upgrade and better satisfy their customers. It illustrates the basic notion of contestable markets. It is behavior that matters, not structure.
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28. AIR TRANSPORTATION INDUSTRY
Market structure explains why it can be cheap to fly to one place and expensive to fly somewhere else of equal distance.
Collectively, airlines look competitive.
Air routes between cities are limited markets.
Must analysis each route separately to understand market power.
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29. AIR TRANSPORTATION INDUSTRY
Airlines price routes differently depending on how many airlines fly the route.
If several airlines fly a route, airlines behave competitively.
If one or two airlines fly a route, airlines behave like monopolists and duopolists.
1 in 10 domestic routes is monopolized.
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30. AIR TRANSPORTATION INDUSTRY
Airports dominated by one or two carriers have higher fares.
Fares from airports with 1-2 carriers are 45-85% higher than at more competitive airports.
This shows what happens when a dominant firm on a route is challenged by a competitor.
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31. AIR TRANSPORTATION INDUSTRY
Fares change significantly when competitors enter/exit market.
Entry and exit can be used to assess market structure on prices.
Monopolies may use a sharp, temporary price reduction to drive out competitors or discourage entry, called predatory pricing.
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32. AIR TRANSPORTATION INDUSTRY
Large carriers maintain monopoly routes by owning landing rights and gates.
Act as barriers to entry.
New carriers unable to enter.
Lottery system for new slots didn’t improve competition as large carriers paid substantial sums to lottery winners to sell.
At Washington, D.C.’s Reagan Airport, six large carriers owned 97 percent of available takeoff/landing slots in 2000.
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33. SUMMARY Defined what a monopoly is.
Explained why price exceeds marginal revenue in monopoly.
Described how a monopoly sets output and price.
Illustrated how monopoly and competitive outcomes differ.
Listed the pros and cons of monopoly structures.
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