1. ECON 211 ELEMENTS OF ECONOMICS I
Session 7– Monopoly (Part 1)
Lecturer: Dr. (Mrs.) Nkechi S. Owoo, Department of Economics
Contact Information:

2. Session Overview
This session introduces a second type of market structure- Monopoly.
We discuss the features, profit maximization conditions and goals of a monopoly firm in the first part of this session.
We introduce the concept and consequences of price discrimination within a monopoly market structure in the second part of the session.

3. Session Outline
The key topics to be covered in the session are as follows:
What is a Monopoly?
What are the Barriers to Entry?
Monopoly Behaviour
Measuring Profit and Loss

4. Reading List
Hall and Lieberman
Chapter 8, pp:

5. Topic One
what is monopoly?

6. Monopoly Single firm that serves an entire market
Sole seller of a product and product does not have substitutes
Classification of monopoly can depend on how broadly a market is defined
Is Ghana Water company a monopoly?
Is Woodin a monopoly?
Is Ruut beer a monopoly?
Spectrum of monopolies based on extent of substitutes

7. How Monopolies Arise
Monopolies exist- other firms find it unprofitable or impossible to enter the market
Barriers to entry source of monopoly power
There are two (2) types of barriers:
Technical Barriers
Economies of scale
Special knowledge of resources or technology
Legal barriers
Protection of intellectual property
Government franchise

8. Barriers to entry: Technical Barriers
Economies of scale
One firm can operate at lower average cost than other firms
Graphical Illustration of LRATC and economies of scale
Natural monopoly - arises when one firm can produce for the entire market at lower cost per unit
Once monopoly established, entry difficult because new firm would produce at lower levels of output, and therefore higher cost

9. A Natural Monopoly C $15 100 Articles of Clothing per Day Dollars 12 B
Three firms –each produce 100 units
Each operate at C on LRATC curve
Cost per unit = $15
Articles of
Clothing
per Day
Dollars 12 B
150
Two firms- each produce 150 units
Each firm operate at B on LRATC
Cost per unit = $12 (higher)
LRATC A
300 5
One firm – produce 300 units
Operate at A on LRATC curve
Cost per unit=$5

10. A Natural Monopoly
A monopoly that arises because of economies of scale is called a natural monopoly
Local monopolies are often natural monopolies
One fuel station, one supermarket, one doctor, etc in a small town
Due to sizeable lumpy inputs, first firm to enter the market will likely be the last

11. Barriers to entry: Technical Barriers
Special knowledge of resources or low-cost productive technique
Knowledge or ownership of unique resources (mineral deposits, land locations, unique managerial talents)
Example is DeBeers Diamond Monopoly
Controls 80% of world’s production of diamonds
As long as consumers believe there are no substitutes for diamonds (a Diamond is forever!), DeBeers continues to wield large market power

12. Barriers to Entry: Legal Barriers
Many pure monopolies created as a matter of law (rather than economic conditions)
Protection of intellectual property
Patents - temporary grant of monopoly for about 20 years
Scientific discoveries
Copyrights - grant of exclusive rights to sell a literary, musical, or artistic work for 70 years or longer
Possible to sell off patent and copyrights
No change in monopoly status
Creators of intellectual property enjoy a monopoly and earn profits for a limited period of time
Afterwards, other competitors enter the market drive price down.

13. Barriers to Entry: Legal Barriers
Defence for protection i.e. legal barriers?

14. Barriers to Entry: Legal Barriers
Defence for protection i.e. legal barriers?
Innovation made more profitable and acts as an incentive

15. Barriers to Entry: Legal Barriers
Government franchise
Grant of exclusive rights over a product
Rationale basis for this?
Hint: natural monopoly
Government tries to serve consumers’ interests
In exchange for monopoly status:
Firm agrees to submit to government regulation and control
Government regulates price and profits of firm
Discuss in detail later

16. Topic One
Monopoly behaviour

17. Monopoly Behavior Monopolists demand curve is downward sloping Goal
Can control price or quantity, but not both
Goal
Earn highest profit possible
A monopolist face economic constraints that limit its behavior
Cost – to produce any level of output
Input prices
Technology
Given market demand curve
the highest price it can charge

18. Monopoly Price or Output Decision
Monopolist does not make 2 separate decisions about price and output
Once a monopolist determines his/her output level, also determines the price
…and v.versa
How is profit-maximizing output level determines?
Same as any other firm- MC & MR

19. Illustration: Output and Revenue data
Quantity of Water
Price (P) TR MR 11 1 10 2 9 18 8 3 24 6 4 7 28 5 30 -2 -4
In order to sell a greater quantity of output, a monopolist must reduce the price on ALL previous units that it sells
Downward sloping DD curve
A monopolists MR is always < P
MR curve lies below demand curve

20. Demand and Marginal Revenue
Dollars
Demand
$13 MR 10 A 3 9 B 4 C -1

21. The Profit-Maximizing Output Level
We have derived our MR curve for a monopolist
To maximize profit
Produce the quantity where MC = MR, and the MC crosses the MR from below
Graphical Illustration

22. The Profit-Maximizing Output Level
Monopoly Price and Output Determination
Qty of Diamonds
Price 40
$60 MC E D
10,000
30,000 MR

23. Profit Maximization and Output Choice
A monopolist will choose to produce that output for which marginal revenue equals marginal cost.
Then uses demand curve to find the price that will induce consumers to buy that quantity
Because monopolist faces a downward-sloping demand curve, market price will exceed marginal revenue and the firm’s marginal cost at this output level.
P> MR= MC
This condition is crucial to understanding the social cost of monopoly

24. Monopoly and Market Power
A monopoly is an example of a firm with market power
The ability to raise prices without causing quantity demanded to go to zero
Do perfect competitive firms have market power?
Any firm with downward sloping demand curve has some market power
Increases in price lead to a fall in quantity demanded
Customers who value the product continue to buy at higher price
Monopoly firm is a price setter or price maker

25. Measuring profit and loss
Topic One
Measuring profit and loss

26. Profit and Loss Profit Loss When P > ATC
Total profit = Profit per unit * Q
Profit per Unit = P – ATC
Loss
When P < ATC
Total loss = Loss per unit * Q
Loss per unit = ATC - P

27. Profit and Loss Monopoly Profit and Loss Dollars (a)
Quantity of Diamonds
(b)
ATC MC
ATC MC
$50 E E
$40 40 32
Total Loss
Total Profit D D
10,000
10,000 MR MR

28. Break-even Profits
Illustrate a scenario where a monopolist breaks even
Zero economic profits

29. Monopoly Profits: Short-Run Equilibrium
In the short run, a monopolist can make profits, losses or break even
When a monopolist suffers a loss in the short run, should it shut down or continue to produce?

30. Monopoly Profits: Short-Run Equilibrium
In the short run, a monopolist can make profits, losses or break even
When a monopolist suffers a loss in the short run, should it shut down or continue to produce?
Depends on relationship between price and AVC
Illustrate graphically, the shut-down decision for a firm

31. Profit and Loss Monopoly Profit and Loss (b) ATC Dollars MC
Quantity of Diamonds
Dollars
(b)
ATC MC
Monopolist is making a loss, and not able to cover AVC.
Should shut down
AVC
$50 E 40
Total Loss D
10,000 MR

32. Profit and Loss Monopoly Profit and Loss (b) ATC Dollars MC
Quantity of Diamonds
Dollars
(b)
ATC MC
Monopolist is making a loss, but is able to cover AVC.
Should not shut down
$50
AVC E 40
Total Loss D
10,000 MR

33. Monopoly Profits: Long run equilibrium
For a PC market, profits are not possible in the long run.
Why?
In a monopoly, there are barriers to entry
Outsiders are unable to enter even if monopolist making profits
Monopolists making losses in the long term are likely to exit the market
Exceptions in a number of government regulated businesses
Therefore in the long run, monopolists do not make losses

34. The Welfare Cost of Monopoly
A monopoly market will have a higher price and a lower output than a PC market
Although profit maximization for both is MC= MR, monopolists charge P > MC
Monopolists make profits, possibly even in the long run
Desirable for firms
Do benefits to firm owners exceed costs to consumers, making monopoly desirable from standpoint of society as a whole?

35. The Welfare Cost of Monopoly
Illustration
What would happen if a single firm took over a perfectly competitive market?
There are 100 individual identical firms
Market is in equilibrium
All firms earn zero economic profit in the long run
Assume a single firm buys up all PC firms
Downward sloping demand curve becomes firm’s individual demand curve
Firm does not change the way that output is being produced
Then Monopolist’s MC curve is the same as market supply curve for PC market

36. Monopoly and Perfect Competition
Comparing Monopoly and Perfect Competition
Quantity of Output
Price per Unit
(a) Competitive Market
(b) Competitive Firm
Dollars per Unit
2. and each firm produces 1,000 units, where P = MC. S MC
ATC
3. When monopoly takes over, the old market supply curve . . . E
$10
$10
d=MR
1. In this competitive market of 100 firms, equilibrium price is $10… D
100,000
1,000

37. Monopoly and Perfect Competition
Comparing Monopoly and Perfect Competition
(c) Monopoly
Price per Unit
4. becomes the monopoly's MC curve.
S = MC F
$15
5. The monopoly produces where MR = MC, E 10 MR D
Quantity of Output
100,000
60,000
6. with a higher price and lower market output than under perfect competition.

38. The Welfare Cost of Monopoly
Recall
Below Q*, value of an extra unit > cost of producing it
Increase production
Above Q*, value of an extra unit < cost of producing it
Reduce production
Therefore, price at Q* is charged
Efficient outcome!

39. The Efficient Level of Output
Price
Marginal cost
Demand
(marginal value to buyers)
Value to
buyers
Cost to
monopolist
Efficient
quantity
Cost to
monopolist
Value to
buyers
Quantity
Value to buyers
is greater than
cost to seller.
Value to buyers
is less than
cost to seller.

40. The Welfare Cost of Monopoly
While PC firms produce P= MR= MC
Monopolist produces where MR= MC, but P> MR
Monopolist produces inefficient quantity
Graphical Illustration
What happens if monopolist produces at the PC output level?
Since P>MC, customers that value good at higher than MC, but lower than P will not buy
Inefficiency because customers value good at higher than cost of producing it
Monopoly prevents some mutually beneficial trades from taking place

41. The Inefficiency of Monopoly
P > MC; monopoly
Price
Demand
Marginal
revenue
Marginal cost
Deadweight
loss
Monopoly
price
quantity
P = MC; perfect competition and optimum
Efficient
quantity
The monopolist produces less than the socially efficient quantity
Quantity

42. References
Economics: Principles and Applications: Hall R.E. and Lieberman M. (2008), Thomson/ South Western (4th Edition)