1. Monopoly
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2. Barriers to Entry Monopoly Barrier to entry
Sole supplier of a product with no close substitutes
Barrier to entry
Any impediment that prevents new firms
From entering an industry
And competing on an equal basis with existing firms
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3. Barriers to Entry Barriers to entry Legal restrictions
Economies of scale
Control of essential resources
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4. Barriers to Entry Legal restrictions Patents and invention incentives
Exclusive right to sell a product for 20 years from the date the patent application is filed
Incentive for innovation
Licenses and other entry restrictions
Government awarding an individual firm the exclusive right to supply a particular good or service
Federal and state license
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5. Barriers to Entry Economies of scale Natural monopoly
Downward-sloping long-run average cost curve
One firm can supply market demand at a lower average cost per unit than could two firms
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6. Exhibit 1 Economies of Scale as a Barrier to Entry $
Cost per unit $
A monopoly sometimes emerges naturally when a firm experiences economies of scale as reflected by a downward-sloping long-run average cost curve. One firm can satisfy market demand at a lower average cost per unit than could two or more firms, each operating at smaller rates of output.
Long-run
average cost
Quantity
per period
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7. Barriers to Entry Control of essential resources
Firm’s control over some resource critical to production
Alcoa (aluminum)
Control the supply of bauxite
Professional sports leagues
China (pandas)
DeBeers Consolidated Mines (diamonds)

8. Great depression – lower diamond prices
Is a diamond forever?
Great depression – lower diamond prices
DeBeers: control the world supply of uncut diamonds
To increase consumer demand
Marketing “A diamond is forever”
Durable, it lasts forever, and so should love
Should remain in the family and not be sold
Retain their value over time
Engagement ring
“Right-hand ring” – independence

9. Limit the supply of rough diamonds
Is a diamond forever?
Limit the supply of rough diamonds
Buyers: wholesalers
Box of uncut diamonds at a set price
No negotiations
Violates US antitrust laws
Mid 1990s: lose control of some rough diamond supplies
Russia
Australia (Argyle)
Canada (Yellowknife)

10. 2006: settle lawsuits ($300 mill.)
Is a diamond forever?
Mid 1980s: 90% of market
2007: 45% of market
Synthetic diamonds
2006: settle lawsuits ($300 mill.)
Comply with US antitrust laws
Americans
5% of world population
50% of world’s retail purchases
Blood diamonds; conflict diamonds

11. Barriers to Entry Supplying something that other producers can’t match
Unique experience
Monopolies
Local, national, international
Long-lasting monopolies
Rare - economic profit attracts competitors
Technological change

12. Revenue for the Monopolist
Monopoly
Supplies the market demand
Downward-slopping (law of demand)
To sell more: must lower the price on all units sold
Total revenue TR=pˣQ
Average revenue AR=TR/Q
For monopolist: p=AR
Demand curve = average revenue curve

13. Exhibit 2
A Monopolist’s Gain and Loss in Total Revenue from Selling a Fourth Unit
If De Beers increases quantity supplied from 3 to 4 diamonds per day, the gain in revenue from the fourth diamond is $6,750. But the monopolist loses $750 from selling the first 3 diamonds for $6,750 each instead of $7,000 each. Marginal revenue from the fourth diamond equals the gain minus the loss, or $6,750 $750 $6,000. Thus, the marginal revenue of $6,000 is less than the price of $6,750.
Dollars per
diamond
$7,000
6,750
D = Average revenue
Loss
Gain
1-carat diamonds
per day 3 4

14. Revenue for the Monopolist
Marginal revenue MR=∆TR/∆Q
For monopolist: MR<p
Declines, can be negative
Marginal revenue curve
Downward sloping
Below the demand curve (average revenue curve)

15. Exhibit 3 Revenue for De Beers, a Monopolist
To sell more, the monopolist must lower the price on all units sold. Because the revenue lost from selling all units at a lower price must be subtracted from the revenue gained from selling another unit, marginal revenue is less than the price. At some point, marginal revenue turns negative, as shown here when the price is reduced to $3,500.

16. Exhibit 4 Monopoly Demand, Marginal Revenue, and Total Revenue
Demand and marginal revenue
Dollars per diamond
$3,750
Elastic
Where demand is price elastic, marginal revenue is positive, so total revenue increases as the price falls. Where demand is price inelastic, marginal revenue is negative, so total revenue decreases as the price falls.
D=Average revenue MR
Unit elastic
Inelastic
1-carat diamonds per day 16 32
(b) Total revenue
Total dollars
$60,000
Where demand is unit elastic, marginal revenue is zero, so total revenue is at a maximum, neither increasing nor decreasing.
Total revenue
1-carat diamonds per day 16 32

17. Revenue for Monopolist
Total revenue curve
Reaches maximum where MR=0
Demand curve: p=AR
Where demand is elastic, as price falls
Total revenue increases
MR>0

18. Revenue for Monopolist
Where demand is inelastic, as price falls
Total revenue decreases
MR<0
Where demand is unit elastic
Total revenue is maximized
MR=0

19. Costs and Profit Maximization
Monopolist
Choose the price
OR the quantity
‘Price maker’
Price maker
Firm with some power to set the price
Demand curve for its output slopes downward
Firms with market power

20. Costs and Profit Maximization
Profit = total revenue minus total cost
Supply the quantity where
Total revenue exceeds total cost by the greatest amount
Marginal revenue equals marginal cost

21. Exhibit 5
Short-Run Costs and Revenue for a Monopolist

22. Exhibit 6 Monopoly Costs and Revenue Per-unit cost and revenue
Profit is maximized by producing where marginal cost equals marginal revenue, which is point e in panel (a). A profit-maximizing monopolist supplies 10 diamonds per day and charges $5,250 per diamond. Total profit, shown by the blue rectangle in panel (a), is $12,500, the profit per unit multiplied by the number of units sold. In panel (b), profit is maximized by producing where total revenue exceeds total cost by the greatest amount, which occurs at an output rate of 10 diamonds per day.
Dollars per diamond
$5,250
4,000
Marginal cost
D=Average
revenue MR
Average total cost a
Profit b e
Diamonds
per day 16 32 10
(b) Total cost and revenue
Total dollars
$52,500
40,000
15,000
Maximum
profit
Total cost
Maximum profit is total revenue ($52,500) minus total cost ($40,000), or $12,500. In panel (a) profit is measured by an area and in panel (b) by a vertical distance. That’s because panel (a) measures cost, revenue, and profit per unit of output while panel (b) measures them as totals.
Total revenue
Diamonds per day 16 32 10

23. Short-Run Losses If the price exceeds average total cost, p>ATC
Economic profit
If the price is between average total cost and average variable cost, ATC>p>AVC
Economic loss
Produce in short run

24. Shutdown Decision
If the price is below the average variable cost, p<AVC
Average variable cost curve is above the demand curve
Economic loss
Shut down in short run

25. Exhibit 7 The Monopolist Minimizes Losses in the Short Run p
Dollars per unit
Marginal cost
Average total cost
Demand=Average revenue
Marginal revenue a
Loss
Average variable cost b c e Q
Quantity per period
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), so the monopolist suffers a loss, identified by the pink rectangle. But the monopolist continues to produce rather than shut down in the short run because price exceeds average variable cost (at point c)

26. Long-Run profit Maximization
Short-run profit
No guarantee of long-run profit
High barriers that block new entry
Economic profit
Erase a loss or increase profit
Adjust the scale of the firm
If unable to erase a loss
Leave the market

27. Monopoly & Allocation of Resources
Perfect competition
Long run equilibrium
Constant-cost industry
Marginal benefit (p) = marginal cost
Allocative efficient market
Maximize social welfare
Consumer surplus

28. Monopoly & Allocation of Resources
Marginal benefit (p) > marginal cost
Restrict quantity below what would maximize social welfare
Smaller consumer surplus
Economic profit
Deadweight loss of monopoly
Allocative inefficiency

29. Monopoly & Allocation of Resources
Deadweight loss of monopoly
Net loss to society
When a firm with market power restricts output and increases the price

30. Exhibit 8 Perfect Competition and Monopoly Compared
A perfectly competitive industry would produce output QC, determined by the intersection of the market demand curve D and the market supply curve SC. The price would be pC. A monopoly that could produce output at the same minimum average cost as a perfectly competitive industry would produce output Qm, determined at point b, where marginal cost intersects marginal revenue. The monopolist would charge price pm. Thus, given the same costs, output is lower and price is higher under monopoly than under perfect competition.
Dollars per unit pm pc a D
MRm m
Sc=MC=ATC b c
Quantity
per period Qm Qc

31. Estimating Deadweight Loss
Deadweight loss of monopoly might be lower
Substantial economies of scale
Lower cost per unit
Keep price below the profit maximizing value
Public scrutiny, political pressure
Avoid attracting competition

32. Estimating Deadweight Loss
Deadweight loss of monopoly might be higher
Secure and maintain monopoly position
Use resources; social waste
Influence public policy (Rent seeking)
Inefficiency
Slow to adopt new technology
Reluctant to develop new products
Lack innovation

33. 1775, US Post Office – Monopoly 1971, US Postal Service
The mail monopoly
1775, US Post Office – Monopoly
1971, US Postal Service
Semi-independent agency
$70 billion revenue in 2009
40% of the world’s total mail delivery
Pays no taxes
Exempt from local zoning laws

34. Legal monopoly First-class stamp First-class letters Mailbox
The mail monopoly
Legal monopoly
First-class letters
Mailbox
First-class stamp
9 cents in 1970
44 cents in 2010

35. Substitutes for first-class mail
The mail monopoly
Substitutes for first-class mail
Phone calls
E-card
Text messaging
Social-networking sites
On-line bill-payment
Competition: UPS, FedEx, DHL

36. Price Discrimination Price discrimination Increasing profit
Charging different groups of consumers
Different prices
For the same product

37. Price Discrimination Conditions for price discrimination
Downward sloping demand curve
Some market power
At last two groups of consumers
With different price elasticity of demand
Ability to charge different prices
At low cost
Prevent reselling of the product

38. A Model of Price Discrimination
Two groups of consumers
One group (a): less elastic demand
The other (b): more elastic demand
Maximize profit
MR=MC in each market
Lower price for group (b)

39. Exhibit 9 Price Discrimination with Two Groups of Consumers
Consumer group
with less elastic demand
(b) Consumer group
with more elastic demand
Dollars
per unit
$3.00
1.00
Dollars
per unit
$1.50
1.00 D MR D’
MR’
LRAC, MC
LRAC, MC
400
Quantity per period
500
Quantity per period
A monopolist facing two groups of consumers with different demand elasticities may be able to practice price discrimination to increase profit or reduce loss. With marginal cost the same in both markets, the firm charges a higher price to the group in panel (a), which has a less elastic demand than group in panel (b).

40. Examples of Price Discrimination
Airline travel
Businesspeople (business class)
Less elastic demand
Higher price
Even within the same class
Different prices
Discount fares
Weekend stay

41. Examples of Price Discrimination
IBM laser printer
5 pages/minute: home; cheaper
Extra chip to insert pauses between pages
10 pages/minute: business; expensive
Intel - two versions of the same computer chip
Cheaper version
Same as the expensive version
Some extra work done to reduce its speed

42. Examples of Price Discrimination
Adobe
Photoshop Elements
Cheaper version of Photoshop CD
Amusement parks
Out-of-towners: less elastic demand
Higher prices
Locals: more elastic demand
Discount coupons available at local businesses

43. Perfect Price Discrimination
Perfectly discriminating monopolist
Monopolist who charges a different price
For each unit sold
The monopolist’s dream
Charge different price for each unit sold
D curve becomes MR curve
Convert consumer surplus into economic profit
Allocative efficiency: No deadweight loss

44. Exhibit 10 Perfect Price Discrimination Dollars per unit c a
D=Marginal revenue
Profit
Long-run average
cost = Marginal cost c
Quantity per period Q
If a monopolist can charge a different price for each unit sold, it may be able to practice perfect price discrimination. By setting the price of each unit equal to the maximum amount consumers are willing to pay for that unit (shown by the height of the demand curve), the monopolist can earn a profit equal to the area of the shaded triangle. Consumer surplus is zero. Ironically, this outcome is efficient because the monopolist has no incentive to restrict output, so there is no deadweight loss.