1. Michael Parkin
ECONOMICS 5e
CHAPTER 13 Monopoly 1

2. Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition 2

3. Learning Objectives (cont.)
Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency 3

4. Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition 4

5. How Monopoly Arises
A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. 5

6. How Monopoly Arises No Close Substitutes Barriers to Entry
If a good has close substitutes, it faces competition from the producer of the substitute.
Barriers to Entry
Barriers to entry are legal or natural constraints that protect a firm from potential competitors. 6

7. How Monopoly Arises Legal Barriers to Entry
In a legal monopoly competition and entry is restricted by the granting of a public franchise, government license, concession, patent, or copyright. 7

8. How Monopoly Arises Natural Barriers to Entry
A natural monopoly results from a situation in which one firm can supply the entire market at a lower price than two or more firms can.
Example: Electric utility, water supply, gas supply, garbage collection, sea port 8

9. Natural Monopoly 15 10 5 ATC D 1 2 3 4 Price (cents per kilowatt-hour)
Instructor Notes:
1) The demand curve for electric poser is D, and the average total cost curve is ATC.
2) Economies of scale exist over the entire ATC curve.
3) One firm can distribute 4 million kilowatt-hour at a cost of 5 cents a kilowatt-hour.
4) This same total output costs 10 a kilowatt-hour with two firms and 15 cents a kilowatt-hour with four firms.
5) So one firm can meet the market demand at a lower cost than two or more firms can, and the market is a natural monopoly. 5
ATC D 1 2 3 4
Quantity (millions of kilowatt-hours) 10

10. Monopoly Price- Setting Strategies
Price discrimination is the practice of selling different units of a good or service for different prices (ie., pizza, airlines).
A single-price monopoly is a firm that must sell each unit of its output for the same price (ie., DeBeers). 12

11. Single-Price Monopoly
The firm’s demand curve is the market demand curve.
Marginal revenue is not the same as the market price. 14

12. Single-Price Monopoly
Bobbie’s Barbershop, in Cairo, Nebraska, is the sole supplier of haircuts in town.
Let’s examine the market for haircuts in Cairo. 15

13. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P  Q) (dollars per
haircut) per hour) (dollars additional haircut)
a 20 0
b 18 1
c 16 2
d 14 3
e 12 4
f 10 5
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10 16

14. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P  Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10 17

15. Demand and Marginal Revenue
Quantity Marginal
Price demanded Total revenue
(P) (Q) revenue
(dollars per (haircuts (TR=P  Q) (dollars per
haircut) per hour) (dollars additional haircut) a b c d e f 18 14 10 6 2
Instructor Notes:
1) The table shows Bobbie’s demand schedule.
2) Total revenue (TR) is price multiplied by quantity sold.
3) For example, in row c the price is $16 a haircut, 2 haircuts are sold, and total revenue is $32.
4) Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
5) For example, when the price falls from $16 to $14 a haircut, the quantity sold increases by 1 haircut and total revenue increases by $10.
6) Marginal revenue is $10 18

16. Demand and Marginal Revenue20
Total revenue loss $4 MR c 16
Price & marginal revenue
(dollars per haircut) d 14
Total revenue gain $14 10
Marginal revenue $10
Instructor Notes:
The demand curve, D, and the marginal revenue curve, MR, are based on the numbers in the table and illustrate the calculation of marginal revenue when the price falls from $16 to $14. D
2 3
Quantity (haircuts per hour) 21

17. Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good. 22

18. Marginal Revenue and Elasticity
Demand and marginal revenue curves 20
Elastic D d
Unit elastic
Price $ marginal revenue
(dollars per haircut) 10
Inelastic f
Quantity
(haircuts
per hour)
Maximum
total revenue 5 10
Instructor Notes:
1) Over the range from 0 to 5 haircuts an hour, a price cut increases total revenue, so marginal revenue is positive, as shown by the blue bars.
2) Demand is elastic.
3) Over the range 5 to 10 haircuts an hour, a price cut decreases total revenue, so marginal revenues is negative, as shown by the red bars.
4) Demand is inelastic.
5) At 5 haircuts an hour, total revenue is maximized, and marginal revenue is zero.
6) Demand is unit elastic.
–10
– 20 MR 27

19. Marginal Revenue and Elasticity
Total revenue curve 50
Zero
marginal
revenue 40
Total revenue (dollars per hour) 30 20
Instructor Notes:
1) The total revenue curve is shown above.
2) Total revenue is maximized where MR is zero--5 haircuts per hour. 10
Quantity
(haircuts
per hour) TR 5 10 30

20. Marginal Revenue and Elasticity
Profit maximizing monopolies will never produce at an output in the inelastic range of its demand curve.
It could charge a higher price, produce a smaller quantity, and earn a larger profit. 31

21. Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition

22. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0
18 1
16 2
14 3
12 4
10 5
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC). 32

23. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC). 33

24. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
20 0 0 18 14 10 6 2
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC). 34

25. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) 18 14 10 6 2
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC). 35

26. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) 18 14 10 6 2 1 3 6 10 15
Instructor Notes:
1) This table gives the information needed to find the profit-maximizing output and price.
2) Total revenue (TR) equals price multiplied by the quantity sold.
3) Profit equals total revenue minus total cost (TC). 36

27. A Monopoly’s Output and Price Decision
Marginal Marginal
Price Quantity Total revenue Total cost
(P) demanded revenue cost Profit
(dollars (Q) (TR = P  Q) (dollars per (TC) (dollars per (TR – TC)
per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars) 18 14 10 6 2 1 3 6 10 15
Instructor Notes:
1) Profit is maximized when the price is $14 and 3 haircuts are sold.
2) Total revenue is $42, total cost is $30, and economic profit is $12 ($42 - $30). 37

28. A Monopoly’s Output and PriceTC
Economic
profit = $12 TR 50 42
Total revenue and total cost
(dollars per hour) 30 20
Instructor Notes:
In this graph, economic profit equals total revenue (TR) minus total cost (TC) and is maximized at 3 haircuts an hour. 10
Quantity (haircuts per hour) 41

29. A Monopoly’s Output and PriceMC 20 MR D
ATC
Profit = $12
($4 x 3 units)
Price and cost (dollars per hour) 14
Economic
profit $12 10
Instructor Notes:
1) In this related graph, economic profit is maximized when marginal cost (MC) equals marginal revenue (MR).
2) The price is determined by the demand curve (D) and is $14.
3) Economic profit, the blue rectangle, is $12--the profit per haircut ($4) multiplied by 3 haircuts.
Quantity (haircuts per hour) 45

30. Learning Objectives
Explain how monopoly arises and distinguish between single-price monopoly and price-discriminating monopoly
Explain how a single-price monopoly determines its output and price
Compare the performance and efficiency of single price monopoly and competition

31. Single Price Monopoly and Competition Compared
Perfect Competition
a price taker
produce where mr = mc
p = mr = mc
no barriers to entry
Monopoly
monopoly influences its price
produce where mr = mc
p > mc;
barriers to entry
restricts output, charges a higher price

32. Single Price Monopoly and Competition Compared
monopoly: Higher
price and smaller
output
Price
S =MC D MR PM QM
Perfect
competition PC QC
Quantity

33. Inefficiency of Monopoly
Perfect Competition
Consumer
surplus
Price MC PC
Instructor Notes:
1) In perfect competition, the quantity QC is sold at the price PC.
2) Consumer surplus is the green triangle.
3) In long-run equilibrium, firms economic profits are zero and consumer surplus is maximized.
Producer
surplus D
Efficient
quantity QC
Quantity 60

34. Inefficiency of Monopoly
Price PA
Consumer
surplus MC PM
Deadweight
loss
Monopoly’s
gain PC
Producer
surplus
Instructor Notes:
1) A single-price monopoly, as shown in the graph, restricts output to QM and increases the price to PM .
2) Consumer surplus is the green triangle.
3) The monopoly takes the blue rectangle and creates a deadweight loss (the gray triangle). MR D QM QC
Quantity 61

35. Learning Objectives Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency 47

36. Rent Seeking
The activity of trying to obtain a monopoly from which an economic profit can be made is called rent seeking.
The term rent includes consumer surplus, producer surplus, and economic profit.
Rent seeking occurs when a monopolist attempts to capture some of the consumer surplus for itself. 63

37. Rent Seeking They attempt to do so by: Buying a monopoly (ex. taxis)
Does not ensure an economic profit.
Creating a monopoly (ex. lobbying)
Very costly. 64

38. Rent Seeking Costs Monopoly ATC MC PM MR D QM Price Quantity Consumer
surplus MC PM
Rent seeking
costs exhaust
producer
surplus
Deadweight
loss MR D QM
Quantity

39. Learning Objectives Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency

40. How do these firms make a profit?
Price Discrimination
Price discrimination - selling a good or service at a number of different prices.
To be able to price discriminate, a monopoly must:
1. Identify and separate different buyer types
2. Sell a product that cannot be resold
How do these firms make a profit? 48

41. Price Discrimination Consumer surplus
Price discrimination attempts to capture the consumer surplus for the monopoly. 49

42. Price Discrimination Discriminating Among Units of a Good
Charging buyers different prices on each good bought (ex. bulk buying discounts)
Discriminating Among Individuals
Some people value additional units differently (ex. pizza) 50

43. Price Discrimination
Let’s look at how price discrimination, when used by a monopoly, can lead to higher profits — Global Air. 51

44. A Single Price of Air Travel
Consumer
surplus MC
2100 MR
Price (dollars per trip)
1800
ATC
Economic
profit
1500
1200
$48
million
900
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
600
300 D 5 8 10 15 20
Passengers (thousands per year) 52

45. New Fair Structure MC ATC MR D Increased economic profit from price
discrimination MC
2100 MR
1800
Price (dollars per trip)
ATC
1600
1400
1200
900
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
600
300 D 2 4 6 8 10 15 20
Passengers (thousands per year) 52

46. Perfect Price Discrimination
Global extracts the entire consumer surplus.

47. Perfect Price Discrimination
Increase in economic
profit from perfect
price discrimination MC
2100
1800
Price (dollars per trip)
ATC
1600
1400
1200
900
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
600
Increase
in output
300 D 2 4 6 8 11 15 20
Passengers (thousands per year) 52

48. Efficiency and Rent Seeking with Price Discrimination
With perfect price discrimination, output increases to the point at which price equals marginal cost - where the marginal cost intersects the demand curve.
Output is identical to that of perfect competition.

49. Efficiency and Rent Seeking with Price Discrimination
Perfect price discrimination pushes consumer surplus to zero but increases producer surplus to equal the sum of consumer surplus and producer surplus in perfect competition.

50. Efficiency and Rent Seeking with Price Discrimination
Deadweight loss is zero.
Perfect price discrimination achieves efficiency.

51. Gains from Monopoly Economies of Scale and Scope
Lowers average total cost and a greater range of goods produced
Incentives to Innovate
The attempt to apply knew knowledge in the production process and obtain a patent

52. Learning Objectives Define rent seeking and explain why it arises
Explain how price discrimination increases profits
Explain how monopoly regulation influences output, price, economic profit, and efficiency

53. Regulating a Natural Monopoly
Profit maximization
The Efficient Regulation
Marginal cost pricing rule
Average Cost Pricing
Average cost pricing rule

54. Regulating a Natural Monopoly
Profit maximization (cont.)
Suppose the natural gas company is not regulated and instead maximizes profit.
This outcome is fine for the gas company, but it is inefficient.

55. Regulating a Natural Monopoly
The Efficient Regulation
If the monopoly regulator wants to achieve an efficient use of resources, it must require the gas company to produce the quantity of gas that brings marginal benefits into equality with marginal costs.
A marginal cost pricing rule sets the price equal to marginal cost.

56. Regulating a Natural Monopoly
The Efficient Regulation (cont.)
The marginal cost pricing rule maximizes total surplus in the regulated industry.
The marginal cost pricing rule is efficient.
It leaves the natural monopoly incurring an economic loss.

57. Regulating a Natural Monopoly30
Profit
maximizing
Price and cost (cents per cubic foot) 20
Average
cost pricing 18 15
Instructor Notes:
1) The first graph shows the demand curve (D), marginal revenue curve (MR), and marginal cost curve (MC) for a route on which Global Air has a monopoly.
2) As a single-price monopoly, Global maximizes profit by selling 10,000 trips a year at $1,500 a trip.
3) Its profit is $5 million, which is shown by the blue rectangle in the first graph.
4) The demand curve in the first graph is the horizontal sum of the demand curves for business travel (DB) in the second graph and the demand for vacation travel (DV) in the third.
5) Global sells 6,000 trips to business travelers for a profit of $3 million and 4,000 trips to vacation travelers for a profit of $2 million.
ATC
Marginal
cost pricing MR 10 MC 1 2 3 4
Quantity (millions of cubic feet per day) 52

58. Regulating a Natural Monopoly
Average Cost Pricing
Regulators almost never impose efficient pricing because of the consequences for the firm’s profit.
Instead, they compromise by permitting the firm to cover all its costs and to earn a normal profit.

59. Regulating a Natural Monopoly
Average Cost Pricing (cont.)
Pricing to cover cost and normal profit means setting price equal to average total cost - called an average cost pricing rule.
The firm earns a normal profit.
The outcome is inefficient, but less so than the unregulated profit maximizing outcome.