F202: Microeconomics

Chapter 13  Monopoly
Notes based on the textbook chapter (Krugman & Wells). Read once, then use these.

What You Will Learn in This Chapter

ˆ What a monopoly is: one rm is the only producer of a good.

ˆ How a monopolist picks the output and price that give the most prot.

ˆ How monopoly diers from perfect competition, and what that does to society's welfare.

ˆ What policy makers do about the problems monopoly causes.

ˆ What price discrimination is, and why rms with market power use it.

1. Types of Market Structure

Economists sort markets into four models. Two things decide the type:

1. How many producers are in the market (one, few, or many).

2. Whether the goods are identical or dierentiated (dierent but seen as somewhat substitutable,
like Coke vs Pepsi).

ˆ Perfect competition: many producers, identical product.

ˆ Monopoly: ONE producer, single undierentiated product.

ˆ Oligopoly: a few producers, identical or dierentiated.

ˆ Monopolistic competition: many producers, each sells a dierentiated product.

How to read the gure

The book's Figure 13-1 is a 2-by-2 grid. Left column = No dierentiated (identical goods): top is
Monopoly (one), bottom is Perfect competition (many). Right column = Yes dierentiated: top
is Oligopoly (few), bottom is Monopolistic competition (many). Keep this picture in your head 
it appears in many exam questions.

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 Figure 1: Book Figure 13-1: Types of market structure.

2. The Meaning of Monopoly

Key Denition

A monopolist is a rm that is the sole supplier of a good that has no close substitutes. An
industry controlled by a monopolist is a monopoly.

ˆ Monopoly is the most extreme departure from perfect competition.

ˆ True monopolies are rare today (antitrust laws block them), but the analysis is the foundation for
oligopoly and monopolistic competition later.

3. What Monopolists Do
A monopolist is the only seller, so its demand curve is the whole market demand curve (downward
sloping). It knows its actions change the price.

Market power  the core idea

Market power = the ability of a rm to raise the price by reducing output. A wheat farmer has
none (must take the market price). A local water company has it.

ˆ Compared with perfect competition, a monopolist reduces output and raises price.

ˆ Reason: to increase prot. The whole is worth more than the sum of competing parts.

ˆ Under perfect competition, economic prot vanishes in the long run. Under monopoly, prot
persists in the long run (because entry is blocked).

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Figure 2: Book Figure 13-2: A monopolist moves from competitive point C up the demand curve to M, cutting
output (QC→QM) and raising price (PC→PM).

4. Why Do Monopolies Exist?

For prot to last, something must stop other rms from entering: a barrier to entry. Five types:

1. Control of a scarce resource or input  De Beers controlled the diamond mines.

2. Increasing returns to scale  large xed cost gives a big rm lower average cost than small
ones. This creates a natural monopoly.

3. Technological superiority  e.g. Intel's chip lead (usually temporary; rivals catch up).

4. Network externality  a good is more valuable when more people use it (e.g. Windows,
internet). The rm with the biggest network wins.

5. Government-created barrier  patents and copyrights give a temporary legal monopoly.

Natural monopoly

A natural monopoly exists when increasing returns to scale give a large cost advantage to a single
rm that produces all of the industry's output. Average total cost (ATC) keeps falling over the
relevant output range. Examples: water, gas, local electricity.

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Figure 3: Book Figure 13-3: Natural monopoly  ATC falls over the whole relevant output range (where price
≥ ATC), so one rm is cheaper than two.

Patent & Copyright

A patent gives an inventor a temporary monopoly (about 1620 years) to make/use/sell an

invention. A copyright gives the creator of a literary/artistic work sole rights to prot, usually
life + 70 years. They reward invention by allowing higher prices while protected; once they lapse,
competition lowers prices.

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Figure 4: Book graph: drug prices paid by consumers in dierent countries (Nasonex). Americans pay far
more  dierence is mainly regulation: other governments cap drug prices. This is price discrimination across
countries.

5. How a Monopolist Maximizes Prot

5.1 The Monopolist's Demand Curve and Marginal Revenue

The optimal output rule (from Chapter 12) holds for ALL rms:

Formula

Prot is maximized where Marginal Revenue = Marginal Cost: MR = MC

ˆ A perfectly competitive rm faces a horizontal demand curve at the market price. Its MR =
price always.

ˆ A monopolist faces the downward-sloping market demand curve. To sell one more unit it
must lower the price on ALL units. So its MR < price.

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Figure 5: Book Figure 13-4: (a) Competitive rm's horizontal demand DC; (b) monopolist's downward-sloping
demand DM (= market demand).

5.2 Quantity eect vs Price eect

When a monopolist sells one more unit, two things happen:

ˆ Quantity eect: it sells one more unit, gaining the price of that unit.

ˆ Price eect: to sell that unit it must cut the price on every unit, losing revenue on all previous
units.

Why MR < Price

Because of the price eect, the monopolist's marginal revenue is always below the demand
curve. More output ⇒ bigger price eect. The wedge between price and MR is what market power
causes.

The table below is the book's Table 13-1 (De Beers diamonds). Study the pattern: as price falls by $100
each step, quantity rises by 1, but MR falls faster and even turns negative.

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 Price of diamond Quantity Total revenue Marginal revenue
P Q TR = P×Q MR = ∆TR/∆Q
$1,000 0 $0 
$950 1 $950 $950
$850 2 $1,800 $850
$750 3 $2,550 $750
$650 4 $3,200 $650
$550 5 $3,750 $550
$450 6 $4,200 $450
$350 7 $4,550 $350
$250 8 $4,800 $250
$150 9 $4,950 $150
$50 10 $5,000 $50
$50 11 $4,950 $50
$150 12 $4,800 $150
$250 13 $4,550 $250
$350 14 $4,200 $350
$450 15 $3,750 $450
$550 16 $3,200 $550
$650 17 $2,550 $650
$750 18 $1,800 $750
$850 19 $950 $850
$950 20 $0 $950

Book Table 13-1: Demand, Total Revenue, and Marginal Revenue for the De Beers Monopoly.

ˆ Total revenue (TR) is hill-shaped: it rises up to 10 diamonds, then falls.

ˆ TR is highest at 10 diamonds, where MR = 0.

ˆ When quantity eect > price eect, TR rises. When price eect > quantity eect, TR falls.

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Figure 6: Book Figure 13-5: (a) Demand D and Marginal Revenue MR (MR below D). Going from 9 to 10
diamonds: green = quantity eect (+$500), yellow = price eect ($450), so MR = $50. (b) Total revenue TR
is hill-shaped, max at 10.

5.3 The Monopolist's Prot-Maximizing Output and Price

Assume MC is constant at $200 (so MC = ATC, a horizontal line).

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 Step by step  how to solve any monopoly problem

1. Draw D, MR, MC (and ATC if needed).

2. Find where MR = MC. That output is the prot-maximizing quantity QM.

3. Go straight up from that point to the demand curve to get the price PM consumers will pay
for QM.

4. Prot per unit = PM  ATC. Total prot = (PM  ATC) × QM (the shaded rectangle).

Figure 7: Book Figure 13-6: MR = MC at point A ⇒ QM = 8 diamonds. Up to demand curve at B ⇒ PM =

$600. Prot = ($600$200)×8 = $3,200. Competitive point C: P = MC = $200, QC = 16, zero prot.

PITFALL: Do NOT read price from point A

Point A (where MR = MC) gives the marginal revenue, NOT the price. The price is always on
the demand curve above A (point B). Students lose marks here constantly.

5.4 Monopoly versus Perfect Competition

ˆ Competitive rm rule: P = MC ⇒ produces QC, earns zero economic prot.

ˆ Monopolist rule: P > MR = MC ⇒ produces less (QM < QC), charges more (PM > PC), earns
prot.

5.5 Monopoly: The General Picture

With a normal U-shaped ATC and swoosh MC:

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Figure 8: Book Figure 13-7: General monopoly. MR = MC at A ⇒ QM. Up to demand at B ⇒ PM. ATC at
C ⇒ ATCM. Prot = (PM  ATCM) × QM (shaded rectangle).

Prot formula

Prot = TR − TC = (PM × QM ) − (AT CM × QM ) = (PM − AT CM ) × QM

Is there a monopoly supply curve? NO.

A supply curve shows quantity supplied at each price. A monopolist does NOT take price as given
 it chooses quantity and lets the demand curve set the price. So monopolists have no supply
curve. Do not draw one.

6. Monopoly and Public Policy

6.1 Welfare Eects of Monopoly

ˆ A monopolist restricts output below where P = MC, raising prot but hurting consumers.

ˆ Loss to consumers (lost consumer surplus) is bigger than the monopolist's gain.

ˆ Result: deadweight loss (DL)  valuable trades that do not happen. Monopoly is a source of
market failure.

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 ˆ Monopoly acts like a tax: it drives a wedge between price and marginal cost.

Figure 9: Book Figure 13-8: (a) Perfect competition: output QC, price PC = MC, total surplus = blue triangle
CSC. (b) Monopoly: output QM, price PM. Blue consumer surplus shrinks; green = prot (PSM); yellow =
deadweight loss (DL). Total surplus falls.

6.2 Preventing Monopoly

ˆ If the industry is not a natural monopoly (e.g. diamonds, oil), the best policy is to prevent
monopoly or break it up (antitrust policy; e.g. Standard Oil split in 1911).

ˆ If it is a natural monopoly, breaking it up would raise average cost, so other tools are used.

6.3 Dealing with Natural Monopoly

Two common answers:

1. Public ownership  government runs it (e.g. US Postal Service, Amtrak). In theory prices set
for eciency, not prot. In practice often poorly run / political.

2. Price regulation  private but regulated; a price ceiling limits the price. Unlike with competition,
a price ceiling on a monopolist need not cause a shortage as long as the price stays above MC
and the rm at least breaks even.

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Figure 10: Book Figure 13-9: (a) Unregulated: monopolist charges PM, earns prot (green), consumer surplus
(blue). (b) Regulated at P*R = price where ATC crosses demand: output expands to Q*R, prot = 0, consumer
surplus = whole blue area. This is the best regulated price (rm just breaks even).

Regulation trick

The best regulated price is where the ATC curve crosses the demand curve (P*R). Set it lower
and the rm loses money and won't produce. Set it higher and consumers lose out. Regulators often
lack the info to hit it exactly.

6.4 Monopsony

Denition

A monopsony exists when there is only one buyer of a good. A monopsonist is the sole buyer.
Example: one big employer in a small town. It lowers the price it pays (e.g. wages) by buying less,
creating its own deadweight loss.

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Figure 11: Book Figure 13-10: Broadband speed vs price across countries. US has slow, expensive broadband
 cable acts as a natural monopoly with little oversight.

7. Price Discrimination
A single-price monopolist charges everyone the same price. Many monopolists (and oligopolists /
monopolistic competitors) instead charge dierent prices to dierent customers for the same
good = price discrimination.

7.1 The Logic of Price Discrimination

Example: Air Sunshine ies BismarckFt. Lauderdale. MC = $125/seat. Business travelers will pay up
to $550; students up to $150. 2,000 of each.

ˆ One price $550: sell only to business ⇒ prot $850,000.

ˆ One price $150: sell to both ⇒ prot $100,000.

ˆ Charge business $550 AND students $150: capture BOTH prots (areas B + S). Best!

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Figure 12: Book Figure 13-11: Two customer types. Charging each its willingness to pay ($550 business, $150
student) captures all consumer surplus as prot (B + S).

7.2 Price Discrimination and Elasticity

The rule that decides the price

Charge higher prices to low-elasticity (insensitive) customers, and lower prices to high-
elasticity (sensitive) customers. Business travelers = low elasticity ⇒ high price. Students /
seniors = high elasticity ⇒ low price.

Airlines separate groups indirectly: Saturday-night stay requirement, advance purchase, last-minute
deals. They stop resale (ID check) so students can't resell cheap tickets to business travellers.

7.3 Perfect Price Discrimination

Denition

Perfect price discrimination = charging each consumer exactly his/her willingness to pay (the
max they would pay). The monopolist captures the ENTIRE consumer surplus as prot.

ˆ The more prices charged, the closer to perfect discrimination, and the more surplus captured.

ˆ With perfect price discrimination there is NO ineciency / no deadweight loss  every

consumer willing to pay at least MC gets the good.

ˆ But it is almost never possible in practice (people hide their true willingness to pay).

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Figure 13: Book Figure 13-12: (a) two prices, (b) three prices, (c) perfect price discrimination. More prices ⇒
more prot captured; at perfect discrimination prot = whole shaded triangle and no DWL.

Common techniques: advance-purchase restrictions, volume discounts, two-part taris (at fee + per-
unit fee, e.g. Sam's Club).

Why policy usually tolerates price discrimination

It often increases eciency vs a single price: some consumers who were priced out can now buy
at a lower price. Governments act only when it creates serious unfairness (e.g. ambulance charges
by emergency severity).

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8. Key Formulas & Denitions to Memorize
Must-remember list

ˆ Monopolist = sole supplier, no close substitutes.

ˆ Market power = ability to raise price by cutting output.

ˆ Barrier to entry (5): scarce resource, increasing returns to scale (natural monopoly), tech
superiority, network externality, government barrier (patent/copyright).

ˆ Optimal output: MR = MC (for every rm).

ˆ Monopolist price: on the demand curve above the MR=MC point.

ˆ Competitive rm: P = MC.

ˆ Monopoly: QM < QC, PM > PC, earns prot short AND long run.

ˆ Monopolist MR always below demand (price eect).

ˆ Deadweight loss: yellow triangle from P > MC.

ˆ Price discrimination: high price to low-elasticity, low price to high-elasticity.

ˆ Perfect price discrimination: no DWL, all surplus = prot.

9. Common Mistakes (exam traps)

Avoid these

1. Reading the price from the MR = MC intersection (point A). Price is on the demand curve
(point B).

2. Forgetting a monopolist has no supply curve.

3. Saying MR = price for a monopolist. It is NOT; MR < price.

4. Thinking monopoly prot is competed away in the long run. It is NOT (barrier to entry).

5. Confusing a monopsony (one buyer) with a monopoly (one seller).

6. Believing price discrimination always reduces welfare. It often increases total surplus; perfect
discrimination causes no deadweight loss.

7. Drawing the MR curve ABOVE the demand curve. It is always BELOW.

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10. Exam Focus  what gets tested
Topics that drive the book problems

1. Build TR and MR from a demand schedule (Table 13-1 style). Then nd the prot-
maximizing quantity where MR = MC.

2. Draw the monopoly diagram: D, MR, MC, (ATC); mark QM at MR=MC, PM on D,

prot rectangle. Compare to competitive point where P=MC.

3. Quantity eect vs price eect: given a price drop, compute each and the resulting MR.

4. Deadweight loss: shade it; explain why monopoly output is too low.

5. Natural monopoly & regulation: unregulated prot vs regulated price at ATC; whether
the rm breaks even.

6. Price discrimination: who pays more (low elasticity), who pays less (high elasticity); perfect
discrimination captures all surplus.

7. Consumer / producer surplus under single-price vs perfect-price monopoly vs competition.

One-line answer template for compare monopoly and perfect competition

A monopolist faces the downward-sloping market demand curve, so its MR < price. It maximizes
prot where MR = MC, producing less (QM < QC) and charging more (PM > PC) than a
competitive industry, earning prot in both the short and long run and creating a deadweight
loss.

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