ECO1001
Topic 9
Monopoly
Textbook Ch. 15
0
In this chapter,
look for the answers to these
questions
1. Why do monopolies arise?
2. Why is MR < P for a monopolist?
3. How do monopolies choose their P and Q?
4. How do monopolies affect society’s well-being?
5. What is price discrimination?
6. What can the government do about
monopolies?
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15-1
Why Monopolies
Arise
2
Introduction
▪ A monopoly is a firm that is the sole seller of a
product without close substitutes.
▪ In this chapter, we study monopoly and contrast it
with perfect competition.
▪ The key difference:
A monopoly firm has market power, the
ability to influence the market price of the product it
sells. A competitive firm has no market power.
▪ [Link]
companies-own-everything-hong-kong
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15-1 Why Monopolies Arise
The main cause of monopolies is barriers
to entry—other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The government gives a single firm the exclusive
right to produce the good.
E.g., patents, copyright laws
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15-1 Why Monopolies Arise
3. Natural monopoly: a single firm can produce the
entire market Q at lower cost than could several
firms.
Example: 1000 homes
Electricity
need electricity Cost
ATC slopes
ATC is lower if downward due
one firm services to huge FC and
all 1000 homes $80 small MC
than if two firms $50 ATC
each service
Q
500 homes. 500 1000
Do Tutorial Q1
5
15-2
How Monopolies Make
Production and Pricing
Decisions
6
15-2a Comparison:
Monopoly vs. Competition
▪ In a competitive market, the market demand curve slopes
downward.
▪ But the demand curve for any individual firm’s product is
horizontal at the market price.
▪ The firm can increase Q without lowering P, so MR = P for the
competitive firm.
P A competitive firm P Competitive Market
S
d = MR = P P
D
Firm’s q Market Q
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15-2a Comparison:
Monopoly vs. Competition
A monopolist is the only
seller, so it faces the market A monopolist’s
demand curve. demand curve
P
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P.
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Example:
A Monopoly’s Revenue
Common Grounds
is the only seller of Q P TR AR MR
cappuccinos in town. 0 $4.50 n.a.
The table shows the 1 4.00
market demand for
2 3.50
cappuccinos.
Fill in the missing 3 3.00
spaces of the table. 4 2.50
What is the relation 5 2.00
between P and AR?
6 1.50
Between P and MR?
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E x a m p l e : A Monopoly’s Revenue
Answers
Here, ________, Q P TR AR MR
same as for a 0 $4.50 n.a.
competitive firm.
1 4.00
Here, _______ for a
monopolist, 2 3.50
whereas ________ 3 3.00
for a competitive
4 2.50
firm.
5 2.00
6 1.50
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Common Grounds’ D and MR Curves
P, MR
$5
Q P MR
4
0 $4.50 Demand curve (P)
$4 3
1 4.00 2
3
2 3.50 1
2 0
3 3.00
1 -1 MR
4 2.50
0 -2
5 2.00 -3
–1 0 1 2 3 4 5 6 7 Q
6 1.50
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15-2b Understanding the Monopolist’s MR
▪ Increasing Q has two effects on total revenue:
• Output effect: higher output raises revenue
• Price effect: lower price reduces revenue
▪ To sell a larger Q, the monopolist must reduce the
price on all the units it sells.
▪ Hence, MR < P
▪ MR could even be negative if the price effect
exceeds the output effect (e.g., when Common
Grounds increases Q from 5 to 6).
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15-2c Profit-Maximization
▪ Like a competitive firm, a monopolist maximizes profit
by producing the quantity where MR = MC.
▪ 2 steps:
1. Find Q by setting MR=MC
2. Find P by looking at D curve (set P=highest WTP)
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15-2c Profit-Maximization
Costs and
1. The profit- Revenue MC
maximizing Q
is where PM
MR = MC.
2. Find P from
the demand curve D
at this Q. MR
QM Quantity
Profit-maximizing output
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15-2d The Monopolist’s Profit
Costs and
Revenue MC
As with a PM
competitive firm, ATC
ATC
the monopolist’s
profit equals
D
(PM – ATC) x QM
MR
QM Quantity
Do Tutorial Q2
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A Monopoly Does Not Have an S Curve
A competitive firm
• takes P as given
• has a supply curve that shows how its Q depends on P.
There is a unique relation between P & Q.
A monopoly firm
• is a “price-maker,” not a “price-taker”
• QM does not depend on PM;
QM and PM are jointly determined by
MC, MR, and the demand curve.
• No unique relation between PM & QM.
Hence, no supply curve for monopoly. 16
CASE STUDY: Monopoly vs. Generic Drugs
▪ For simplicity, assume the
MC of producing drugs is Price
constant. The market for
a typical drug
▪ Patents on new drugs give
a temporary monopoly to PM
the seller.
➔ Higher price, smaller PC = MC
quantity
D
▪ When the patent expires,
the market becomes MR
competitive, generics
appear. QM Quantity
QC
➔ Lower price, larger
quantity
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15-3
The Welfare Cost of
Monopolies
DWL =
Dying with Laughter!!
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15-3 The Welfare Cost of Monopoly
▪ Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
▪ In the monopoly eq’m, PM > MR = MC
• The value to buyers of an additional unit (PM)
exceeds the cost of the resources needed to
produce that unit (MC).
• The monopoly QM is too low –
could increase total surplus with a larger QM.
• Thus, monopoly results in a deadweight loss (DWL).
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15-3 The Welfare Cost of Monopoly
Competitive eq’m:
Price Deadweight
quantity = QC loss MC
Pc = MC
Total surplus is PM
maximized Pc = MC
MC
Monopoly eq’m: D
quantity = QM MR
PM > MC
Q M QC Quantity
➔ Deadweight loss
Do Tutorial Q3 – 4
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15-4
Price Discrimination
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15-4 Price Discrimination
▪ Discrimination: treating people differently based on
some characteristic, e.g. race or gender.
▪ Price discrimination: selling the same good
at different prices to different buyers.
▪ The characteristic used in price discrimination
is willingness to pay (WTP):
• A firm can increase profit by charging a higher price
to buyers with higher WTP.
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15-4c Single Price Monopoly vs
Perfect Price Discrimination
Single Price Monopoly Consumer
Price
The monopolist charges surplus
the same price (PM) to Deadweight
all buyers. PM loss
A deadweight loss
MC
results. Monopoly
profit D
MR
QM Quantity
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15-4c Single Price Monopoly vs
Perfect Price Discrimination
Perfect Price
discrimination Price
Monopoly
The monopolist produces profit
the competitive quantity,
but charges each buyer his
or her WTP for every unit. MC
Thus, the demand curve is D=MR
the same as MR curve.
The monopolist captures
all CS as profit. Quantity
Q
But there’s no DWL.
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Price Discrimination in the Real World
▪ In the real world, perfect price discrimination is not
possible:
• No firm knows every buyer’s WTP
• Buyers do not reveal it to sellers
▪ So, firms divide customers into groups based on
some observable trait that is likely related to WTP,
such as age.
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15-4d Examples of Price Discrimination
▪ Age discounts
Theme parks such as Disneyland charge a higher
price for an adult than for a kid.
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15-4d Examples of Price Discrimination
▪ Student discounts
Some providers of mobile phone services charge
students a discounted price for mobile phone
services.
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15-4d Examples of Price Discrimination
▪ Online price discrimination
▪ An online store can offer each website customer
a different price based on his or her individual
characteristics or assumed characteristics and
behaviour.
▪ Amazon reportedly charged more to existing
customers than to would-be customers. When a
regular customer deleted his computer’s cookies, he
saw the price of a DVD drop.
Do Tutorial Q5
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15-5
Public Policy toward
Monopolies
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15-5 Public Policy Toward Monopolies (FYI)
▪ Increasing competition with anti-competitive laws
• The Competition Ordinance was set to commence full
operation on 14 December 2015 (amended on 20 April 2018).
• The Ordinance prohibits restrictions on competition in Hong
Kong through three competition rules:
- The First Conduct Rule prohibits anti-competitive
agreements;
- The Second Conduct Rule prohibits abuse of market
power;
- The Merger Rule prohibits anti-competitive mergers and
acquisitions.
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15-5 Public Policy Toward Monopolies
▪ Regulation
• Government agencies set the monopolist’s price.
• e.g. for efficiency’s sake, set P=MC (MC pricing)
▪ Public ownership
• Example: Hong Kong Post
• Problem: Public ownership is usually less efficient
since no profit motive to minimize costs
▪ Doing nothing
• The foregoing policies all have drawbacks,
so the best policy may be no policy.
Do Tutorial Q6
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CONCLUSION: The Prevalence of Monopoly
▪ In the real world, pure monopoly is rare.
▪ Yet, many firms have market power, due to:
• selling a unique variety of a product
• having a large market share and few significant
competitors
▪ In many such cases, most of the results from this
chapter apply, including:
• markup of price over marginal cost
• deadweight loss
Do Tutorial Q7
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Tutorial Q1
A Firm is a natural monopoly if it exhibits the
following as its output rises:
a) decreasing marginal revenue.
b) increasing marginal cost.
c) decreasing average revenue.
d) decreasing average total cost.
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Tutorial Q2
If a monopoly’s fixed costs increase, its price will ___
and its profit will ___.
a) increase, decrease
b) decrease, increase
c) increase, stay the same
d) stay the same, decrease
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Tutorial Q3
Compared to the social optimum, a monopoly firm
chooses
a) a quantity that is too high and a price that is too
low.
b) a quantity that is too low and a price this is too
high.
c) a quantity and a price that are both too high.
d) a quantity and a price that are both too low.
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Tutorial Q4
The deadweight loss from monopoly arises because
a) the monopoly firm makes higher profits than a
competitive firm would.
b) some potential consumers who forgo buying
the good value it more than its marginal cost.
c) consumers who buy the good have to pay
more than marginal cost, reducing their
consumer surplus.
d) the monopoly firm chooses a quantity that
fails to equate price and average revenue.
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Tutorial Q5
a. The entry fee of the Taj Mahal is Rs. 50 per person
for domestic tourists, whereas the entry fee for
foreigners is Rs. 1300 per person. Is this an example
of price discrimination? Explain.
This is / is not price discrimination because different
buyers (tourists) are charged ________________ for
___________________________.
It is considered that foreign tourists are willing to ___
_____ price than domestic tourists. 37
Tutorial Q5
b. Airlines such as Hong Kong Express charge a
passenger an extra payment if he or she wants to
choose his or her seat. Is this an example of price
discrimination? Explain.
This is / is not price discrimination because different
seats _____________.
Some seats with ___________ have higher values
to passengers.
Airlines extract __________ from those passengers
who want to ______________.
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Tutorial Q6
Describe the two problems that arise when regulators tell
a natural monopoly that it must set a price equal to
marginal cost.
- Because a natural monopoly has a _______________
_________________________________, setting price
equal to marginal cost means that the firm will incur a
____. The firm would then ____ the industry unless
the government _________ it. However, getting
revenue for such a subsidy would cause the
government to _______________, increasing the
_______________.
- The second problem of using costs to set price is that
it gives the monopoly ________________________. 39
Tutorial Q7
True /False Statement : A monopolist will never produce a
quantity at which the demand curve is inelastic.
• _____
• Because a firm maximizes profit
where _____________________,
• and marginal cost is either
positive or __________,
• the profit-maximizing quantity can
__________ where marginal
revenue is either positive or
__________.
• Thus, it can never be on the
___________ or _____________
of the demand curve. 40
Summary
• A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry,
including: government-granted monopolies, the
control of a key resource, or economies of scale
over the entire range of output.
• A monopoly firm faces a downward-sloping
demand curve for its product. As a result, it
must reduce price to sell a larger quantity, which
causes marginal revenue to fall below price.
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Summary
• Monopoly firms maximize profits by producing
the quantity where marginal revenue equals
marginal cost. But since marginal revenue is
less than price, the monopoly price will be
greater than marginal cost, leading to a
deadweight loss.
• Monopoly firms (and others with market power)
try to raise their profits by charging higher prices
to consumers with higher willingness to pay.
This practice is called price discrimination.
42
Summary
• Policymakers may respond by regulating
monopolies, using antitrust laws to promote
competition, or by taking over the monopoly and
running it. Due to problems with each of these
options, the best option may be to take no
action.
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