Monopoly
Why Monopolies Arise?
• Monopoly: a firm that is the sole
seller of a product without any
close substitutes.
• The cause of monopoly is barriers
to entry:
i) Monopoly resources
ii) Govt regulation
iii) The production process
Natural Monopoly
• Natural monopoly: a type of
monopoly that arises because a
single firm can supply a good or
service to an entire market at a
lower cost than could two or more
firms.
• There are economies of scale over
the relevant range of output.
How Monopolies Make Production and Pricing
Decisions
• A competitive firm: a price taker vs a price maker as a monopoly firm.
• The competitive firm faces a horizontal demand curve (due to many
perfect substitutes).
• By contrast, because a monopoly is the sole producer in its market, its
demand curve is the market demand curve sloping downward.
• If the monopolist raises the price of its good, consumers buy less of it.
• Or, if the monopolist reduces the quantity of output it produces and
sells, the price of its output increases.
A Monopoly’s Revenue
• For a monopolist: MR < P
• Due to the downward-sloping demand curve,
to increase the amount sold, a monopoly firm
must lower the price it charges to all
customers.
• When a monopoly increases the amount it
sells, this action has two effects on total
revenue (PxQ):
i) The output effect: More output is sold, so Q is
higher, which tends to increase total revenue.
ii) The price effect: The price falls, so P is lower,
which tends to decrease total revenue.
Profit
Maximization
• For a competitive firm:
P = MR = MC.
• For a monopoly firm:
P > MR = MC
A Monopoly’s
Profit
• Profit = TR – TC = (TR/Q – TC/Q) x Q =
(P – ATC) x Q
The Welfare Cost of Monopolies
The Monopoly’s Profit
• Monopolies are decried for profiteering by virtue of its market
power.
• Monopoly profits shift surplus from consumers to producers
without reducing total surplus. The issue is equity, not efficiency.
• Underproduction: output falls below the level that maximizes total
surplus, creating deadweight loss.
• The issue is not the profit on sold units, but the loss from
consumers priced out of the market.
• If a monopoly spends resources (e.g., lobbying) to maintain its
power, social loss includes both these costs and the deadweight
loss from reduced output.
Price Discrimination
• Price discrimination: the business practice of selling the same good at
different prices to different customers.
• Three lessons from price discrimination:
i) Price discrimination is a rational strategy for a profit-maximizing
monopolist.
ii) Price discrimination requires the ability to separate customers
according to their willingness to pay.
• A corollary to this second lesson is that certain market forces can
prevent firms from price discriminating, such as arbitrage.
iii) Price discrimination can raise economic welfare.
• Note: the increase in welfare from price discrimination shows up as
higher producer surplus rather than higher consumer surplus.
Example of Price Discrimination
• Movie tickets
• Airline prices
• Discount coupons
• Financial aids
• Quantity discounts
Public Policy toward
Monopolies
• By trying to make monopolized
industries more competitive.
• By regulating the behavior of the
monopolies.
• By turning some private
monopolies into public
enterprises.
• By doing nothing at all.