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Monopoly

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

PowerPoint Slides prepared by:

Andreea CHIRITESCU

Eastern Illinois University

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Why Monopolies Arise

  • Monopoly
    • Firm that is the sole seller of a product without close substitutes
    • Price maker
  • Barriers to entry
    • Monopoly resources
    • Government regulation
    • The production process

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Why Monopolies Arise

  • Government regulation
    • Government gives a single firm the exclusive right to produce some good or service (patent and copyright laws)

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Why Monopolies Arise

  • Natural monopoly
    • A single firm can supply the entire market at a lower cost than two or more firms
    • Economies of scale: Average cost per unit falls as output expands, so one large producer is more efficient than several small ones

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Figure 3

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Demand Curve for a Monopoly

Price

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$11

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The demand curve shows how the quantity affects the price of the good. The marginal-revenue curve shows how the firm’s revenue changes when the quantity increases by 1 unit. Because the price on all units sold must fall if the monopoly increases production, marginal revenue is always less than the price.

Quantity

of water

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Demand

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Table 1

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A Monopoly’s Total, Average, and Marginal Revenue

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Figure 3

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Demand and Marginal-Revenue Curves for a Monopoly

Price

2

1

-1

-2

-3

5

4

3

6

7

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9

10

$11

-4

The demand curve shows how the quantity affects the price of the good. The marginal-revenue curve shows how the firm’s revenue changes when the quantity increases by 1 unit. Because the price on all units sold must fall if the monopoly increases production, marginal revenue is always less than the price.

Quantity

of water

0

1

2

3

4

5

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Demand

Marginal revenue

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Figure 6

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

The Market for Drugs

Costs

and

Revenue

When a patent gives a firm a monopoly over the sale of a drug, the firm charges the monopoly price, which is well above the marginal cost of making the drug. When the patent on a drug runs out, new firms enter the market, making it more competitive. As a result, the price falls from the monopoly price to marginal cost.

Quantity

0

Demand

Marginal revenue

Monopoly

quantity

Price

during

patent life

Marginal cost

Price after

patent

expires

Competitive

quantity

A

B

C

D

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Production and Pricing Decisions

  • Profit maximization
    • If MR > MC – increase production
    • If MR < MC – decrease production
    • Profit is maximized at the quantity where MR(Q) = MC(Q)
  • A monopoly’s profit: Area ABCD

​

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Production and Pricing Decisions

  • Profit maximization
    • Perfect competition: P=MR=MC
      • Price equals marginal cost
    • Monopoly: P>MR=MC
      • Price exceeds marginal cost

​

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Monopoly Drugs versus Generic Drugs

  • Market for pharmaceutical drugs
    • New drug under patent – monopoly
      • Produces Q where MR=MC, so P>MC
    • Generic drugs – competitive market
      • Produces Q where MR=MC, so P=MC
  • The generic drug therefore sells below the monopolist’s price

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The Welfare Cost of Monopolies

  • Total surplus
    • Economic well-being of buyers and sellers in a market
    • Sum of consumer surplus and producer surplus

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The Welfare Cost of Monopolies

  • Benevolent planner – maximize total surplus
    • Produce where the marginal cost curve meets the demand curve
    • Charge P=MC

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Figure 9

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The Inefficiency of Monopoly and Price Discrimination

Price

Panel (a) shows a monopolist that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopolist that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.

Quantity

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(a) Monopolist with Single Price

Price

Quantity

0

(b) Monopolist with Perfect Price Discrimination

Profit

Consumer

surplus

Deadweight

loss

Monopoly

price

Quantity

sold

Marginal

revenue

Demand

Marginal cost

Quantity

sold

Profit

Demand

Marginal cost

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Supply Curve

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Price Discrimination

  • Price discrimination
    • Sell the same good at different prices to different customers
    • Rational strategy to increase profit
    • Requires the ability to separate customers according to their willingness to pay
    • Can raise economic welfare

​

​

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Price Discrimination

  • Perfect price discrimination
    • Charge each customer a different price
      • Exactly his or her willingness to pay
    • The monopolist captures the entire surplus as profit
    • No deadweight loss

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Price Discrimination

  • Examples of price discrimination
    • Movie tickets
    • Airline prices
    • Discount coupons
    • Financial aid
    • Quantity discounts

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Public Policy Toward Monopolies

  • Regulation
    • Regulating the prices monopolists charge
    • Common in the case of natural monopolies

​

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.