Chapter 13 - Monopoly.docx
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Chapter 13: Monopoly
Monopoly and How It Arises
A monopoly is a market
That produces a good where there are no close substitute
Where there is one supplier that is protected from competition by a barrier preventing the entry of new firms
A monopoly has two key features:
No close substitutes
o The firm effectively faces competition from the producers of the substitute if a good has a good substitute
(even if it is produced by only one firm)
o A monopoly sells a good that has no close substitutes
Barriers to entry
o A constraint that protects a firm from potential competitors
o There are three types of barriers to entry:
Create natural monopoly, which is a market where economies of scale allow one firm to
supply the entire market at the lowest possible cost
o Economies of scale are so powerful that they are still being achieved even when
the entire market demand is met
o LRAC curve still slopes downward to meet the demand curve
When one firm owns a significant portion of a key resource
Create legal monopoly, which is a market where competition and entry are restricted by
the granting of a
o Public franchise
o Government license
o Patent or copyright
Monopoly Price-Setting Strategies
A monopoly firm must choose the appropriate price to determine the quantity it sells. There are two types of monopoly
Single-price monopoly is a firm that has to sell each units for the same price to all its customers
Price discrimination is when a firm sells different units of their good/service at different prices. Many firms price
discriminate but not all of them are monopoly firms.
A Single-Price Monopoly’s Output and Price Decision
Price and Marginal Revenue
A monopoly is a price setter, not a price taker (like firms in perfect competition) because the market demand is entirely
made up of the demand for the monopoly’s output.
To sell a larger output, a monopoly must set a lower price.
Total revenue = Price x Quantity
Marginal revenue is the change in total revenue resulting from one-unit increases in the quantity sold.
For a single-price monopoly, marginal revenue is less than price at each level of output, or MR < P.
Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity of a good’s demand: if a demand is elastic, a fall in
price results into an increase in total revenue.
The increase in revenue from the greater quantity sold outweighs the decrease in revenue from the lower price per unit,
and MR is positive. As the price falls, total revenue increases.
If demand is inelastic, a fall in price brings a decrease in total revenue.
Rise in revenue from the increase in quantity sold is outweighed by the fall in revenue from the lower price per unit, and
MR is negative.
As price falls, total revenue decreases.
A fall in price does not change total revenue – the rise in revenue from the greater quantity sold equals the fall in revenue
from the lower price per unit, and MR = 0.
Total revenue is maximized when MR = 0.
In Monopoly, Demand is Always Elastic
Single-price monopoly never produces an output where there is inelastic demand.
It it did produce this output, firms could increase total revenue, decrease total cost, and increase economic profit by
Price and Output Decision
The monopoly faces the same types of technology constraints as the competitive firm, but the monopoly faces a different
The monopoly selects the profit-maximizing quantity in the same manner as a competitive firm, where MR = MC.
Monopoly set its price at the highest level at which it can sell the profit-maximizing quantity.
Monopoly might make an economic profit (even in the long run) because barriers to entry protect the firm from competitor
firms. However, a monopoly that incurs an economic loss might shut down temporarily in the short run or exit the market
in the long run.
Single-Price Monopoly and Competition Compared
Quantity demanded = quantity supplied (at quantity Qc and Pc) is the equilibrium. (Graph on the left)
Equilibrium (QM) occurs when MR = MC. Equilibrium price (PM) occurs on the demand curve at the profit-maximizing
quantity. (Graph on the right)
Compared to perfect competition, monopoly produces a smaller output while
charging a higher price.
Market demand curve is marginal social benefit curve (MSB). The market
supply curve is the marginal social cost curve (MSC).
Therefore, competitive equilibrium is efficient: MSB = MSC.
Total surplus (the sum of consumer and producer surplus) is maximized.
The quantity produced is efficient.
The graph on the left shows the inefficiency of monopoly.
Because P > MSC, therefore MSB > MSC
Therefore a deadweight loss arises.
Retribution of Surpluses
Some of the lost consumer surplus goes to the monopoly as producer surplus.
Any surplus (consumer, producer, economic profit) is called economic rent.
Rent seeking is the pursuit of wealth by capturing economic rent. Rent seekers
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