CHAPTER 13: MONOPOLY
1. What is Monopoly?
2. How Monopoly arises? --No close substitute & ownership, legal
and natural barrier to entry
3. Monopoly Price-Setting Strategies
Single price monopoly
Price discriminating monopoly
4. A Single-Price Monopoly’s Output and Price Decision
Price and Marginal Revenue
Marginal Revenue and Elasticity
In Monopoly, Demand Is Always Elastic
Price and Output Decision
Comparing monopoly Price & Output with competitive
price & output
Redistribution of Surpluses
Rent Seeking, Rent-Seeking Equilibrium
5. Price Discrimination
Capturing Consumer Surplus
Profiting by Price Discriminating
Perfect Price Discrimination
Efficiency and Rent Seeking with Price Discrimination
5. Monopoly Regulation
6. Efficient Regulation of a Natural Monopoly
Marginal cost pricing rule
Second-Best Regulation of a Natural Monopoly
1 average cost pricing rule
1.What is Monopoly?
A monopoly is a market:
That produces a good or service for which no close
In which there is one supplier that is protected from
competition by a barrier preventing the entry of new firms.
2. How Monopoly arises? --No close substitute & ownership, legal and
natural barrier to entry
A monopoly has two key features:
a) No close substitutes. The absence of any firms making close
substitutes allows the monopolist to avoid competition in the
b) Barriers to entry. Legal or natural constraints that protect a firm
from potential competitors are called barriers to entry.
Three types of barriers to entry are legal barriers, natural barriers &
a) Legal barriers to entry create a legal monopoly, a market in
which competition and entry are restricted by the granting of:
i) Public franchise. The exclusive right granted to a firm to
supply a good or service is called a public franchise. For
example, Canada Post has a public franchise to deliver first-class
ii) Government license. The government controls entry into
particular occupations, professions and industries by requiring a
government license. For example, a license is required to
2 practice law. Licensing doesn’t always create a monopoly, but it
does restrict competition.
iii) Patent and copyright. A patent is an exclusive right
granted to the inventor of a product or service. A copyright is an
exclusive right granted to the author or composer of a literary,
musical, dramatic, or artistic work. Because these rights can be
sold, patents and copyrights don’t always create a monopoly, but
they do restrict competition.
b) Natural barriers to entry create a natural monopoly, which is an
industry in which one firm can supply the entire market at a lower
price than two or more firms can. Figure 12.1 shows the average
total cost curve for an electrical power company that is a natural
In a natural monopoly, economies of scale are so powerful that
they are still being achieved even when the entire market demand
The LRAC curve is still sloping downward when it meets the
3 c) An ownership barrier to entry occurs if one firm owns a
significant portion of a key resource. During the last century, De
Beers owned 90 percent of the world’s diamonds
4 3. Monopoly Price-Setting Strategies
For a monopoly firm to determine the quantity it sells, it must
choose the appropriate price.
There are two types of monopoly price-setting strategies:
a) A single-price monopoly is a firm that must sell each unit of
its output for the same price to all its customers
b) Price discrimination is the practice of selling different units
of a good or service for different prices. Many firms price
discriminate, but not all of them are monopoly firms.
1. A Single-Price Monopoly’s Output and Price Decision
a. Price and Marginal Revenue
A monopoly is a price setter, not a price taker like a
firm in perfect competition.
The reason is that the demand for the monopoly’s
output is the market demand.
To sell a larger output, a monopoly must set a lower
TR = P x Q and MR = Δ TR/ ΔQ
For a single-price monopoly, marginal revenue is less than
price at each level of output. That is,
MR < P
5 b. Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity
of demand for its good:
6 • If demand is elastic, a fall in price brings an increase in total revenue.
The increase in revenue from the increase in quantity sold outweighs the decrease in
revenue from the lower price per unit, and MR is positive. As the price falls, total revenue
• If demand is unit elastic, a fall in price does not change total revenue.
The rise in revenue from the increase in quantity sold equals the fall in revenue from the
lower price per unit, and MR = 0.
Total revenue is maximized when MR = 0.
• If demand is inelastic, a fall in price brings a decrease in total
The 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.
c. In Monopoly, Demand Is Always Elastic
A single-price monopoly never produces an output at which
demand is inelastic. If it did produce such an output, the firm
could increase total revenue, decrease total cost, and increase
economic profit by decreasing output.
d. Price and Output Decision
The monopoly faces the same types of technology constraints as
the competitive firm, but the monopoly faces a different market
a) The monopoly selects the profit-maximizing level of
output in the same manner as a competitive firm, where MR =
b) The monopoly sets its price at the highest level at which
it can sell the profit-maximizing quantity. Table 12. uses a
numerical example to illustrate the profit-maximizing output and
7 Figure 13.4 illustrates the profit-
maximizing choices of a single-price monopoly.
In part (a), the monopoly produces the
quantity that maximizes total