Topic 9 – Monopoly
(Week night Nov 10 - Nov 15 ) th
2. MR < P (DD)
3. Profit-Maximizing output & price
4. “Contrived Scarcity”: when Competitive Industry is monopolized;
5. Price Discrimination;
6. Why is Monopoly Bad?
7. Natural Monopoly & Regulation of a natural monopoly.
-- Single seller of product with no close substitutes;
-- Barrier to entry:
1) legal barriers (legal monopoly);
-- e.g. post office (legal monopoly on first class mail); patents
2) natural barriers (natural monopoly);
MR < P
-- In monopoly, Marginal Revenue is always smaller than Price.
Why? Because monopolists face a downward-sloping demand unlike perfectly competitive firms face
The Output Effect: More output is sold, so Q is higher;
The Price Effect: The Price falls, so P is lower.
Monopoly Perfect Competition
ee Price effect ee
P 0 P0= P1
Q0 Q 1 Quantity Q0 Q1 Quantity
Assume Q -1 =10(an additional unit)
MR = change in TR/change in Q
= (P1xQ 1 P 0Q )0 MR = change in TR/change in Q
= output effect – price effect
= P1/( Q1-Q0)
= P1(Q 1Q 0 – Q 0P 0P 1 = P1
= P – a real number
which is always smaller than simply P 1
Monopolists face a downward-sloping
Firms in perfect competition face a
demand, so higher quantity must have a horizontal demand curve, and the firm is
trade-off of a lower price. Thus MR of able to sell any quantity it likes in a constant
monopolists is affected by both output price. Thus there is no price effect on
effect and price effect; individual firms in perfect competition. Therefore, the downward-sloping demand curve that monopolists face lead to the fact that at certain level
of output, its MR is always smaller than the price it charges at that quantity.
P Q TR MR
(PXQ) (△TR/△Q) PPrice
10 0 0 - 9
9 1 9 9 8
8 2 16 7 7
7 3 21 5 6
6 4 24 3 4
5 5 25 1 3
4 6 24 -1 2 DD
3 7 21 -3 1 2 3 4 5 6 7 8 Quantity
2 8 16 -5 MR
For monopolists, MR lies everywhere to the left of market DD.
Profit Maximizing Output and Price
ee 1. Downward-Sloping demand;
2. The revenue you received for additional
M output is everywhere less than the price you
sell for that output;
Q1 Q M Q2 Quantity
1. Monopolist chooses M where MR=MC;
At Q1, MR > MC: the revenue of producing an additional unit of output exceeds the cost of it; the firm
should expand output;
At Q2, MR < MC: the cost of producing an additional unit of output exceeds the revenue of it; the firm
should contract output;
At Q0, MR = MC: the revenue of producing an additional unit of output equals the cost of it; this is the
profit – maximizing level of output for the firm.
2. To sell the maximized outpuM Q , monopolists must chaMge P (according to the demand curve); Insight:
1. Monopolists cannot charge “unlimited price”;
2. In a monopoly there is no supply curve.
-- Monopolists are not price takers; They do not set price equal to marginal revenue, the price does not
equal marginal cost.
-- Similarly, a monopoly firm does not respond to price changes by moving along its marginal cost curve. A
monopoly does not necessarily supply larger quantities at higher prices or smaller quantities at lower
-- Therefore monopolists don’t have a market supply curve.
Economic Profit for Monopolists
MC P > ATC Economic Profit;
P = ATC Breaks Even;
P < ATC Economic Loss
Q M Quantity
When Competitive Markets are monopolized
Q: what will happen to price and output if a perfectly competitive industry becomes a monopoly?
Price Perfect Competition Price Monopoly
PPrice SS = MC PPrice
ee ee MC
DD MR DD
Quantity Q M C Quantity
1. Market SS = sum of all individual firms’ ss schedules
= MC for the industry as a whole;
= MC of the monopolist.
2. Output is reduced (“contrived scarcity”) and price increases.
Application 1 – Government Policy Towards New Drugs
1) encourage research and development;
2) Protect consumers from monopoly prices
Policy: Government grants patent protection for monopoly (as a reward for the innovation), but only for a
limited period of time; Within the patent protection, consumer pay the monopoly price P , and
after the patent expires (legal barrier of entry was eliminated), other firms are free to enter the
market, and price drops, with quantity increases. Application 2 – Superbugs
Existing antibiotics are becoming less useful.
-- Objective: How to encourage development of new antibiotics?
-- Solution: Extend patent protection for new antibiotics
-- How does it work? Patent creates a temporary monopoly; the economic profit provides incentives for
Q: Why do firms issue coupons?
Why do firms offer student or senior discount?
A: To further maximize their profit using price discrimination.
Price Discrimination: Firm sell the same product to different consumers at different prices.