ECON1101 Study Guide - Final Guide: Natural Monopoly, Demand Curve, Market Power
Monopoly
• Monopoly - a market with a single seller of a product with no close substitutes.
• A monopoly has market power - a firm's power to set its price without losing its entire share of
the market.
• Price-maker - a firm that has the power to set its price, rather than taking the price set by the
market.
• Barriers to entry - anything that prevents firms from entering a market.
Sources of Monopoly
1. Economies of scale - natural monopoly - a market most cheaply served by a single firm.
Depends on size of market.
2. Exclusive access to important inputs or technology
3. Patents and copyrights - peet othe fis fo dupliatig a opa’s poduts.
4. Government licenses
Profit-Maximising Monopolist
• Profits = Revenues - Costs
• Profits = P(Q)Q - C(Q)
• Thinking on the Margin:
• Monopolist maximises profits and produces where MR = MC.
• MR = d Revenues/ d Q = d P(Q)Q/d Q
• Or MR = P + Q (dP/dQ)
• MC = d C/d Q
• MR = P + Q (d P/d Q) < P since d P/d Q is negative.
• Additional revenues from marginal unit (i.e. the Q0 + 1st unit) = P (i.e. area of A).
• Lost revenues from other infra-marginal units = Q (d P/d Q) (i.e. area of B).
• So MR < P due to the above lost revenues.
• Since MR < P, the MR curve lies below the demand curve.
• With linear D, the MR curve is also linear. It lies below the D curve and is twice as steep.
Thinking on the Margin:
• Monopolists maximise profits and produce where MR = MC.
1. Where MR=MC determined profit-max QM.
2. D curve indicates price consistent with QM.
3. ATC curve indicates ATC consistent with QM.
4. Monopolist profits = [PM – ATC (at QM)] x QM.
• Note: For a monopoly, MR = MC, but MR does not equal price. Hence, for the monopolist,
price is not necessarily equal to MC.
The Generic Diagram of a Monopoly and Its Profits
• The monopoly's production is determined at the point at which MR=MC.
• The monopoly's price is determined from the demand curve at the point at which the QS = QD.
• The monopoly's profits are determined by subtracting the total costs rectangle from the total
revenue rectangle. The total revenue rectangle is given by the price times the quantity
produced. The total costs rectangle is given by the ATC x Q produced.
• If a monopoly finds that ATC > P at which MR=MC, then it runs losses.
• If P < AVC, then the monopoly should shut down.
• At Qhigh: MC > MR → produce less.
• At Qlow: MC < MR → produce more.
• Monopolists always operate on elastic portion of demand curve.
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• At inelastic portion, reducing output lowers production costs, increases revenue, and raises
profits.
• Hence, original output cannot be profit-maximising.
Monopolists Produce Too Little
• The monopoly produces less and charges a higher price than the competitive industry would.
• Monopolist producer produces where MR = MC but P > MR.
• Consumers consumer where MB = P so MB = P > MR = MC and MB (to consumers) > MC (to
producer), i.e. not output efficient.
• A monopoly creates a DW loss because it restricts output below what the competitive market
would produce. The cost is measured by the DW loss, which is the reduction in the sum of CS +
PS.
• From social perspective, need to produce and consumer more.
Price Discrimination
• Price discrimination – different consumers pay different prices for the same good.
• Reasons for downward sloping demand curve:
1. People differ in their willingness-to-pay or maximum price a customer will pay to
purchase one unit.
2. People may buy multiple units but demand reflects declining marginal value for
good.
• Max profits: Produce QD where MRN=MC.
• CS = Cons. Benefit – Cons. Expd. = ABQNO – PNBQNO = ABP
• Prod. Revenues (Sum of MR) – Sum of MC = ADQNO – EDQNO = ADE
• First-degree P.D. – sellig eah uit of output at a pie eual to ue’s illigess to pa.
• Demand curve is MR curve.
• Max profits: produce QD where MRD=MC.
• With first-degree P.D., monopolist output QD is efficient (MB=MC and total surplus is
maximised) but there are equity concerns.
• Discriminating monopolist case:
o Cons. Surplus = 0
o Cons. Pay = willingness to pay
o Prod. Surplus = ACQDO – ECQDO = ACE
• Price discrimination or differences gives incentives for arbitrage.
• Second-degree P.D. – same price schedule offered to all buyers but they sort themselves
through self-selection.
• E. uatit disouts - monopolist offers different (quantity, price) bundles - if price
discrimination leads a monopolist to increase its production, then it can help reduce DWL.
• Monopolist knows there are different types of consumers with different demand. But, for
a idiidual osue, oopolist does’t ko hat tpe he o she is uatit, pie
bundles allows consumers to sort/identify themselves.
• Third-degree P.D. – monopolist can identify separate groups of buyers of a good who differ
in their demand for a good and charge different prices to these goods.
• Ex. osues ith diff. pie elastiities of dead - because a monopolist has market
power, it can charge different prices to different consumers (depending on how elastic their
demand is) as long as it can prevent the consumers from reselling the good.
• Why? Because it maximises profits. Charge higher prices for less price elastic group.
11. Product Differentiation, Monopolistic Competition and Oligopoly
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Document Summary
Sources of monopoly: economies of scale - natural monopoly - a market most cheaply served by a single firm. Depends on size of market: exclusive access to important inputs or technology, patents and copyrights - p(cid:396)e(cid:448)e(cid:374)t othe(cid:396) fi(cid:396)(cid:373)s f(cid:396)o(cid:373) dupli(cid:272)ati(cid:374)g a (cid:272)o(cid:373)pa(cid:374)(cid:455)"s p(cid:396)odu(cid:272)ts, government licenses. It lies below the d curve and is twice as steep. Lost revenues from other infra-marginal units = q (d p/d q) (i. e. area of b). So mr < p due to the above lost revenues. Hence, for the monopolist, price is not necessarily equal to mc. The total revenue rectangle is given by the price times the quantity produced. The total costs rectangle is given by the atc x q produced. If a monopoly finds that atc > p at which mr=mc, then it runs losses. The cost is measured by the dw loss, which is the reduction in the sum of cs + Ps: from social perspective, need to produce and consumer more.
