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Chapter 10

Chapter 10


Department
Economics for Management Studies
Course Code
MGEA02H3
Professor
Gordon Cleveland
Chapter
10

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Chapter 10: Monopoly, Cartels, and Price Discrimination
A monopoly occurs when the output of an entire industry is produced and sold by a
single firm, called a monopolist or a monopoly firm.
10.1 A SINGLE-PRICE MONOPOLIST
Cost and Revenue in the Short Run
Because a monopolist is the sole producer of the product that it sells, the demand curve
it faces is simply the market demand curve for that product.
Unlike a perfectly competitive firm, a monopolistic faces a negatively sloped demand
curve.
For a monopolist, sales can be increased only if price is reduced, and price can be
increased only if sales are reduced.
Average Revenue
TR = p X Q
AP = p
Marginal Revenue
Marginal revenue is the revenue resulting from the sale of one more unit of the product.
The monopolists marginal revenue is less than the price at which it sells its output.
Thus the monopolists MR curve is below its demand curve.
MR = change in TR / change in Q
The perfectly competitive firm is a price taker; it can sell all it wants at the given market
price.
In contrast, the monopolist faces a negatively sloped demand curve; it must reduce the
market price to increase its sales.
A profit-maximizing monopolist will always produce on the elastic portion of its demand
curve (where MP is positive).
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Short-Run Profit Maximization
Nothing guarantees that a monopolist will make positive profits in the short-run, but if
it suffers persistent losses, it will eventually go out of business.
No Supply Curve for a Monopolist
If follows that there is a unique relationship between market price and quantity supplied
by any single firm: an increase in the market price leads to an increase in quantity
supplied.
For a monopolist, there is no unique relationship between market price and the quantity
of output supplied. A monopolist therefore does not have a supply curve.
Firm and Industry
The monopolist is the industry.
The short-run, profit-maximizing position of the firm is also the short-run equilibrium of
the industry.
Competition and Monopoly Compared
For a perfectly competitive industry, the equilibrium is determined by the intersection of
the industry demand and supply curves.
The equilibrium output in a perfectly competitive industry is such that price equals
marginal cost.
Since demand curves are downward sloping and MC curves are typically upward sloping,
the gap between price and marginal cost implies one thing: the level of output in a
monopolized industry is less than the level of output that would be produced if the
industry were instead made up of many price-taking firms.
A perfectly competitive industry produces a level of output such that price equals
marginal cost. A monopolist produces a lower level of output, with price exceeding
marginal cost.
The monopolists profit-maximizing decision to restrict output below the competitive
level creates a loss of economic surplus–a deadweight loss–and thus leads to market
inefficiency.
A monopolist restricts output below the competitive level and thus reduces the amount of
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economic surplus generated in the market. The monopolist therefore creates an
inefficient market outcome.
The level of output in a monopolized industry is less than the level of output that would
be produced if the industry were perfectly competitive.
Entry Barriers and Long-Run Equilibrium
In a monopolized industry, as in a perfectly competitive one, losses and profits provide
incentives for exit and entry.
If monopoly is suffering losses in the short run, it will continue to operate as long as it
can cover its variable costs. In the long run, however, it will leave the industry unless it
can find a scale of operations as which its full opportunity costs can be covered.
If the monopoly is making profits, other firms will wish to enter the industry in order to
earn more than the opportunity cost of their capital. If such entry occurs, the firm will
cease to be a monopoly.
If monopoly profits are to persist in the long run, the entry of new firms into the
industry must be prevented.
Anything that prevents the entry of new firms is called an entry barrier.
Natural Entry Barriers
A natural monopoly occurs when the industrys demand conditions allow no more than
one firm to cover its costs while producing its minimum efficient scale.
Another type of natural entry barrier is setup costs.
Created Entry Barriers
Many entry barriers are created by conscious government action.
oPatent laws, a firm may be granted a charter or a franchise that prohibits
competition by law, the regulation and/or licensing of firms.
Other barriers can be created by the firm or firms already in the market.
oThe threat of force or sabotage can deter entry
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