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Chapter 9 Monopoly• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2000 South-Western College Publishing

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In this chapter, you will learn to solve these economic puzzles:

Why doesn’t the monopolist gouge consumers by charging the highest

possible price?

How can price discrimination be fair?

Are medallion cabs in New York City monopolists?

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What is a Monopoly?• Single seller• Unique product• Impossible entry into

the market

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What are the most common Monopolies? Local monopolies are more

common real-world approximations of the model than national or world market monopolies

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What does it mean to have a Unique Product?

There are no close substitutes for the monopolists product

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What are some examples of Impossible Entry?

• Owner of a vital resource• Legal barriers• Economies of scale

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What is aNatural Monopoly?

An industry in which the long-run average cost of production declines throughout the entire market

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What is unique about a Natural Monopoly?

A single firm will produce output at a lower per-unit cost than two or more firms in the industry

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What is a Price Maker?A firm that faces a

downward-sloping demand curve

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What is the difference between Monopoly and Perfect Competition?The D and MR curves of

the monopolist are downward sloping; in perfect competition they are horizontal

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What is unique about the Demand Curve for a

Monopolist?The monopolist demand

curve and the industry demand curve are one in the same

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2015105

20

303540

60 80 100

Minimizing Costs in a Natural Monopoly

Cos

t p

er U

nit

(d

olla

rs)

25 5 firms

2 firms

1 firm

Quantity of Output

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What determines Price for a Monopolist?

Demand

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Why is MR < P for all but the first unit of output?To sell additional units, the

price has to be lowered; this price-cut applies to all units, not just the last unit

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$-25$-50$-75

$-100

2 4 6

0$25$50$75

10 12 14 16 18

MonopolyDemand

$100

Marginal R

evenuePri

ce &

Mar

gin

al R

even

ue

Q

16

8

$200

$100

2 4 6

$300

$400

10 12 14 16 18

Monopoly

Q

Tot

al R

even

ue

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Where does a Monopolist produce to maximize

profit or minimize losses?

MR = MC

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$100$75$50$25

1 2 3 4

$125$150$175$200

5 6 7 8 9

ATC

MCMR=MC

DMR

ProfitAVC

Q

P

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$100$75$50$25

1 2 3 4

$125$150$175$200

5 6 7 8 9

ATCMC

MR=MC

DMR

Loss

AVC

P

Q

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Can a Monopolist make a profit in the long-run?If the positions of a

monopolist’s demand and cost curves give it a profit and nothing disturbs these curves, it can make a profit in the long-run

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What isPrice Discrimination?

The practice of a seller charging different prices for the same product not justified by cost differences

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What isArbitrage?

The practice of earning a profit by buying a good at a low price and reselling the good at a higher price

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Is PriceDiscrimination unfair?Many buyers benefit from

the discrimination by not being excluded from purchasing the product

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Is Monopoly efficient?A monopolist is characterized

by inefficiency because resources are underallocated to the production of its product

25Q1

MC

MR=MC

DMR

T1

Price DiscriminationMarket for average studentsP

Q

26Q2

MC

MR=MC

DMR

T2

MonopolistP

Q

Price DiscriminationMarket for superior students

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Is Perfect Competition Efficient?

A perfectly competitive firm that produces where P = MC achieves an efficient allocation of resources

28Qc

MCMR=MC

Pc

Perfect Competition

MR, D

P

Q

29Qm

MCMR=MC

DMR

Pm

MonopolistP

Q

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How does Monopoly harm Consumers?

It charges a higher price and produces a lower quantity than would be the case in a perfectly competitive situation

31Qm

MCMR=MC

D

Pm

Impact of Monopolizing and IndustryP

Q

Pc

Qc

MR

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What is the case against Monopoly?

• Higher price• Charges a Price > MC• Long-run economic profit• Alters the distribution of

income to favor monopolist

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Key Concepts

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Key Concepts• What is a Monopoly?

• What is a Natural Monopoly?

• What is unique about a Natural Monopoly?

• What is a Price Maker?

• What is the difference between Monopoly and Perfect Competition?

• Why is MR < P for all but the first unit of output?

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Key Concepts cont.

• Where does a Monopolist produce to maximize profit or minimize losses?

• Can a Monopolist make a profit in the long-run?

• What is Price Discrimination?

• How does Monopoly harm Consumers?

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Summary

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Monopoly is a single seller facing the entire industry demand curve because it is the industry. The monopolist sells a unique product, and extremely high barriers to entry protect it from competition.

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Barriers to entry that prevent new firms from entering an industry are (1) ownership of an essential resource, (2) legal barriers, and (3) economies of scale. Government franchises, licenses, patents, and copyrights are the most obvious legal barriers to entry.

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A natural monopoly arises because of of economies of scale in which the LRAC curve falls as production increases. Without government restrictions, economies of scale allow a single firm to produce at a lower cost than any firm producing a smaller output. Thus, smaller firms leave the industry, new firms fear competing with the monopolist, and the result is that a monopoly emerges naturally.

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303540

60 80 100

Minimizing Costs in a Natural Monopoly

Cos

t p

er U

nit

(d

olla

rs)

25 5 firms

2 firms

1 firm

Quantity of Output

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A price-maker firm faces a downward-sloping demand curve. It therefore searches its demand curve to find the price-output combination that maximizes its profit and minimizes its loss.

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The marginal revenue and the demand curves are downward-sloping for a monopolist. The marginal revenue curve for a monopolist is below the demand curve, the total revenue curve reaches its maximum where marginal revenue equals zero.

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Price elasticity of demand corresponds to sections of the marginal revenue curve. When MR is positive, price elasticity of demand is elastic, Ed > 1. When MR is equal to zero, price elasticity of demand is unit elastic, = 1. When MR is negative, price elasticity of demand is inelastic, Ed < 1.

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The short-run-profit-maximizing monopolist, like the perfectly competitive firm, locates the profit-maximizing price by producing the output where the MR and the MAC curves intersect. If this is less than the AVC curve, the monopolist shuts down to minimize losses.

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$100$75$50$25

1 2 3 4

$125$150$175$200

5 6 7 8 9

ATC

MCMR=MC

DMR

ProfitAVC

Q

P

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$100$75$50$25

1 2 3 4

$125$150$175$200

5 6 7 8 9

ATCMC

MR=MC

DMR

Loss

AVC

P

Q

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The long-run-profit-maximizing monopolist earns a profit because of barriers to entry. If demand and cost conditions prevent the monopolist from earning a profit, it will leave the industry.

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Price discrimination allows the monopolist to increase profits by charging buyers different prices, rather than a single price.

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Three conditions are necessary for price discrimination: (1) the demand curve must be downward-sloping, (2) buyers in different markets must have different price elasticities of demand, and (3) buyers must be prevented from reselling the product at a higher price than the purchase price.

50Q1

MC

MR=MC

DMR

T1

Price DiscriminationMarket for average studentsP

Q

51Q2

MC

MR=MC

DMR

T2

MonopolistP

Q

Price DiscriminationMarket for superior students

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Monopoly disadvantages are these: (1) A monopolist charges a higher price and produces less output than a perfectly competitive firm, (2) resource allocation is inefficient because the monopolist produces less than if competition existed, (3) monopoly produces higher long-run profits than if competition existed, and (4) monopoly transfers income from consumers to producers to a greater degree than under perfect competition.

53Qc

MCMR=MC

Pc

Perfect Competition

MR, D

P

Q

54Qm

MCMR=MC

DMR

Pm

MonopolistP

Q

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Chapter 9 Quiz

©2000 South-Western College Publishing

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1. A monopolist always faces a demand curve that is a. perfectly inelastic.b. perfectly elastic.c. unit elastic.d. the same as the market demand curve.

D. A monopoly is the only seller, so there is no distinction between the market demand curve and the individual demand curve.

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2. A monopoly sets thea. price at which marginal revenue equals

zero.b. price that maximizes total revenue.c. highest possible price on its demand curve.d. price at which marginal revenue equals

marginal cost.D. Profits are always maximized if the firm

produces at the point where MR = MC.

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$40$30$20$10

1 2 3 4

$50$60$70$80

5 6 7 8 9

ATC

MCMR=MC

DMR

ProfitAVC

Q

P

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3. A monopolist sets a. the highest possible price.b. a price corresponding to the minimum

average total cost.c. a price equal to marginal revenue.d. a price determined by the point on the

demand curve corresponding to the level of output at which marginal revenue equals marginal cost.

e. none of the above. D. Demand determines price in all market

forms.

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4. Which of the following is true for the monopolist? a. Economic profit is possible in the long-

run.b. Marginal Revenue is less than the price

charged.c. Profit maximizing or loss minimizing

occurs when marginal revenue equals marginal cost.

d. All of the above are true.D. All of the above are characteristics of a monopoly.

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$20

$10

100 200

$30

$40

300 400

ATC

AVC

MC

DMR

Exhibit 8

Q

P

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5. As shown in Exhibit 8, the profit-maximizing or loss-minimizing output for this monopolist is a. 100 units a day.b. 200 units a day.c. 300 units a day.d. 400 units a day.

B. 200 units is the point at which MR = MC.

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6. As shown in Exhibit 8, this monopolist a. should shut down in the short-run.b. should shut down in the long-run.c. earns zero economic profit.d. earns positive economic profit.

D. At the point where MR = MC (on the vertical line), P is greater than ATC; therefore, total revenue is greater than total cost and an economic profit is being made.

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7. To maximize profit or minimize loss, the monopolist in Exhibit 8 should set its price at a. $30 per unit.b. $25 per unit.c. $20 per unit..d. $10 per unit.e. $40 per unit.

B. Maximum profit or minimized losses are found by drawing a vertical line where MR = MC. This line intersects the demand curve at $25.

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8. If the monopolist in Exhibit 8 operates at the profit-maximizing output, it will earn total revenue to pay about what portion of its total fixed cost? a. None.b. One-half.c. Two-thirds.d. All total fixed costs.

D. Since the monopolist is making a profit, it can pay all of its fixed costs.

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9. For a monopolist to practice effective price discrimination, one necessary condition isa. identical demand curves among groups of

buyers.b. differences in the price elasticity of demand

among groups of buyers.c. a homogeneous product.d. none of the above.

B. Price discrimination takes place when a monopolist is faced with buyers that are widely different; therefore, the buyers elasticity of demand for the product will be different.

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10. What is the act of buying a commodity at a lower price and selling it at a higher price?a. Buying short.b. Discounting.c. Tariffing.d. Arbitrage.

D. The practice of earning a profit by buying a good at a low price and reselling the good at a higher price

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11. Under both perfect competition and monopoly, a firm a. is a price taker.b. is a price maker.c. will shut down in the short run if price falls

short of average total cost.d. always earns a pure economic profit.e. sets marginal cost equal to marginal

revenue.

E. The profit maximizing output for any firm is where MR = MC.

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END