Chapter 10 The Theory of Monopoly Introduction to Economics (Combined Version) 5th Edition.

Chapter 10

The Theory of Monopoly

Introduction to Economics (Combined Version) 5th Edition


Varieties of Monopoly A closed monopoly is protected by legal

restrictions on competition. For example, state law in Washington prevents anyone from offering competing car ferry service to islands served by the Washington State Ferry System.

A natural monopoly is an industry in which long-run average cost is minimized when just one firm serves the entire market. Distribution of natural gas to residential customers is an example.

An open monopoly is a case in which a firm becomes, at least for a time, the sole supplier of a product without having the special protections against competition that is enjoyed by a closed or natural monopoly. Apple’s first iPad was an example, which is now widely imitated A Washington State Ferry


Marginal Revenue and the Demand Curve The area under the D curve at

any point is equal to total revenue at that point. (R=P*Q)

With a negatively sloped linear demand curve, revenue increases at first, then reaches a maximum, and then decreases as the price decreases.

Maximum revenue is at the midpoint of the demand curve.

The change in total revenue when quantity changes by one unit is known as marginal revenue.


Marginal Revenue and Demand: Another View Total revenue is found by

multiplying price by output at each point on the demand curve.

Marginal revenue is the increase in total revenue that results from a one-unit increase in output. When demand is elastic,

marginal revenue is more than zero and total revenue is increasing.

When demand is inelastic, marginal revenue is less than zero and total revenue is decreasing.

Marginal revenue is less than price at all levels of output.


Profit Maximization A monopolist maximizes

profits by producing the quantity of output when the marginal cost equals the marginal revenue.

The price it charges for the product is determined by the height of the demand curve (rather than the height of the marginal revenue curve) at the profit-maximizing output.

Beyond 13 units of output, total revenue continues to rise for a while, but profit falls because total cost rises even more rapidly.


Short-Run Loss Minimization for a Monopoly When the demand curve

lies below the average total cost curve at all points, the best the monopolist can do in the short run is minimize loss by producing at the point where marginal cost equals marginal revenue.

If the demand curve were to shift downward even further, preventing the firm from obtaining a price that would cover average variable cost, the short-run loss-minimizing strategy would be to shut down.


Zero-Profit Long-Run Equilibrium

Here the firm earns enough revenue to cover all costs but not enough for an economic profit.

A monopoly could be driven to this position in the long run because of competition from

substitute products costs of defending its

monopoly position against rent seekers


Limit Pricing A strategy of limit pricing

sets a price lower than the one that yields somewhat less than the maximum short-run profit but, at the same time, makes the market a less attractive target for would-be competitors.

A variant of limit pricing known as: “sliding down the demand curve” introduces a new product at a high price and later lowers it to slow entry of competitors

Consumer electronic companies often use the “sliding down the demand curve” strategy


Price Discrimination Price discrimination is

charging different prices to different buyers

Examples: Child ticket discounts Business vs. leisure hotel

rooms Different prices on an airline

flight Prices that are vary with the

income of the country where the good is sold

Using coupons to attract price-sensitive customers

Scholarship aid can be viewed as a type of price discrimination in which selected customers are offered

discounts according to their elasticity of demand


Example of Simple Price Discrimination

A pharmaceutical company produces a drug at constant marginal cost, MC.

Profit maximizing point for the U.S. is (Q0,P0).

At P0 nothing is sold in Mexico. If Mexico is treated as a separate

market, profit-maximizing point will be (Q1, P1).

Sales of additional units Q1 will increase both total producer and consumer surplus.


Two-Part Pricing In two-part pricing, the

firm charges a fixed access fee and also a per-unit user fee.

ExamplesMembership fee plus

greens fee per play at a golf club

Monthly fixed charge plus charge per call for a cell phone

Night clubs that impose a cover charge plus additional charges for food and drink are an example of two-part pricing


Deadweight Loss under Simple Monopoly

Under perfect competition (a) the price consumers are willing to pay for the last unit produced just equals the opportunity cost of producing it. All possible producer and consumer surplus is realized.

Under simple monopoly, production stops short of that point so there is a deadweight loss.

Strategies like two-part pricing, limit pricing, or price discrimination may reduce deadweight loss compared to the case of simple monopoly shown here.


Does Monopoly Promote Inequality?

Monopoly can give rise to great wealth for some people, but not always.

Some monopolies are small businesses like the only pizza outlet in a small town.

Sometimes shareholders in a monopoly are pension funds or others than benefit people of moderate income.

Not all monopolies make profits in the long run because of indirect competition.

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Chapter 10 The Theory of Monopoly Introduction to Economics (Combined Version) 5th Edition.

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Transcript of Chapter 10 The Theory of Monopoly Introduction to Economics (Combined Version) 5th Edition.