McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Pure Monopoly

Chapter 10

Chapter Objectives

• Characteristics of pure monopoly

• Profit-maximizing output and price

• Economic effects of monopoly• Charging different prices in

different markets

10-2

Characteristics of Monopoly

• Single seller• No close substitutes• “Price maker”• Blocked entry• Nonprice competition

10-3

Examples of Monopoly

• Regulated or natural monopolies–electricity

• Near monopolies–Western Union–Frisbee–De Beers

• Geographic monopolies–Professional sport teams

• Dual objectives of study

10-4

Barriers to Entry

• Economies of scale• Legal barriers to entry

–Patents–Licenses

• Ownership or control of essential resources

• Pricing and other strategic barriers to entry

10-5

Monopoly Demand

• Assumptions:–Monopoly status is secure

–No government regulation

–Single-price monopolist

• Face down-sloping demand–Entire market demand

10-6

0 1 2 3 4 5 6

$142

132

122

112

102

92

82

Price and Marginal RevenueMarginal revenue is less than price

D

• A monopolist isselling 3 units at$142

• To sell 4, price mustbe lowered to $132

• All customers must pay the sameprice

• TR increases $132 minus $30 (3x$10)

Gain = $132

Loss = $30

10-7

0 1 2 3 4 5 6

$142

132

122

112

102

92

82

D

• A monopolist isselling 3 units at$142

• To sell 4, price mustbe lowered to $132

• All customers must pay the sameprice

• TR increases $132 minus $30 (3x$10)

• $102 becomes a point on the MR curve

• Try other prices todetermine other MR points

Gain = $132

Loss = $30

The Constructed Marginal Revenue CurveMust Always Be Less Than the Price

MR

Price and Marginal RevenueMarginal revenue is less than price

10-8

Down-Sloping Demand

• Marginal revenue < price–To increase sales, must lower price

• Firm is a price maker–Choose P,Q combination

• Operate in the elastic region–Marginal revenue > 0

–Total-revenue test (recall)10-9

Profit Maximization

• Output-price determination–Marginal revenue marginal cost

rule

–Same cost definitions

• No supply curve

10-10

Monopoly Revenue and Costs

(1)Quantity

Of Output

(2)Price

(AverageRevenue)

(3)Total

Revenue(1) X (2)

(4)MarginalRevenue

(5)Average

Total Cost

(6)Total Cost

(1) X (5)

(7)Marginal

Cost

(8)Profit (+)

or Loss (-)

0123456789

10

$172162152142132122112102928272

$0162304426528610672714736738720

$16214212210282624222

2-18

$190.00135.00113.33100.00

94.0091.6791.4393.7597.78

103.00

$100190270340400470550640750880

1030

$90807060708090

110130150

$-100-28+34+86

+128+140+122

+74-14

-142-310

Revenue Data Cost Data

]]]]]]]]]]

]]]]]]]]]]

Can you See Profit Maximization?10-11

$200

150

100

50

0

$750

500

250

0

2 4 6 8 10 12 14 16 18

2 4 6 8 10 12 14 16 18

Pri

ceT

ota

l Rev

enu

e

Monopoly Revenue and Costs

Elastic InelasticDemand and Marginal-Revenue Curves

Total-Revenue Curve

DMR

TR

10-12

Profit Maximization

0

$200

175

150

125

25

100

75

50Pri

ce, C

ost

s, a

nd

Rev

enu

e

1 2 3 4 5 6 7 8 9 10

Quantity

D

MR

ATC

MC

MR=MC

Pm=$122

A=$94

EconomicProfit

10-13

Misconceptions

• Not the highest price

• Total, not unit, profit

• Possibility of losses

10-14

Loss Minimization

0

Pri

ce, C

ost

s, a

nd

Rev

enu

e

Quantity

D

MR

ATC

MC

MR=MC

Loss

AVCPm

Qm

V

A

10-15

Economic Effects

PurelyCompetitive

Market

PureMonopoly

D D

S=MC MC

P=MC=Minimum

ATC

MR

Pc

Qc

Pc

Pm

QcQm

Pure competition is efficientMonopoly is inefficient

a

b

c

10-16

• Pure competition is efficient–Productive efficiency–Allocative efficiency–CS+PS maximized

• Monopoly is inefficient–Charge P>MC–Deadweight loss

• Income transfer

Economic Effects

10-17

Cost Complications

• Economies of scale–Simultaneous consumption–Network effects

• X-inefficiency–Lowest ATC not achieved

• Rent seeking behavior• Technological advance

–More likely with monopoly?

10-18

Policy Options

• Use antitrust laws–Divide the firm

• Natural monopoly–Regulate price

• Ignore–Unstable in long run

10-19

Price Discrimination

• Three forms– Charge each customer max

willingness to pay– Charge one price for first unit

and a lower price for subsequent units

– Charge different customers different prices

10-20

• Conditions – Monopoly power– Market segregation– No resale

• Examples – Airfares– Electric utilities– Theaters & golf courses

Price Discrimination

10-21

Regulated Monopoly

• Natural monopolies• Rate regulation• Socially optimum price

P = MC• Fair return price

P = ATC

10-22

0

Pri

ce a

nd

Co

sts

(Do

llars

)

Quantity

Dilemma of RegulationMonopoly

Price

Fair-ReturnPrice

SociallyOptimal

Price

Pr

D

r

f

b

aPf

Pm

Qm Qf Qr

MR

MC

ATC

Regulated Monopoly

10-23

De Beers Diamonds

• 66 years of monopoly pricing–Independent producers went along

• Mid-2000 abandoned monopoly–New discoveries–Independent producers withdrew–Political considerations

• New strategy–“The diamond supplier of choice”

10-24

Key Terms

• pure monopoly

• barriers to entry

• simultaneous consumption

• network effects

• X-inefficiency

• rent-seeking behavior

• price discrimination

• socially optimal price

• fair-return price10-25

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Monopolistic Competitionand Oligopoly

10-26