Lecture Essentials of Economics: Chapter 7 - Bradley R. Schiller, Cynthia Hill

Chapter 7 Monopoly, after reading this chapter, you should be able to: Define what a monopoly is, explain why price exceeds marginal revenue in monopoly, describe how a monopoly sets output and price, illustrate how monopoly and competitive outcomes differ, discuss the pros and cons of monopoly structures.

Monopoly

Monopoly 

• A monopoly is one firm that produces

the entire market supply of a particular good or service

• Because there is only one firm in a

monopoly industry, the firm is the

industry

• In a monopoly structure, the firm’s

demand curve is identical to the market demand curve for the product

Price versus  Marginal Revenue

• Marginal revenue (MR) is the change

in total revenue that results from a unit increase in quantity sold

one-• Price equals marginal revenue only for perfectly competitive firms

• Marginal revenue is always less than

price for a monopolist

• A monopolist can sell additional output

only if it reduces prices.

• The MR curve lies below the demand

curve at every point but the first

Price versus  Marginal Revenue

Figure 7.1

• A monopolist:

– Makes pricing decisions that perfectly

competitive firms cannot make.

– Uses the profit-maximization rule to

determine its rate of output.

– Maximizes profit at the rate of output

where MR = MC.

• The profit maximization rule applies to

Figure 7.2

• The intersection of the marginal

revenue and marginal cost curves

establishes the profit-maximizing rate

of output

• The demand curve tells us the highest

price consumers are willing to pay for

that specific quantity of output

• Only one price is compatible with the

profit-maximizing rate of output

• Total profit equals profit per unit times

the number of units produced

• Profit per unit = price minus average

total cost:

Profit per unit = p – ATC

• Total profit = profit per unit times

• A competitive industry produces 5 units and sells at $9, while a monopolist produces 4 units and sells at $10.

• Obstacles that make it difficult or

impossible for would-be producers to

enter a particular market

• Examples include patents, legal

harassment, exclusive licensing,

bundled products, and government

franchises

Monopoly

• In competition, as well as in monopoly, high prices and profits signal

consumers’ demand for more output

• In competition, the high profits attract

new suppliers

• In monopoly, barriers to entry are

erected to exclude potential

competition

• In competition, production and supplies expand, and prices slide down the

market demand curve

• In monopoly, production and supplies

are constrained, and prices don’t move

down the market demand curve

Competition versus 

Monopoly

• In competition, a new equilibrium is

established, and average costs of

production approach their minimum

• In monopoly, no new equilibrium is

established, and average costs are not

necessarily at or near a minimum

Competition versus 

Monopoly

• In competition, economic profits

approach zero, and price equals

marginal cost throughout the process

• In monopoly, economic profits are at a

maximum, and price exceeds marginal

cost at all times

Competition versus 

Monopoly

• In competition, the profit squeeze

pressures firms to reduce costs or

improve product quality

• In monopoly, there is no profit squeeze

to pressure the firm to reduce costs or

improve product quality

Competition versus 

Monopoly

• In duopoly, two firms together produce

the industry output

• In oligopoly, several firms dominate

the market

• In monopolistic competition, many

firms each have a monopoly on their

own brand image but must still contend

Near Monopolies

• A natural monopoly is an industry in

which one firm can achieve economies

of scale over the entire range of market supply

– Examples include local telephone, cable,

and utility services.

– Having two or more firms produce will

require excessive duplication of

production and distribution equipment.

How Does the Monopolist  Answer the Questions?

• WHAT? – Less is produced and it is sold

at higher prices

• HOW? – There is no need to upgrade

quality due to no competition

• FOR WHOM? – Fewer customers can

afford the product; producer will make

greater profits

• A contestable market is an

imperfectly competitive industry subject

to potential entry if prices or profits

increase

• How contestable a market is depends

not so much on its structure as it does

on its barriers to entry