MICROECONOMICS
TOPIC 8 – Monopoly
AFTER LEARNING TOPIC 8, YOU SHOULD BE ABLE TO:
1. Understand how monopolies are created
2. Explain how a monopoly determines the quantity to produce
and the price to charge
3. Analyse how the monopoly’s decisions affect economic
surplus
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CHARACTERISTICS OF A MONOPOLY
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• The only seller
• Unique product: No close substitute
• Market power: Able to set the price of a
good or service
• Barriers to entry: difficult for new firms to
enter the market
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SOURCES OF
MARKET POWER
• Exclusive control of resources
o ALCOA, De Beers
• Government created barriers
o Patents, copyright laws
• Network economies: Value to
customers increases with the number
of customers
o Facebook, Optus
• Economies of scale: Natural monopoly.
Second company with a small market
share cannot survive
o Distribution of electricity
MONOPOLY VERSUS PERFECT COMPETITION - 1
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• The key difference between a competitive firm and a monopoly is the
monopoly’s ability to influence the price
• A competitive firm is small relative to the market and, therefore, takes the
price as given by market conditions
• Because a monopoly is the sole producer in its market, it can set the price
by choosing the output level
• Thus the monopoly faces a trade-off between the quantity it sells and the
price it receives
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MONOPOLY VERSUS PERFECT COMPETITION - 2
COMPARING THE DEMAD CURVE
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PROFIT MAXIMISATION
• Profit-maximizing rule for any firm:
oMR = MC.
• Under perfect competition: P = MR.
• With a monopoly: P > MR.
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MONOPOLY MARGINAL REVENUE - 1
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• Why does TR first increase and then decrease?
oPrice effect:
❖All units are now sold at a lower price. By itself, this is a loss for
the firm
oOutput effect:
❖More units are sold. By itself, this is a gain for the firm.
MONOPOLY MARGINAL REVENUE - 2
MONOPOLY MARGINAL REVENUE AND DEMAND
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DECIDING HOW MUCH TO PRODUCE - 1
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• Profit-maximising quantity is determined by the intersection of the
marginal revenue (MR) and the marginal cost (MC) curves
• At a low level of output, MC is less than MR. If the firm increased
production by one unit, the additional revenue would exceed the
additional costs, and profit would rise
• At high level of output, marginal cost is greater than marginal revenue. If
the firm reduced production by one unit, the costs saved would exceed
the revenue lost
• A monopolist is not guaranteed an economic profit. Depends on the
market demand
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DECIDING HOW MUCH TO PRODUCE - 2
THE MONOPOLIST’S PROFIT—1
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CLASS ACTIVITY
• A monopolist faces the following demand and cost schedule. How
much should the firm produce? How much profit will it earn? You
have five minutes.
Price Quantity TR TC MR MC Profit
$10 1 $2
$8 2 $4
$6 3 $6
$4 4 $8
$2 5 $10
THE PROBLEMS WITH MONOPOLIES - 1
1. Produce an inefficient level of output and charge an inefficient price.
o This comes from the fact that P > MC and that output is restricted compared to competitive
markets.
2. Less choice for consumers.
oCable companies and bundling.
o Forces you to buy more to get what you want.
o Small rival firms may be forced out of the industry to remain a monopolist.
3. Rent-seeking behavior.
oOccurs when resources are used to secure monopoly rights through the political
process.
oResources used to monopolize rather than become a more competitive firm.
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INEFFICIENCY OF MONOPOLY
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DEADWEIGHT LOSS OF MONOPOLY
1. Breaking up the monopoly:
o Promote competition, which can reduce or eliminate deadweight loss.
2. Reducing trade barriers:
o Barriers reduce the potential gains from trade.
o Tariffs as a trade barrier.
o Reducing barriers creates more competition and promotes the efficient use of resources.
3. Regulating markets:
o Why not break up natural monopolies?
o Governments can use price regulation:
o Price = MC.
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SOLUTIONS TO MONOPOLIES