Chapter 14 – Monopoly
CHAPTER 14
MONOPOLY
Chapter Overview
Monopolies can use their market power to hold price above the level that
would prevail in a competitive market. By doing so, they turn consumer
surplus into positive economic profits and reduce total social welfare. This
poses a tricky problem for policy-makers, who want to regulate or break up
monopolies to increase social welfare. Practically speaking, it can be di”cult
to accomplish this goal without causing more ine”ciency. Policies designed
to address the problems associated with monopolies run the risk of setting
prices at the wrong level or raising costs by breaking up a natural monopoly.
This di”cult situation is complicated further by the fact that few firms are
truly perfect monopolies. Instead, many markets include firms with some
degree of market power, ranging on the spectrum from perfect monopoly to
perfect competition. We can call markets in this range “imperfectly
competitive.” It turns out that small di’erences in the structure of
imperfectly competitive markets can make big di’erences in how firms
behave; those di’erences can give policy-makers headaches. In the next
chapter, we’ll take a close look at two specific varieties of imperfect
competition.
Learning Objectives
LO 14.1: List four barriers to entry into monopoly markets.
LO 14.2: Explain why a monopolist is constrained by demand.
LO 14.3: Calculate the profit-maximizing production price and quantity for a
monopolist.
LO 14.4: Calculate the loss in total social welfare associated with a
monopoly.
LO 14.5: Describe the pros and cons of common public policy responses to
monopoly.
LO 14.6: Explain why a firm has an incentive to use price discrimination
when possible.
Chapter Outline
DIAMONDS WEREN’T ALWAYS FOREVER
Why Do Monopolies Exist?
Barriers to Entry (LO 14.1)
BOX FEATURE: REAL LIFE – CHINA’S RARE EARTH
How Monopolies Work
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Chapter 14 – Monopoly
Monopolists and the Demand Curve (LO 14.2)
Monopoly Revenue (LO 14.3)
Problems with Monopoly and Public Policy Solutions
The Welfare Costs of Monopoly (LO 14.4)
BOX FEATURE: FROM ANOTHER ANGLE – POOR MONOPOLISTS
Public Policy Responses (LO 14.5)
BOX FEATURE: REAL LIFE – ROCKERS VS. TICKETMASTER
Market Power and Price Discrimination
What Is Price Discrimination? (LO 14.6)
BOX FEATURE: FROM ANOTHER ANGLE – RICKSHAW RIDES: PRICE
DISCRIMINATION AND ASYMMETRIC INFORMATION
Beyond the Lecture
Class Discussion: Barriers to Entry (LO 14.1)
In order to highlight monopoly behavior and entry barriers, consider showing
a clip from the TV show The Simpsons. Show students the segment 10:20-
14:30 of the episode Who Shot Mr. Burns? Part I. In this episode, Mr. Burns is
trying to monopolize the power industry by blocking the sun.
1. Are there any substitutes for electricity?
2. What are the entry barriers to supplying electricity?
Class Discussion: Barriers to Entry (LO 14.1)
Consider discussing New York City taxis. To limit the number of drivers, the
city requires the purchase of a very expensive medallion, which acts as a
barrier to entry into the cab market. However, the new firms Uber and Lyft
continue to expand and take market share away from traditional cabs. Taxi
cab unions are fighting Uber and Lyft, often trying to get the programs
removed from the city. See this article for some more information. There is
an embedded video on the page as well.
1. Why would the taxi system require a medallion? How does it create an
entry barrier?
2. Why would cab drivers want to eliminate Uber and Lyft from the city?
Writing Assignment/Class Discussion: The Welfare Costs of
Monopoly and Public Policy Responses (LO 14.4, LO 14.5)
Consider discussing the FTC case against Whole Foods in order to highlight
potential welfare losses of monopoly and potential public policy responses.
This case is particularly interesting as the FTC viewed Whole Foods as
dominating a relatively narrow market. Not everyone agrees with the policy
response; you can find an argument that it was unjustified here. Students
can be asked to write a short essay either supporting or disagreeing with the
decision to use public policy in this case.
Class Discussion: What Is Price Discrimination? (LO 14.6)
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Chapter 14 – Monopoly
Have students read this blog post about airline price discrimination. It is an
interesting subject. You can tell your students that on a Gight with 100
people, there very well may have been 100 di’erent prices for those tickets
sold!
1. How do airlines use price discrimination?
2. What generally happens to the price of Gights as the Gight date
approaches?
3. What are the conditions necessary for price discrimination to occur?
Clicker Questions
There are three main purposes to clicker questions. First, they are a great
way to do a quick and instant “on demand” test of student understanding of
the material. You can cover material, and instantly get feedback on student
comprehension. You can see whether you need to explain certain topics
again, or move on to the next subject. Second, they are a great method to
break up the class and take a moment away from lecture. It gets the
students actively involved. Finally, certain clicker questions can be framed in
a “discussion” manner, in which you can invite students to talk about the
possible right answer with their peers. You can instruct students to convince
their classmate of a right or wrong answer.
1. Why would the government purposefully create an entry barrier by
granting patents to firms? [LO 14.1]
A. We don’t want all markets to be competitive
Feedback: Without patents and copyrights, many new goods wouldn’t have
been created at all!
2. As the only seller, why doesn’t a monopoly have face a vertical demand
curve? [LO 14.2]
A. Not everyone is aware of the monopoly firm and the product it sells
Feedback: Example: Maybe there is only one movie theater in town. They
still can’t charge $50 per ticket. People would go miniature golfing instead,
or stay home and watch TV.
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Chapter 14 – Monopoly
3. When total revenue is maximized, what is true about marginal revenue
(MR)? [LO 14.3]
A. MR > 0
B. MR < 0
C. MR = 0 and is increasing
D . MR = 0 and is decreasing
4. Why are monopolies generally undesirable according to economic theory?
[LO 14.4]
A . Deadweight loss exists in the market (compared to perfect competition)
B. More competition always reduces costs of production
C. The monopoly produces too much output
D. Consumer surplus increase too much with monopolies
5. What will be the most effective (profitable) example of price
discrimination? [LO 14.6]
D. A car dealer sells vehicles to veterans at a higher price
Feedback: Remember that we’d want to charge a higher price to the
relatively inelastic group. This would be the group that has higher incomes
and is willing to pay more for the good.
Solutions to End-of-Chapter Questions and Problems
Review Questions
1. If competition places discipline on costs, motivating firms to innovate and
find more cost-effective ways to produce, explain why in some markets a
single firm without competitors will produce at a lower cost than if the firm
faced competition. [LO 14.1]
Answer: If a firm faces economies of scale, the more output it produces,
the more it lowers its average total costs. Sometimes, economies of scale
2. Suppose a city has a chain of fitness centers (gyms) all owned by the
same company, Fit Fun. A new company is considering opening a gym in the
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Chapter 14 – Monopoly
city. Give an example of an aggressive tactic Fit Fun might take to maintain
its monopoly. [LO 14.1]
Answer: One possible tactic might be temporarily cutting prices. Fit Fun
3. Suppose that De Beers and the local water utility are both monopolists, in
the markets for diamond jewelry and water, respectively. If both monopolies
decided to raise prices 15 percent, which monopoly would be more likely to
see its total revenue decrease? Why? [LO 14.2]
Answer: De Beers would be more likely to see total revenue decrease as
4. Suppose that a producer in a previously competitive market is granted the
sole right to produce in the market. Given that demand in the market is
unchanged but now all consumers must purchase from the same producer,
why might the new monopolist produce less than the quantity that was
produced when the market was competitive? [LO 14.2]
Answer: When the market was competitive, producers were price takers.
For each producer, the profit-maximizing choice was to produce all output
5. Suppose that an inventor discovers a new chemical compound that can
change the color of people’s eyes with no negative side effect. Since she
holds a patent on this chemical, she has a monopoly over the sale of the new
eye-color treatment. However, she’s an inventor, not a businessperson.
Explain to her how she should set the price for the eye-color treatment in
order to maximize her profits. [LO 14.3]
Answer: The inventor will need to know the demand for her product at
di’erent prices. Once she has estimated the demand curve, she should
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Chapter 14 – Monopoly
6. Suppose a monopolist has to purchase new equipment and his fixed costs
increase. Explain what will happen to the monopolist’s profit-maximizing
output quantity and the monopolist’s profits. [LO 14.3]
Answer: The profit-maximizing output quantity will not change. The
7. Until the 1980s, AT&T held a monopoly over the national market for phone
services. Suppose that AT&T argued that it was a natural monopoly because
the fixed cost of creating a nationwide phone network generated huge
economies of scale, and that there was therefore no welfare loss associated
with its monopoly. Counter this argument by explaining how even a natural
monopoly causes deadweight loss. [LO 14.4]
Answer: If AT&T is a natural monopoly, it does make sense for it to be the
sole provider of phone services due to its large economies of scale.
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Chapter 14 – Monopoly
8. Suppose you are advising a mayoral candidate in your town. The
candidate’s platform includes strong opposition to monopoly suppliers
because consumer welfare is compromised by monopoly pricing. Present
your candidate with an alternative view about why it may make sense to
tolerate the existence of some monopoly firms. [LO 14.4]
Answer: Monopolies do reduce consumer surplus by producing less and
charging more than the outcomes that would occur in a competitive
9. Suppose that your state is considering a law that would force all
monopolies to charge no more than their average total costs of production.
Explain to your legislator the pros and cons of this approach. [LO 14.5]
Answer: Under this pricing regulation, the monopolist would make a
normal rate of return (zero economic profit) and could stay in business.
Compared to monopoly pricing, charging a price equal to ATC will reduce
10. Suppose that your state is considering a law that would force all
monopolies to charge the e”cient price that would prevail if the market were
competitive. Explain to your legislator why the state will have to subsidize
natural monopolies if this law goes into e’ect. [LO 14.5]
Answer: The defining characteristic of a natural monopoly is that
economies of scale are so large that ATC is falling for the entire range of
11. Suppose a small town has one theater for live performances and
several restaurants, including one Indian restaurant. Will it be easier for the
theater or for the Indian restaurant to price discriminate? [LO 14.6]
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Chapter 14 – Monopoly
Answer: It will be easier for the theater to price-discriminate than for the
restaurant to do so. Price discrimination is more successful when there is
more market power. There may be no or few good substitutes for the only
12. Suppose a museum charges di’erent entrance fees for children,
students, adults, and seniors, but these groups all pay the same amount for
souvenirs at the gift shop. Explain why the museum price discriminates on
admission but not souvenirs. [LO 14.6]
Answer: It is easy to distinguish between children, students, adults, and
Problems and Applications
1. The U.S. Postal Services maintains a monopoly on mail delivery in part
through its exclusive right to access customer mail-boxes. Which barrier to
entry best describes this situation: scarce resources, economies of scale,
government intervention, or aggressive tactics? [LO 14.1]
Answer: The entry barrier that best describes the situation is government
2. Which (if any) of the following scenarios is the result of a natural
monopoly? [LO 14.1]
a. Patent holders of genetically modified seeds are permitted to sue farmers
who save seeds from one planting season to the next.
b. Doctors in the United States are prohibited from practicing without a
medical license.
c. There is one train operator with service from Baltimore to Philadelphia.
d. Coal is used as the primary energy in a country with abundant coal
deposits.
Answer: c. Railroads have large fixed costs. Economies of scale suggest
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Chapter 14 – Monopoly
3. Due to arduous certification requirements, Nature’s Crunch is currently
the only certified organic produce grower in a region that produces lots of
nonorganic produce alternatives. From a profit-maximizing perspective,
would it be better for Nature’s Crunch to lobby the government to relax
organic certification requirements or to require grocery stores to clearly label
its produce as organic? [LO 14.2]
Answer: Nature’s Crunch would not want the government to relax
organic certification requirements because doing so would create
4. Nature’s Crunch is currently the only certified organic produce grower in a
region that produces lots of nonorganic produce alternatives. To be certified
organic, a producer cannot use chemical pesticides. Which of the following
scenarios would increase Nature’s Crunch’s profits? Check all that apply. [LO
14.2]
a. A tomato blight affecting chemically treated plants.
b. An increase in the cost of chemical pesticides.
c. A new report about the environmental dangers of chemically treated
plants.
d. Income tax cuts for all consumers.
e. A new report showing that there is no nutritional di’erence between
organic and non-organic produce.
Answer: a, b, c, and d.
A tomato blight affecting chemically treated plants: Supply of nonorganic
An increase in the cost of chemical pesticides: Due to an increase in
A new report about the environmental dangers of chemically treated
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