Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
262
WHAT’S NEW IN THE SEVENTH EDITION:
A new
In the News
box on “Price Discrimination in Higher Education” has been added.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
why some markets have only one seller.
how the monopoly’s decisions affect economic well-being.
why monopolies try to charge different prices to different customers.
CONTEXT AND PURPOSE:
Chapter 15 is the third chapter in a five-chapter sequence dealing with firm behavior and the organization
monopolist is a price maker as opposed to a price taker. The purpose of Chapter 15 is to examine the
production and pricing decisions of monopolists, the social implications of their market power, and the
ways in which governments might respond to the problems caused by monopolists.
KEY POINTS:
MONOPOLY
15
Chapter 15/Monopoly ❖ 263
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Because a monopoly is the sole producer in its market, it faces a downward-sloping demand curve for
its product. When a monopoly increases production by one unit, it causes the price of its good to fall,
which reduces the amount of revenue earned on all units produced. As a result, a monopoly’s
marginal revenue is always below the price of its good.
Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at which
marginal revenue equals marginal cost. The monopoly then sets the price at which that quantity is
demanded. Unlike a competitive firm, a monopoly firm’s price exceeds its marginal revenue, so its
price exceeds marginal cost.
A monopolist can often increase profit by charging different prices for the same good based on a
buyer’s willingness to pay. This practice of price discrimination can raise economic welfare by getting
the good to some consumers who otherwise would not buy it. In the extreme case of perfect price
discrimination, the deadweight loss of monopoly is completely eliminated, and the entire surplus in
Policymakers can respond to the inefficiency of monopoly behavior in four ways. They can use the
antitrust laws to try to make the industry more competitive. They can regulate the prices that the
monopoly charges. They can turn the monopolist into a government-run enterprise. Or, if the market
failure is deemed small compared to the inevitable imperfections of policies, they can do nothing at
all.
CHAPTER OUTLINE:
II. Why Monopolies Arise
A. Definition of monopoly: a firm that is the sole seller of a product without close
substitutes.
1. Monopoly Resources
production of the good.
b. A key example is DeBeers which has at times controlled about 80% of the diamonds in
the world.
264 ❖ Chapter 15/Monopoly
2. Government-Created Monopolies
b. Patents are issued by the government to give firms the exclusive right to produce a
product for 20 years.
development.
3. Natural Monopolies
a. Definition of natural monopoly: a monopoly that arises because a single firm
can supply a good or service to an entire market at a smaller cost than could
two or more firms.
b. A natural monopoly occurs when there are economies of scale, implying that average
total cost falls as the firm's scale becomes larger.
c. Other examples of natural monopolies are club goods – goods that are excludable but
not rival in consumption.
III. How Monopolies Make Production and Pricing Decisions
A. Monopoly versus Competition
1. The key difference between a competitive firm and a monopoly is the monopoly's ability to
influence the price of its output.
2. The demand curves that each of these types of firms faces is different as well.
b. A monopoly faces the market demand curve because it is the only seller in the market. If
a monopoly wants to sell more output, it must lower the price of its product.
B. A Monopoly's Revenue
1. Example: sole producer of water in a town.
Figure 1
Figure 2
Chapter 15/Monopoly ❖ 265
Quantity
Price
Total Revenue
Average Revenue
Marginal Revenue
0
$11
$0
----
----
1
10
10
$10
$10
2
9
18
9
8
3
8
24
8
6
4
7
28
7
4
5
6
30
6
2
6
5
30
5
0
7
4
28
4
-2
8
3
24
3
-4
2. A monopoly's marginal revenue will always be less than the price of the good (other than at
the first unit sold).
a. If the monopolist sells one more unit, his total revenue (
P
×
Q
) will rise because
Q
is
getting larger. This is called the output effect.
b. If the monopolist sells one more unit, he must lower price. This means that his total
Table 1
ALTERNATIVE CLASSROOM EXAMPLE:
The Whatsa Widget Company has a monopoly in the sale of widgets. The demand the firm
faces can be shown by the following schedule:
Quantity
Price
Total Revenue
Marginal Revenue
0
$15
$0
----
1
14
14
$14
2
13
26
12
3
12
36
10
4
11
44
8
5
10
50
6
266 ❖ Chapter 15/Monopoly
c. Note that, for a competitive firm, there is no price effect.
3. When graphing the firm's demand and marginal revenue curve, they always start at the same
C. Profit Maximization
1. The monopolist's profit-maximizing quantity of output occurs where marginal revenue is
equal to marginal cost.
firm’s level of output.
firm’s level of output.
monopolies, there is one important difference.
a. In competitive firms,
P
=
MR
; at the profit-maximizing level of output,
P
=
MC
.
Figure 3
At this point, you may want to discuss the price elasticity of demand again. Remind
students that demand tends to be elastic along the upper left-hand portion of the
demand curve. Thus, a decrease in price causes total revenue to increase (so that
marginal revenue is greater than zero). Further down the demand curve, the demand
is inelastic. In this region, a decrease in price results in a drop in total revenue
(implying that marginal revenue is now less than zero). Marginal revenue is equal to
zero when demand is unit elastic.
Students often have trouble with this. Go through the table making sure that they
understand the calculation of both total revenue and marginal revenue as output
increases. Emphasize that the monopolist is selling all units at the same price.
Chapter 15/Monopoly ❖ 267
b. In a monopoly,
P
>
MR
; at the profit-maximizing level of output,
P
>
MC
.
3. The monopolist's price is determined by the demand curve (which shows us how much
buyers are willing to pay for the product).
Figure 4
After having seen profit-maximization for a perfectly competitive firm, students
generally do not have difficulty understanding that a monopolist will maximize profit
where marginal revenue equals marginal cost. However, students do have trouble
remembering to use the demand curve to find the monopolist’s price. Be careful to
review this point several times.
ALTERNATIVE CLASSROOM EXAMPLE:
The costs for the Whatsa Widget Company can be represented by the following schedule:
Quantity
Total Cost
Marginal Cost
0
$8
----
1
11
$3
2
16
5
3
26
10
4
39
13
5
57
18
Using the earlier information regarding the demand for widgets, have the students find the
profit-maximizing level of output (where marginal revenue is equal to marginal cost). Use the
information on total revenue and total cost to calculate the level of maximum profit.
268 ❖ Chapter 15/Monopoly
D.
FYI: Why a Monopoly Does Not Have a Supply Curve
2. But a monopoly firm is a price maker; the firm sets the price at the same time it chooses the
quantity to supply.
3. It is the market demand curve that tells us how much the monopolist will supply because the
E. A Monopoly's Profit
1. We can find profit using the following equation:
Profit =
TR
–
TC
.
2. Because
TR
=
P
×
Q
and
TC
=
ATC
×
Q
, we can rewrite this equation:
Profit = (
P
–
ATC
) ×
Q
.
F.
Case Study: Monopoly Drugs versus Generic Drugs
characteristics.
2. When a firm discovers a new drug, patent laws give the firm a monopoly on the sale of that
drug. However, the patent eventually expires and any firm can make the drug, which causes
the market to become competitive.
Figure 5
Figure 6
Chapter 15/Monopoly ❖ 269
IV. The Welfare Cost of Monopolies
A. The Deadweight Loss
good or service.
2. The socially efficient quantity of output is found where the demand curve and the marginal
cost curve intersect. This is where total surplus is maximized.
4. The price that a monopolist charges is also above marginal cost. Although some potential
maximized.
5. The deadweight loss can be seen on the graph as the area between the demand and
marginal cost curves for the units between the monopoly quantity and the efficient quantity.
Figure 7
Figure 8
Remind students that total surplus is the area between the demand curve and the
marginal cost curve. It should be clear that surplus is not realized for quantities of
output between the monopoly output and the socially efficient output.
Point out to students that this is similar to the analysis of taxes in Chapter 8. Here,
the monopolist places a wedge between price and marginal cost and the quantity
sold ends up being short of the optimum level.
270 ❖ Chapter 15/Monopoly
B. The Monopoly's Profit: A Social Cost?
1. Welfare in a market includes the welfare of both consumers and producers.
2. The transfer of surplus from consumers to producers is therefore not a social loss.
3. The deadweight loss from monopoly stems from the fact that monopolies produce less than
the socially efficient level of output.
4. If the monopoly incurs costs to maintain (or create) its monopoly power, those costs would
also be included in deadweight loss.
V. Price Discrimination
different prices to different customers.
B. A Parable about Pricing
1. Example: Readalot Publishing Company
printing the book is zero.)
3. The firm knows that there are two types of readers.
a. There are 100,000 die-hard fans (living in Australia) of the author willing to pay up to
$30 for the book.
$5 for the book.
4. How should the firm set its price?
a. If the firm sets its price equal to $30, it will sell 100,000 copies of the book, receive total
b. If the firm sets its price equal to $5, it will sell 500,000 copies, receive total revenue of
$2.5 million, and earn only $500,000 in profit.
c. It will choose to set its price at $30 and sell 100,000 books. Note that there is a
5. Since it would be difficult for Australian readers to buy a copy of the book in the United
States, the company could make even more profit by selling 100,000 copies to the die-hard
fans at $30 each, and then selling 400,000 copies to the other readers for $5 each.
b. The total revenue from selling 400,000 copies at $5 each is $2 million.
c. Because the firm's costs are $2 million, profit will be $3 million.
Chapter 15/Monopoly ❖ 271
C. The Moral of the Story
2. To price discriminate, a firm must be able to separate customers by their willingness to pay.
3. Arbitrage (the process of buying a good in one market at a low price and then selling it in
another market at a higher price) will limit a monopolist's ability to price discriminate.
Activity 1—Price Discrimination and Time Travel
Type: In-class demonstration
Topics: Price discrimination, consumer surplus
Materials needed: None
Time: 10 minutes
Class limitations: Works in any size class
Purpose
This example illustrates how a price-discriminating monopolist can earn even higher profits
than a monopolist charging a single price. The example uses an imaginary time machine to
look at monopoly profits and consumer surplus. The cases of competition, monopoly, and
price discriminating monopoly are examined.
Instructions
Use student names in the demand for time travel shown below:
“Steve” wants to travel back in time to see the dinosaurs; he is willing to pay as much
as $200 to use the time machine.
“Joyce” wants to relive this entire semester; she is willing to pay up to $150 to use
the time machine.
“Chip” can’t wait for the semester to end; he is willing to pay as much as $125 to use
the time machine.
“Dawn” just wants to get through this class period; she is willing to pay up to $100 to
use the time machine.
The demand curve for time travel is:
Price Quantity
$200 1
150 2
125 3
competitive industry, price would equal marginal cost ($100) and 4 trips would be sold.
