272 ❖ Chapter 15/Monopoly
D. The Analytics of Price Discrimination
1. Perfect price discrimination describes a situation where a monopolist knows exactly the
2. Without price discrimination, a firm produces an output level that is lower than the socially
efficient level.
3. If a firm perfectly price discriminates, each customer who values the good at more than its
marginal cost will purchase the good and be charged his or her willingness to pay.
a. There is no deadweight loss in this situation.
b. Because consumers pay a price exactly equal to their willingness to pay, all surplus in
this market will be producer surplus.
E. Examples of Price Discrimination
1. Movie Tickets
2. Airline Prices
3. Discount Coupons
4. Financial Aid
5. Quantity Discounts
1. While there is a common belief that the cost of a college education has risen sharply in
families.
VI. Public Policy toward Monopolies
A. Increasing Competition with Antitrust Laws
1. Antitrust laws are a collection of statutes that give the government the authority to control
markets and promote competition.
b. The Clayton Act was passed in 1914; it strengthened the government’s ability to curb
monopoly power and authorized private lawsuits.
Figure 9
Chapter 15/Monopoly ❖ 273
2. Antitrust laws allow the government to prevent mergers and break up large, dominating
companies.
3. Antitrust laws also impose costs on society. Some mergers may provide
synergies
, which
B. Regulation
2. Most often, regulation involves government limits on the price of the product.
do.
its economies of scale.
b. When average total cost is falling, marginal cost must be lower than average total cost.
market.
4. Therefore, governments may choose to set the price of the monopolist’s product equal to its
average total cost. This gives the monopoly zero profit, but assures that it will remain in the
market.
a. There is still a deadweight loss in this situation because the level of output will be lower
than the socially efficient level of output.
b. Average-cost pricing also provides no incentive for the monopolist to reduce costs.
C. Public Ownership
1. Rather than regulating a monopoly run by a private firm, the government can run the
monopoly itself.
2. However, economists generally prefer private ownership of natural monopolies.
a. Private owners have an incentive to keep costs down to earn higher profits.
b. If government bureaucrats do a bad job running a monopoly, the political system is the
taxpayers’ only recourse.
D. Doing Nothing
Figure 10
Local phone and electric companies are good examples of regulated monopoly firms.
274 ❖ Chapter 15/Monopoly
1. Sometimes the costs of government regulation outweigh the benefits.
alone.
VII. Conclusion: The Prevalence of Monopolies
B. Table 2 summarizes the key similarities and differences between monopoly and competitive
markets.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
Examples of monopolies include: (1) the water producer in a small town, who owns a key
resource, the one well in town; (2) a pharmaceutical company that is given a patent on a
new drug by the government; and (3) a bridge, which is a natural monopoly because (if the
bridge is uncongested) having just one bridge is efficient. Many other examples are possible.
3. A monopolist produces a quantity of output that is less than the quantity of output that
maximizes total surplus because it produces the quantity at which marginal cost equals
marginal revenue rather than the quantity at which marginal cost equals price. This lower
production level leads to a deadweight loss.
examples are possible.
Compared to a monopoly that charges a single price, perfect price discrimination reduces
consumer surplus to zero, increases producer surplus, and increases total surplus because
there is no deadweight loss.
Table 2
Chapter 15/Monopoly ❖ 275
5. Policymakers can respond to the inefficiencies caused by monopolies in one of four ways:
(1) by trying to make monopolized industries more competitive; (2) by regulating the
behavior of the monopolies; (3) by turning some private monopolies into public enterprises;
or (4) by doing nothing at all. Antitrust laws prohibit mergers of large companies and
prevent large companies from coordinating their activities in ways that make markets less
competitive, but such laws may keep companies from merging and generating synergies that
increase efficiency. Some monopolies, especially natural monopolies, are regulated by the
government, but it is hard to keep a monopoly in business, achieve marginal-cost pricing,
and give the monopolist an incentive to reduce costs. Private monopolies can be taken over
by the government, but the companies are not likely to be well-run. Sometimes doing
nothing at all may seem to be the best solution, but there are clearly deadweight losses from
monopoly that society will have to bear.
Questions for Review
allow firms or individuals to be monopolies for extended periods of time—20 years for
2. An industry is a natural monopoly when a single firm can supply a good or service to an
entire market at a smaller cost than could two or more firms. As a market grows, it may
evolve from a natural monopoly to a competitive market.
units it was already selling.
A monopolist’s marginal revenue can be negative because to get purchasers to buy an
additional unit of the good, the firm must reduce its price on
all
units of the good. The fact
inelastic, marginal revenue will be negative.
4. Figure 1 shows the demand, marginal-revenue, average-total-cost, and marginal-cost curves
for a monopolist. The intersection of the marginal-revenue and marginal-cost curves
determines the profit-maximizing level of output,
Q
m. The profit-maximizing price,
P
m can be
ATCM
) and a base of
QM
.
276 ❖ Chapter 15/Monopoly
Figure 1
5. The level of output that maximizes total surplus in Figure 1 is where the demand curve
area between
Q
c and
Q
m that is above the marginal-cost curve and below the demand curve.
for the quantities between
Q
m and
Q
c.
6. One example of price discrimination is in publishing books. Publishers charge a much higher
price for hardback books than for paperback books—far higher than the difference in
charged just one price.
A second example is the pricing of movie tickets. Theaters give discounts to children and
Many other examples are possible.
7. The government has the power to regulate mergers between firms because of antitrust laws.
8. When regulators tell a natural monopoly that it must set price equal to marginal cost, two
problems arise. The first is that, because a natural monopoly has a marginal cost that is
always less than average total cost, setting price equal to marginal cost means that the firm
will incur a loss. The firm would then exit the industry unless the government subsidized it.
However, getting revenue for such a subsidy would cause the government to raise other
taxes, increasing the deadweight loss. The second problem of using costs to set price is that
it gives the monopoly no incentive to reduce costs.
Chapter 15/Monopoly ❖ 277
Quick Check Multiple Choice
1. d
2. b
3. d
4. a
5. b
6. c
Problems and Applications
1. The following table shows revenue, costs, and profits:
Price
Quantity
Total
Revenue
Marginal
Revenue
Total Cost
$100
0
$0
—-
$2,000,000
90
100,000
9,000,000
$90
3,000,000
80
200,000
16,000,000
70
4,000,000
70
300,000
21,000,000
50
5,000,000
60
400,000
24,000,000
30
6,000,000
50
500,000
25,000,000
10
7,000,000
40
600,000
24,000,000
-10
8,000,000
30
700,000
21,000,000
-30
9,000,000
20
800,000
16,000,000
-50
10,000,000
10
900,000
9,000,000
-70
11,000,000
0
1,000,000
0
-90
12,000,000
million.
b. Marginal revenue is less than price. Price falls when quantity rises because the demand
curve slopes downward, but marginal revenue falls even more than price because the
firm loses revenue on all the units of the good sold when it lowers the price.
278 ❖ Chapter 15/Monopoly
Figure 2
e. If the author were paid $3 million instead of $2 million, the publisher would not change
the price, because there would be no change in marginal cost or marginal revenue. The
only thing that would be affected would be the firm’s profit, which would fall.
2. a. Figure 3 illustrates the market for groceries when there are many competing
supermarkets with constant marginal cost. Output is
Q
C, price is
P
C, consumer surplus is
Figure 3 Figure 4
Chapter 15/Monopoly ❖ 279
b. Figure 4 illustrates the new situation when the supermarkets merge. Quantity declines
area F.
3. a. The following table shows total revenue and marginal revenue for each price and
quantity sold:
Price
Quantity
Total
Revenue
Marginal
Revenue
Total
Cost
Profit
24
10,000
$240,000
—-
$50,000
$190,000
22
20,000
440,000
$20
100,000
340,000
20
30,000
600,000
16
150,000
450,000
18
40,000
720,000
12
200,000
520,000
16
50,000
800,000
8
250,000
550,000
14
60,000
840,000
4
300,000
540,000
$550,000.
c. As Johnny’s agent, you should recommend that he demand $550,000 from them, so he
receives all of the profit (rather than the record company). The firm would still choose to
produce 50,000 CDs because their marginal cost would not change.
quantity because the firm is a monopolist.
Price
Quantity
(in Thousands)
Total Revenue
(in Thousands)
Marginal
Revenue
$8
0
$0
—-
7
100
700
$7
6
200
1,200
5
5
300
1,500
3
4
400
1,600
1
3
500
1,500
-1
2
600
1,200
-3
1
700
700
-5
0
800
0
-7