Chapter 11/Monopoly
CHAPTER 11
MONOPOLY
Chapter 11 presents the basic structure of a monopoly. Like perfect competition, monopoly is a
polar case, of which real-world examples are difficult to find. It needs to be studied because it is
CHAPTER OUTLINE
MONOPOLY DEFINED
For a pure monopoly to exist:
1. There must be only one firm in the industry.
Sources of Monopoly: Barriers to Entry and Cost Advantages
There are many possible causes of monopoly:
1. Legal restrictions
2. Patents
Natural Monopoly
A natural monopoly may exist when there are extreme economies of scale or economies of
scope; that is, when a single large firm can produce and sell more cheaply than can two or
more smaller firms.
THE MONOPOLIST’S SUPPLY DECISION
Because a monopoly faces a negatively sloped demand curve for its output, it is a price
maker, not a price taker, and does not have a supply curve as we usually define the term.
Determining the Profit-Maximizing Output
The monopolist maximizes profit by choosing the output level where marginal revenue
equals marginal cost (MR = MC).
Chapter 11/Monopoly
Comparing Monopoly and Perfect Competition
Compared to an industry in perfect competition, a monopolist:
1. May enjoy a long-run profit
Monopoly Is Likely to Shift Demand
A monopoly may raise demand for its product (thus negating the inefficient reduction in
output noted earlier).
Monopoly Is Likely to Shift Cost Curves
CAN ANYTHING GOOD BE SAID ABOUT MONOPOLY?
Monopoly May Aid Innovation
Because a monopoly has no rivals, it is able to capture the benefits of any cost-saving
methods or new products it can produce. As such, a monopoly has a greater incentive to
innovate.
Natural Monopoly: Where Single-Firm Production is Cheapest
Where a monopoly is natural, costs of production would be higher if the single large firm
were broken up into many smaller firms.
PRICE DISCRIMINATION UNDER MONOPOLY
A monopolist (as well as other firms that are not perfectly competitive) may be able to
maximize profits by price discriminating, that is, by charging different prices to different
groups of customers where these price differences are not a reflection of cost differences.
Chapter 11/Monopoly
Is Price Discrimination Always Undesirable?
No, sometimes justice appears to demand different prices in different markets.
PUZZLE RESOLVED: COMPETITION IN TELEPHONE SERVICES
Until recently, the market for local telephone service was considered a natural monopoly and
as a result government prevented competition in these markets because they believed it
would lead to duplication of effort and increased costs.
MARGIN DEFINITIONS
Pure Monopoly: an industry in which there is only one supplier of a product for which there are
no close substitutes and in which it is very hard or impossible for another firm to coexist.
Barriers to Entry: attributes of a market that make it more difficult or expensive for a new firm
to open for business than it was for firms already present in the market.
MAJOR IDEAS
1. Monopoly can persist only if there are important cost advantages to single-firm operation
or barriers to free entry.
2. One important case of cost advantages is natural monopoly: instances where only one
firm can survive because of important economies of large-scale production.
Chapter 11/Monopoly
ON TEACHING THE CHAPTER
Like Chapter 10, this chapter is an application of the profit-maximizing paradigm that was
outlined in Chapter 8. The text takes the position that there are not separate theories of pure
competition, monopoly, etc. but rather a single theory of profit maximization, applied to different
market circumstances.
Instructors should note that this chapter just hints at the implications for welfare and public
policy that follow from monopolies and other forms of imperfect competition. So instructors
should familiarize themselves with the material in Chapter 15 on the welfare consequences of
PROBLEMS
1. Slash and Burn is a monopolist that can sell its output at these prices and with these total
costs:
Output Price Total Cost
4 $27 $28
5 26 34
6 25 42
7 24 52
8 23 64
9 22 88
10 21 105
11 20 125
12 19 148
13 18 174
Chapter 11/Monopoly
14 17 204
a) What level of output will Slash and Burn choose to produce? What are the selling
price and profit?
b) Suppose that Slash and Burn produced at the level that a perfectly competitive
industry would, with marginal cost equal to price. What would be the output, price,
and profit?
Solution:
2. Hardly Limited is a natural monopolist; it has large fixed costs and continuously
declining average costs.
a) Draw a diagram similar to Figure 2 in the text, to show Hardly’s equilibrium output
and price. (Hint: remember the relationship between marginal and average curves.)
b) Suppose the government forces Hardly to produce at the point it thinks a purely
competitive industry would achieve, where price was equal to marginal cost. What
problem would this create for Hardly?
Solution:
a) Hardly will maximize profits at Q1 and P1 in the graph below.
Chapter 11/Monopoly
3. Explain why it is incorrect to speak of a monopolist’s supply curve.
Solution: A monopoly firm does not have a “supply curve” as we usually define the term.
Unlike a firm operating under perfect competition, a monopoly is not at the mercy of the
4. (more difficult) Mr. White is a monopolist who, through a combination of good products,
friendly service, and occasional acts of grisly violence, maintains effective barriers to
entry. He has two types of customers (pink customers and orange customers), which he
can easily identify. They have the following demand schedules (pay close attention to the
changes in quantity at each price). Assume these prices and quantities represent all the
choices the consumers have (for example, don’t try to extrapolate quantities demanded at
a price of $5.50). Hint: Remember that marginal revenue is the change in total revenue
divided by the change in quantity.
Price Quantity (pink) Quantity (orange)
8 0 10
7 4 12
6 8 14
5 12 16
4 16 18
3 20 20
a) If Mr. White has constant marginal costs of $4 and sunk fixed costs of $10.00, what
will be his profit if he price discriminates?
b) The government decides that Mr. White should not be allowed to price discriminate
and effectively prevents him from doing so. What would be his output level, price,
and profits if he cannot price discriminate?
Solution:
a) His profits would be $26. He would sell 16 units at a price of $4 to pink consumers
DISCUSSION QUESTIONS
1. “There are no pure monopolies in the real world. There are always substitutes for the
output of any firm. When the price of a good rises, consumers can always decide to buy
something else.” Discuss.
Chapter 11/Monopoly
Suggested Answer: It is true that there is no pure monopoly in the real world because for
almost all commodities, substitute products exist. But there are some markets where no
2. “Economists are wrong to argue that monopolies harm the public welfare. The public
actually benefits from the existence of large monopolies that have the resources to invest
in research and development, and that have the scale to use modern technology at its most
efficient level.” Discuss.
Suggested Answer: Students should discuss the pros and cons of monopoly market. Some
argue that monopoly is the handmaiden of innovation. Although the argument is an old
3. “One of the most ridiculous government enterprises is the patent office. It permits
inventors of new processes and products to create monopolies, when we know very well
that monopolies reduce output, raise price, and in other ways act to gouge the public.”
Discuss.
Suggested Answer: A patent office grants patent only for a limited period of time. During
this period, the patent owner will have monopoly power in the market, which will help
4. “The government should prohibit price discrimination with the same vigor that it attacks
racial and gender discrimination.” Discuss.
Suggested Answer: Students should come up with their own arguments. When a firm
charges discriminatory prices, profits are normally higher than when the firm charges
nondiscriminatory prices. Price discrimination is not always undesirable. People can