262
WHAT’S NEW IN THE SIXTH EDITION:
A new
In the News
box on “President Obama’s Antitrust Policy” has been added.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ why some markets have only one seller.
CONTEXT AND PURPOSE:
Chapter 15 is the third chapter in a five-chapter sequence dealing with firm behavior and the organization
of industry. Chapter 13 developed the cost curves on which firm behavior is based. These cost curves
were employed in Chapter 14 to show how a competitive firm responds to changes in market conditions.
In Chapter 15, these cost curves are again employed, this time to show how a monopolistic firm chooses
KEY POINTS:
• A monopoly is a firm that is the sole seller in its market. A monopoly arises when a single firm owns a
key resource, when the government gives a firm the exclusive right to produce a good, or when a
single firm can supply the entire market at a lower cost than many firms could.
MONOPOLY
15
Chapter 15/Monopoly ❖ 263
• Like a competitive firm, a monopoly firm maximizes profit by producing the quantity at which
marginal revenue equals marginal cost. The monopoly then chooses 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 often can raise its profit by charging different prices for the same good based on the
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
the market goes to the monopoly producer. More generally, when price discrimination is imperfect, it
can either raise or lower welfare compared to the outcome with a single monopoly price.
CHAPTER OUTLINE:
I. A competitive firm is a price taker; a monopoly firm is a price maker.
II. Why Monopolies Arise
A. Definition of monopoly: a firm that is the sole seller of a product without close
substitutes.
B. The fundamental cause of monopoly is barriers to entry.
1. Monopoly Resources
264 ❖ Chapter 15/Monopoly
2. Government-Created Monopolies
a. Monopolies can arise because the government grants one person or one firm the
exclusive right to sell some good or service.
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.
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
Figure 1
Figure 2
Seinfeld, “The Soup Nazi.”
(Season 7, 1:19-2:03; 2:54-4:17; 6:47-8:52;
13:48-14:54; 16:45-17:31; 18:03-18:38; 19:33-20:27; 21:21-22:14). The
Soup Nazi makes delicious soup—so good there’s always a line outside his shop. He
refuses service to Elaine, and by a stroke of luck she comes across his stash of soup
Chapter 15/Monopoly ❖ 265
a. A competitive firm faces a perfectly elastic demand at the market price. The firm can sell
all that it wants to at this price.
1. Example: sole producer of water in a town.
Quantity
Price
Average Revenue
Marginal Revenue
0
$11
—-
—-
1
10
$10
$10
2
9
9
8
3
4
5
6
7
8
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.
Table 1
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
point (because
P
=
MR
for the first unit sold); for every other level of output, marginal
revenue lies below the demand curve (because
MR
<
P
).
C. Profit Maximization
1. The monopolist’s profit-maximizing quantity of output occurs where marginal revenue is
equal to marginal cost.
2. Even though
MR
=
MC
is the profit-maximizing rule for both competitive firms and
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
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
2
16
3
26
10
4
39
13
5
57
18
Figure 4
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
268 ❖ Chapter 15/Monopoly
D.
FYI: Why a Monopoly Does Not Have a Supply Curve
1. A supply curve tells us the quantity that a firm chooses to supply at any given price.
E. A Monopoly’s Profit
1. We can find profit using the following equation:
Profit =
TR
–
TC
.
F.
Case Study: Monopoly Drugs versus Generic Drugs
1. The market for pharmaceutical drugs takes on both monopoly characteristics and competitive
characteristics.
Figure 5
Figure 6
Chapter 15/Monopoly ❖ 269
IV. The Welfare Cost of Monopolies
A. The Deadweight Loss
1. The demand curve represents the value that buyers place on each additional unit of a good
or service. The marginal-cost curve represents the additional cost of producing each unit of a
good or service.
3. Because the monopolist sets marginal revenue equal to marginal cost to determine its output
level, it will produce less than the socially efficient quantity of output.
Figure 7
Figure 8
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.
output between the monopoly output and the socially efficient output.
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.
V. Price Discrimination
A. Definition of price discrimination: the business practice of selling the same good at
different prices to different customers.
B. A Parable about Pricing
1. Example: Readalot Publishing Company
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
4. How should the firm set its price?
$2.5 million, and earn only $500,000 in profit.
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.
Chapter 15/Monopoly ❖ 271
a. The total revenue from selling 100,000 copies at $30 each is $3 million.
C. The Moral of the Story
1. By charging different prices to different customers, a monopoly firm can increase its profit.
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
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.
The demand curve for time travel is:
Price Quantity
$200 1
150 2
272 ❖ Chapter 15/Monopoly
D. The Analytics of Price Discrimination
1. Perfect price discrimination describes a situation where a monopolist knows exactly the
willingness to pay of each customer and can charge each customer a different price.
2. Without price discrimination, a firm produces an output level that is lower than the socially
efficient level.
E. Examples of Price Discrimination
1. Movie Tickets
2. Airline Prices
F.
In the News: TKTS and Other Schemes
1. Every night in New York City, about 25,000 people attend Broadway shows (on average).
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.
Figure 9
Chapter 15/Monopoly ❖ 273
2. Antitrust laws allow the government to prevent mergers and break up large, dominating
companies.
4.
In the News: President Obama’s Antitrust Policy
a. President Obama has promised a more vigorous application of antitrust laws.
B. Regulation
1. Regulation is often used when the government is dealing with a natural monopoly.
a. If the firm is a natural monopoly, its average total cost curve will be declining because of
its economies of scale.
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.
C. Public Ownership
1. Rather than regulating a monopoly run by a private firm, the government can run the
monopoly itself.
Figure 10
Local phone and electric companies are good examples of regulated monopoly firms.
274 ❖ Chapter 15/Monopoly
2. However, economists generally prefer private ownership of natural monopolies.
a. Private owners have an incentive to keep costs down to earn higher profits.
D. Doing Nothing
1. Sometimes the costs of government regulation outweigh the benefits.
2. Therefore, some economists believe that it is best for the government to leave monopolies
alone.
VII. Conclusion: The Prevalence of Monopolies
A. Monopoly firms behave very differently from competitive firms.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. A market might have a monopoly because: (1) a key resource is owned by a single firm; (2)
the government gives a single firm the exclusive right to produce some good; or (3) the costs
of production make a single producer more efficient than a large number of producers.
2. A monopolist chooses the amount of output to produce by finding the quantity at which
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.
4. Examples of price discrimination include: (1) movie tickets, for which children and senior
Table 2