1

Pure Monopoly

2

Learning Objectives

• Review the nature of barriers to entry into an industry, their form and their likely occurrence.

• Examine demand from a monopolist’s viewpoint.

• Understand how monopoly adjusts price and output in short-run and long-run situations.

3

Learning Objectives (cont.)

• Compare the outcome of a monopoly industry with that of one that is purely competitive. Is the allocative and productive efficiency observed in pure competition achieved by the monopolist?

• Discuss whether government can play a role in modifying monopoly behaviour.

4

Barriers to Entry

• High barriers to entry explain the existence of monopolies

• Block all potential competitors

• Economies of scale:– Defined as the forces that reduce the average cost

of producing a product as the firm expands the size of the output in the long run

– In some industries, efficient, low-cost production can only be achieved if producers are large

5

Barriers to Entry (cont.)

• Ownership of essential raw materials

• Legal barriers: patents and licences

• Note:– Pure monopolies are rare– Monopolies may be desirable or undesirable

depending on what premise is used– Natural monopoly occurs in industries whose

technological and economic realities are out of the possibility of competitive markets

6

Monopoly Demand

Three assumptions:1. Monopolist’s position is guaranteed:

– ownership of patent or control of raw materials

2. No prospect of government intervention or regulation of the firm

3. Monopolist does not discriminate between buyers

7

Monopoly Demand (cont.)

• Monopolist’s demand curve is the industry demand curve and therefore is down-sloping

• Price (P ) exceeds marginal revenue (MR)

• Monopolist is a ‘price maker’ since it can influence total supply

8

MarginalRevenue

0 1 23456789

10

Quantityof

Output

Price(AverageRevenue)

TotalRevenue

MarginalCost

Profit +or

Loss –

AverageTotalCost

TotalCost

$172 162 152142132122112102

928272

] ]$ 0162304426528610672714736738720

]]]]]]]]]

$162142122102

82624222

2– 18

$190.00135.00113.33100.00

94.0091.6791.4393.7397.78

103.00

$100190270340400470550640750880

1030

]]]]]]]]]

90807060708090

110130150

– $100– 28+ 34+ 86

+ 128+ 140+ 122

+ 74– 14

– 142– 310

Monopoly Revenue and Cost

]]

9

Monopoly Demand

Price elasticity and total revenue

• Marginal revenue is negative beyond the point of unit elasticity of demand

10

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ

Do

llars

Do

llars

200

150

100

50

750

500

250

MRMR

Elastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18QQ

DD

TRTR

Inelastic

Unit ElasticityUnit Elasticity

Demand, MR, TR: Imperfectly Competitive Firm

11

Price and Output Determination

• Profit-seeking monopolist employs same rationale as in a competitive industry:– MC = MR Rule

• No supply curve. Why?– At any given demand and cost conditions,

there is only one profit-maximising price–output combination

12

Misconceptions Concerning Monopoly Pricing

• Not highest price– monopolists seek to maximise profit, not necessarily

price

• Total profits not unit profits– monopolists seek to maximise total profit, not

necessarily per-unit profit

• Losses are possible– Pure monopoly does not guarantee economic profits– In the short-run, monopolist may experience losses

because of weak demand or high costs

13

Profit

Q0 1 2 3 4 5 6 7 8 9 10

200

175

150

125

100

75

50

25

P

DD

MR

MCMC

ATC

$94

$122

MR = MC

ProfitPer Unit

CompetitivePrice

Profit Maximisation Under Monopoly

14

Loss

Q0 1 2 3 4 5 6 7 8 9 10

200

175

150

125

100

75

50

25

P

DD

MR

MCMC

ATC

LossPer Unit

AVC

Loss Minimisation Under Monopoly

MR = MC

15

Economic Effects of Monopoly

• Productive inefficiency:– Minimum ATC is not necessarily chosen

• Allocative inefficiency:– P price does not necessary equal MC

• Income distribution

16

Economic Effects of Monopoly

• Cost complications– Economies of scale– X-inefficiency– Very long run may allow for

technological progress

17

Q

P

DMR

MC

Pm

Qm

MonopolistMonopolistwill sell lesswill sell less

units at aunits at ahigher pricehigher price

than inthan incompetitioncompetitionPc

Qc

Profit Maximisation under Monopoly

18

Technological Progress

• Dynamic efficiency:– ability to develop the most efficient

production techniques over time

• Are purely competitive firms or monopolists more innovative over time?– competitive model– monopolist model

19

Price Discrimination

Three required Conditions• Monopoly power• Market segmentation• No resale

Consequences• More profits• More production

20

Regulating Monopolies

• Historically, monopolies have been operated or heavily regulated by the government

• Socially optimal price: P = MC– may result in severe losses

• ‘Fair-return’ price: P = AC– normal profit is generated– only partially resolves problem of under-allocation

21

Regulated Monopoly

Q

DMR

P

Pric

e an

d C

osts

MC

ATC

Monopoly Price:MR = MC

Socially Optimum Price:Price = MC

Fair Return Price:Price = ATC