Monopoly and

Monopolistic Competition 14
1

Monopoly and Monopolistic Competition

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Monopolistic Competition 14
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Chapter Goals
 Summarize how and why the decisions facing a
monopolist differ from the collective decisions of
competing firms
 Determine a monopolist’s price, output, and profit
graphically and numerically

 Show graphically the welfare loss from monopoly

 Explain why there would be no monopoly without

barriers to entry
 Explain how monopolistic competition differs from
monopoly and perfect competition

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A Monopolistic Market
 Monopoly is a market structure in which one firm makes up
the entire market
 Barriers to entry into the market prevent competition
 Barriers to entry can be:
• Legal
• Sociological
• Natural
• Technological
 There are no close substitutes for the monopolist’s product

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The Key Difference Between

a Monopolist and a Perfect Competitor
 A monopolistic firm’s marginal revenue is not its price
• Marginal revenue is always below its price
• Marginal revenue changes as output changes and
is not equal to the price
 A monopolistic firm’s output decision can affect price
 There is no competition in monopolistic markets so
monopolists see to it that monopolists, not consumers,
benefit

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Determining the Monopolist’s
Price and Output Numerically
 The goal of the monopolistic firm is to maximize profits,
the difference between total revenue and total cost
 The monopoly maximizes profit when marginal revenue
equals marginal cost
 Marginal revenue (MR) is the change in total revenue
associated with a change in quantity
 Marginal cost (MC) is the change in total cost associated
with a change in quantity

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Determining the Monopolist’s
Price and Output Numerically
 The profit-maximizing condition of a monopolistic firm is:
• MR = MC
 For a monopolistic firm, MR < P
 A monopolistic firm maximizes total profit, not profit per unit

If MR > MC,
• The monopoly can increase profit by increasing output
If MR < MC,
• The monopoly can increase profit by decreasing its output

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Monopolistic Profit Maximization The profit-
Table maximizing
condition is:
Q P ($) TR ($) MR ($) TC ($) MC ($) ATC ($) Profit ($) MR = MR
0 36 0 47 --- -47
33 1
1 33 33 48 48.00 -15 If MC < MR,
27 2
2 30 60 50 25.00 10 increase
21 4 production
3 27 81 54 18.00 27
15 8
4 24 96 62 15.50 34 Profit maximizing
9 16
5 21 105 78 15.60 27 quantity is where
3 54 MC = MR
6 18 108 102 17.00 6
-3 40
7 15 105 142 20.29 -37 If MC > MR,
-9 56
8 12 96 198 24.75 -102 decrease
-15 80 production
9 9 81 278 30.89 -197

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Monopolistic Profit Maximization Graph

Marginal revenue is not constant
P as Q increases because:
• revenue increases as the
MC
Monopolist Price: monopolist sells more
$36 D at Qprofit max • revenue decreases because the
monopolist must lower the price
to sell more
$24
Competitive Find output where MC = MR,
$20.50 Price
this is the profit maximizing Q

MC = MR
D Find how much consumers will
MR pay where the profit max Q
Q intersects demand, this is the
4 (profit max)
monopolist price

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Comparing Monopoly and Perfect Competition

• In a monopoly, P>MR,
P • In perfect competition, P=MR=D
MC • MR=MC is the profit max rule for
both

First find the monopoly

PM Q and P
PPC
Then find the perfectly
DPC= MRPC competitive Q and P
DM
Outcome: Monopoly output
MRM is lower and price is higher
Q
QM QPC than perfect competition

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Find output where Determining Profits Graphically:
MC = MR, this is the profit
A Firm with Profit
maximizing Q
P
Find how much consumers MC
will pay where the profit
max Q intersects demand, D at Qprofit max
this is the monopolist price ATC

P
Find profit per unit where Profits
the profit max Q ATC ATC at Qprofit max
intersects ATC
MC = MR
D
Since P>ATC at the MR
profit maximizing quantity, Q
Qprofit max
this firm is earning profits

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Determining Profits Graphically: Find output where
A Firm with Zero Profit or Losses MC = MR, this is the profit
maximizing Q
P
MC Find how much consumers
will pay where the profit
ATC
D at Qprofit max max Q intersects demand,
this is the monopolist price

P
ATC at Qprofit max Find profit per unit where
=ATC
the profit max Q
intersects ATC
MC = MR
D Since P=ATC at the
MR profit maximizing quantity,
Q this firm is earning
Qprofit max
zero profit or loss

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Find output where

Determining Profits
MC = MR, this is the profit Graphically: A Firm with Losses
maximizing Q
P
Find how much consumers ATC at Qprofit max MC
will pay where the profit ATC
max Q intersects demand,
this is the monopolist price
ATC D at Qprofit max
Losses
P
Find profit per unit where
the profit max Q
intersects ATC
MC = MR
D
Since P<ATC at the MR
profit maximizing quantity, Q
Qprofit max
this firm is earning losses

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Welfare Loss from a Monopoly:
The Normal Monopolist
P • The welfare loss from a
MC monopoly is represented by
the triangles B and D
• The rectangle C is a transfer
of surplus from the consumer
PM
PPC C D to the monopolist
B
• The area A represents the
opportunity cost of diverted
D resources, which is not a loss
A MR to society
QM QPC Q

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The Price-Discriminating Monopolist

 When a monopolist price discriminates, it charges

different prices to different individuals or groups of
individuals
• Consumers with less elastic demands are charged
higher prices.
• Consumers with more elastic demands are
charged lower prices

 Price discrimination increases output and profits

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The Price-Discriminating Monopolist

 Examples of price discrimination
• Movie discounts to senior citizens and children
• Airline charge more to fly on Fridays and Sundays
• Tracking consumer information and pricing
accordingly

 It might seem unfair for a monopolist to charge

different people different prices, but doing so
eliminates welfare loss from monopoly
 For a price-discriminating monopolist, because it can
charge what consumers are willing to pay, all
consumer surplus is captured by the monopolist
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Barriers to Entry
 Natural Ability
• A firm is better at producing the good than anyone
else
 Natural Monopolies
• Natural monopoly is when a single firm can
produce at a lower cost than can two or more firms
 Government-Created Monopolies
• Patents
 If there were no barriers to entry, profit-maximizing firms
would always compete away monopoly profits

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Average Cost for Natural Monopolist

Average • One firm producing Q1 has average cost C1
Cost
• If two firms share the market, each produces
Q1/2 and has average cost C2

• If three firms share the market, each

produces Q1/3 has average cost C3
C3

C2

C1
ATC
Q 1/3 Q 1/2 Q1 Q

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Profit of Natural Monopolist

• A natural monopolist produces QM and
Average
Cost charges PM, therefore earning a profit
• If there is government regulation and a
competitive solution where P = MC is
required, the monopolist produces QC
PM and charges PC, therefore earning a loss
Profits
CM

CC
Losses ATC
PC
MR MC
D
Q
QM QC

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Government Policy and Monopoly: AIDS
Drugs
 A few companies have patents for COVID-19 related
technology for development of Vaccines. This enables
them to charge high prices because demand is inelastic

Policy Options
• Government regulation where price = marginal cost
benefits society, but discourages research
• Government purchase of the patents and allowing
anyone to produce the drugs so their price = marginal
cost. This is expensive for taxpayers.

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Characteristics of Monopolistic Competition

Four distinguishing characteristics:
1. Many sellers that do not take into account rivals’
reactions
2. Product differentiation where the goods that are
sold aren’t homogenous
3. Multiple dimensions of competition make it harder
to analyze a specific industry, but these methods of
competition follow the same two decision rules as
price competition
4. Ease of entry of new firms in the long run because
there are no significant barriers to entry

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Output, Price, and Profit of a
Monopolistic Competitor
 Like a monopoly,
• The monopolistic competitive firm has some
monopoly power so the firm faces a downward
sloping demand curve
• Marginal revenue is below price
• At profit maximizing output, marginal cost will
be less than price
 Like a perfect competitor, zero economic profits exist in
the long run

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Monopolistic Competition Compared
with Perfect Competition Graph
P
MC
• In monopolistic competition
in the long run, P > min ATC
ATC
• In perfect competition in the
PMC long run, P = min ATC
PPC DPC
Outcome:
Monopolistic competition
DMC
output is lower and
price is higher than
MRMC perfect competition
Q
QMC QPC

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Comparing Monopolistic Competition with
Monopoly
 It is possible for the monopolist to make economic
profit in the long run because of the existence of
barriers to entry
 No long-run economic profit is possible in
monopolistic competition because there are no
significant barriers to entry

 For a monopolistic competitor in long-run equilibrium,

(P = ATC) ≥ (MC = MR)

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Advertising and Monopolistic Competition

 Perfectly competitive firms have no incentive to

advertise, but monopolistic competitors do
 The goals of advertising are to increase demand and
make demand more inelastic
 Advertising increases ATC
 The increase in cost of a monopolistically competitive
product is the cost of “differentness”

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Chapter Summary
 A monopolist maximizes profit or minimizes losses where
MR=MC
 To determine a monopolist’s profit or loss: Find output
where MR=MC; Determine price and ATC at that output;
Profit or loss = (P – ATC) * Q
 Because monopolies reduce output and charge P > MC,
monopolies create a welfare loss for society
 Monopoly output is lower and price is higher than in
competitive markets
 Natural monopolies exist in industries with strong
economies of scale
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Chapter Summary
 A price-discriminating monopolist earns more profit than
a normal monopolist by charging a higher price to those
with less elastic demand and a lower price to those with
more elastic demand
 Three important barriers to entry are natural ability,
economies of scale, and government restrictions
 Monopolistic competition is characterized by many
sellers, differentiated products, multiple dimensions of
competition, and ease of entry for new firms
 A monopolistic competitor differs from a monopolist in
that a monopolistic competitor makes zero economic
profit in long-run equilibrium
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