ECON1211

IntroductIo
n to
EconomIcs
LECTURE 11
Monopoly
from MANKIW 2008; Ch. 16

1
Monopoly

 While a competitive firm is a price

taker, a monopoly firm is a price
maker.
 A firm is considered a monopoly if . . .
 it is the sole seller of its product.
 its product does not have close
substitutes.
 The fundamental cause of monopoly
is barriers to entry.

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 Barriers of entry &
monopoly
 Barriers to entry have three sources:
 Although exclusive ownership of a key resource is a potential source
of monopoly, in practice monopolies rarely arise for this reason.
 De Beers in diamond industry
 Governments may restrict entry by giving a single firm the exclusive
right to sell a particular good in certain markets.
 Patent and copyright laws
 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.
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Natural monopolies
 A natural monopoly arises when there are economies of
scale over the relevant range of output.
Cost

Average
total
cost
4
0 Output
Monopoly v.
Competition
 Monopoly
 Is the sole producer
 Faces a downward-sloping demand curve
 Is a price maker
 Reduces price to increase sales

 Competitive Firm
 Is one of many producers
 Faces a horizontal demand curve
 Is a price taker
 Sells as much or as little at same price

5
 Monopoly v.
Competition
(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve

Price Price

Demand

Demand

0 Quantity of Output 0 Quantity of Output

6
A monopoly’s revenue
 Total Revenue

P  Q = TR
 Average Revenue

TR/Q = AR = P
 Marginal Revenue

DTR/DQ = MR

 A monopolist’s marginal revenue is always less than the

price of its good.
 The demand curve is downward sloping.

7
 Demand & marginal
revenue
Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average
1 revenue revenue)
0
–1 1 2 3 4 5 6 7 8 Quantity of Water
–2
–3
–4

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 Profit maximization
Costs and
Revenue 2. . . . and then the demand 1. The intersection of the
curve shows the price marginal-revenue curve
consistent with this quantity. and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity 9
Profit maximization
 Comparing Monopoly and Competition
 For a competitive firm, price equals marginal cost.
P = MR = MC
 For a monopoly firm, price exceeds marginal cost.
P > MR = MC
 Profit equals total revenue minus total costs.
 Profit = TR - TC
 Profit = (TR/Q - TC/Q)  Q
 Profit = (P - ATC)  Q

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 A monopoly’s profit
Costs and
Revenue

Marginal cost

Monopoly E B
price

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue

0 QMAX Quantity 11
Case Study: Monopoly
Drugs Versus Generic
Drugs
 The market for pharmaceutical
drugs takes on both monopoly
characteristics and competitive
characteristics.

 When a firm discovers a new drug,

patent laws give the firm a
monopoly on the sale of that drug.

 The patent eventually expires and

any firm can make the drug, which
causes the market to become
competitive.

 Prices of drugs fall after patents

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expire.
 The Market for Drugs
Costs and
Revenue

Price
during
patent life

Price after
Marginal
patent
cost
expires
Marginal Demand
revenue

0 Monopoly Competitive Quantity

quantity quantity 13
Welfare cost of
monopoly
 In contrast to a competitive firm, the monopoly charges a
price above the marginal cost.
 From the standpoint of consumers, this high price makes
monopoly undesirable.
 Because a monopoly sets its price above marginal cost, it
places a wedge between the consumer’s willingness to pay
and the producer’s cost.
 This wedge causes the quantity sold to fall short of the
social optimum.

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 The ineffciency of
monopoly
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity 15
The ineffciency of
monopoly
 The Inefficiency of Monopoly
 The monopolist produces less than the socially efficient quantity of
output.
 The deadweight loss caused by a monopoly is similar to the
deadweight loss caused by a tax.
 The difference between the two cases is that the
government gets the revenue from a tax, whereas a private
firm gets the monopoly profit.

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Public policy toward
monopolies
 Government responds to the problem of monopoly in one
of four ways.

1. Making monopolized industries more competitive.

2. Regulating the behavior of monopolies.
3. Turning some private monopolies into public
enterprises.
4. Doing nothing at all.

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Increasing competition

 Antitrust laws are a collection of statutes aimed

at curbing monopoly power.

 Antitrust laws give government various ways to promote
competition.
 They allow government to prevent mergers.
 They allow government to break up companies.
 They prevent companies from performing activities that make
markets less competitive.
Sherman Antitrust Act (1890) in USA
Law # 4054: protection of competition (1994) in
Turkey
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 Regulation
 Government may regulate the prices that the monopoly charges.
 The allocation of resources will be efficient if price is set to equal marginal cost.

Price

Average total
cost Average total cost
Loss
Regulated
price Marginal cost

Demand

0 Quantity 19
Public ownership & do
nothing
 Rather than regulating a natural monopoly that is run by a
private firm, the government can run the monopoly itself

 Government can do nothing at all if the market failure is

deemed small compared to the imperfections of public
policies.
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Key concepts of the
lecture
 Monopoly
 Natural monopoly
 Antitrust / competition policy
 Regulation

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Exercise

 Suppose a pharmaceutical firm is the sole producer of a

drug, because of patent protection. Assume its marginal
cost is constant.
a) Suppose government recognizes the social benefit of
the drug, and regulates the monopolist firm to charge
efficient price (marginal cost pricing).
On a diagram compare the equilibrium before and
after the regulation.
b) Because of the regulation the monopolist firm suffers
loss, and the government decides to pay this loss in
order to keep the firm in the market. Show the amount
of the loss on a separate diagram.
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