Economic Principles I

Lecture 13:
The Market Structure of Monopoly
What is a Monopoly?
Monopolies arise because of barriers to entry:
A single firm controls a key resource
The government creates a monopoly by giving
one firm exclusive rights (e.g. a patent)
Economies of scale mean a single producer is
more efficient than many (natural monopoly)
Demand Curves Compared
A monopoly can influence the price of its output, by adjusting
quantity, So it faces a downward sloping demand curve
Demand
Output
(a) A Competitive Firms Demand Curve
0
Price
(b) A Monopolists Demand Curve
0
Output
Price
Demand
Profit-maximising Output in
Monopoly
Quantity Price
Total
Revenue
Average
Revenue
Marginal
Revenue
0 11 0
1 10 10 10 10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4
Revenue is maximised at 6 units where MR=0
A Closer Look at Marginal
Revenue
Marginal revenue is different compared to a
competitive firm
As output increases, price on all units sold falls
Marginal revenue falls
The marginal revenue starts at the same point
on the vertical axis as demand (AR)
But it is twice as steep, so it lies below demand
(AR)
Demand and Marginal Revenue
Curves for a Monopolist
Quantity
Price
11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
1 2 3 4 5 6 7 8
Marginal
Revenue
Demand
(Average Revenue)
MC=MR applies in Monopoly,
too
MC

ATC

D
=AR
MR

Price
Quantity
A

B

Q
MAX
P
*
MR=MC at point
A. This gives the
point of profit
maximising
output: Q
MAX

Read up to the
demand curve at
point B to find the
price P*

Profit Maximisation
MC

ATC

D
=AR
MR

Price
Quantity
A

B

Q
MAX
P
*
For a competitive
firm P=MR=MC
For a monopolist
P>MR=MC
Price exceeds
marginal cost in a
monopoly market
C

D

E

Super-normal profit:
(P-ATC).Q [Box BCDE]
Welfare Consequences:
Monopoly imposes social costs on the economy
Higher prices increase profits (producer surplus)
But reduced output and higher prices reduce
consumer welfare (consumer surplus)
Loss of consumer surplus exceeds gain in
monopoly profit
Monopoly Welfare Loss
MC

Price
Quantity
MR

D
=AR

A

B

F

Lost consumer
surplus
Gained
monopoly
profit
Difference
equal
deadweight
loss *Area:
ABF]
So How Should Government
Respond? (1)
Increase competition through anti-monopoly laws
Rules in most countries stop existing
monopolies abusing their position, and stop
firms merging to create monopolies
The European Commission operates rules to
prevent monopolies arising within the EU
Public ownership
So How Should Government
Respond? (2)
By regulating the prices charged by monopolies
In Britain all public utilities and other monopolies
are monitored by Regulatory Agencies (e.g.
OFGEM, OFTEL, OFWAT)
One problem is that if the regulator tells the
monopoly to set P=MC then it has no incentive to
improve efficiency
So often a rule that allows the monopoly to raise
price in line with inflation minus an amount for
cost savings is used (RPI-X)
Price Discrimination
Charging different prices to different consumers
A way of extracting consumer willingness-to-pay
Examples:
Economy and business class
Hardback and paperback
Student rail cards
Money-off coupons
Conclusion
We have looked at where a market is supplied by a
monopoly:
Monopolies face downward sloping demand curves
They produce at a point where P>MC and make
super-normal profit
They may price discriminate
Governments may need to act to control monopolies
Lecture 9 will look at the case where the market is
dominated by few firms oligopoly
Economic Principles I
Lecture 13:
The Market Structure of Monopoly