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Economic Principles I

Lecture 13:

The Market Structure of Monopoly

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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)

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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

0Output

Price

Demand

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Profit-maximising Output in

Monopoly

Quantity Price

Total

Revenue

Average

Revenue

Marginal

Revenue

0 11 0

1 10 10 10 102 9 18 9 8

3 8 24 8 6

4 7 28 7 4

5 6 30 6 26 5 30 5 0

7 4 28 4 -2

8 3 24 3 -4

Revenue is maximised at 6 unitswhere MR=0

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A Closer Look at Marginal

Revenue

Marginal revenue is different compared to acompetitive firm

As output increases, price on all units sold falls Marginal revenue falls

The marginal revenue starts at the same pointon the vertical axis as demand (AR)

But it is twice as steep, so it lies below demand(AR)

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Demand and Marginal Revenue

Curves for a Monopolist

Quantity

Price11

10

9

87

6

5

4

3

2

1

0

-1

-2

-3

-4

1 2 3 4 5 6 7 8

Marginal

Revenue

Demand(Average Revenue)

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MC=MR applies in Monopoly,

too

MC

ATC

D

=ARMR

Price

Quantity

A

B

QMAX

P*

MR=MC at point

A. This gives the

point of profit

maximising

output: QMAX

Read up to the

demand curve at

point B to find the

price P*

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Profit Maximisation

MC

ATC

D

=ARMR

Price

Quantity

A

B

QMAX

P*

For a competitive

firm P=MR=MC

For a monopolist

P>MR=MC

Price exceeds

marginal cost in a

monopoly marketCD

E

Super-normal profit:

(P-ATC).Q [Box BCDE]

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Welfare Consequences:

Monopoly imposes social costs on the economy

Higher prices increase profits (producer surplus)

But reduced output and higher prices reduceconsumer welfare (consumer surplus)

Loss of consumer surplus exceeds gain in

monopoly profit

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Monopoly Welfare Loss

MC

Price

Quantity

MR

D

=AR

A

B

F

Lost consumer

surplus

Gained

monopoly

profit

Difference

equal

deadweight

loss *Area:

ABF]

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So How Should Government

Respond? (1)

Increase competition through anti-monopoly laws

Rules in most countries stop existing

monopolies abusing their position, and stopfirms merging to create monopolies

The European Commission operates rules toprevent monopolies arising within the EU

Public ownership

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So How Should Government

Respond? (2)

By regulating the prices charged by monopolies

In Britain all public utilities and other monopoliesare 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 toimprove efficiency

So often a rule that allows the monopoly to raiseprice in line with inflation minus an amount forcost savings is used (RPI-X)

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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

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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 firmsoligopoly

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Economic Principles I

Lecture 13:

The Market Structure of Monopoly