ECON1101 Chapter 10: ECON1101 Chapter 10
Natasha Warrell
Chapter 10 – Monopoly
A Model of Monopoly:
Monopoly: One firm in an industry selling a product that does not have close
substitutes
• Implicit in the definition of monopoly are barriers to entry – other firms are not
free to enter the industry
• The economist’s model of a monopoly assumes that the monopoly will
choose a level of output that maximises profits – the model of a monopoly is
like that of a competitive firm
• If increasing production will increase a monopoly’s profits, then the monopoly
will raise production – just as a competitive firm would
• The difference between a monopoly and a competitive firm: not what
motivates the firm but rather how its actions affect the market price
• MONOPOLY has market power
• MONOPOLY is a price-maker, competitive firms are price takers
Market Power: A firm’s power to set its price without losing its entire share of the
market
Price Maker: A firm that has the power to set its price, rather than taking the price set
by the market
Barriers to Entry: Anything that prevents firms from entering a market
E.g. De Beers created barriers to entry by maintaining exclusive rights to the
diamonds in most of the world’s diamond mines
Getting an Intuitive Feel for the Market Power of a Monopoly:
No One Can Undercut the Monopolist’s Price:
• When several sellers are competing with one another in a competitive market,
one seller can try to sell at a higher price, but no one will buy at that price
because another seller is always nearly who will undercut that price
• If a seller chargers at a higher price, everyone will ignore that seller; there is
no effect on the market price
• Monopoly’s situation is quite different:
▪ Instead of several sellers – the market has only one seller
▪ If the single seller sets a high price, it has no need to worry about
being undercut by other sellers
▪ There are no other sellers
▪ Therefore, the single seller – the monopoly – has the power to set a
high price
▪ The buyers probably will buy less at the higher price – this is, as the
price rises, the quantity demanded declines – but because no other
sellers offer that product or service, they probably will buy something
from the lone seller
The Impact of Quantity Decisions on the Price:
• Important difference between monopoly and a competitor: examine what
happens to the price when a firm changes the quantity is produces
▪ 100 firms in a market producing the same amount of bagels per day, if
one firm cuts its production the market price will rise by very little
(also, this price increase could motivate other firms to increase
Natasha Warrell
production slightly) – but overall impact on the price is negligible – no
power to affect the price
▪ Monopoly – is now the only firm in the market, if they were to cut
production the total quantity of product supplied to the market is cut in
half – big effect on the price in the market (immense power to affect
the price)
Showing Market Power with a Graph:
The Effects of Monopoly’s Decision on Revenues:
Total Revenue and Marginal Revenue:
• Marginal revenue declines as the quantity of output rises and eventually
becomes negative – so although a monopolist has the power to influence the
price, this does not mean that it can get as high a level of total revenue as it
wants
• To sell more output – the monopolist must lower the price to get people to
buy the increased output, as it raises output it must lower the price more and
more – causing increase in total revenue to get smaller (as price falls to very
low levels revenue declines)
Total Revenue and Marginal Revenue:
• Marginal revenue is less than the price (except at the first unit of output,
where it equals the price)
• Marginal revenue curve lies below the demand curve
▪ Because when a monopolist increases output by one unit there are
two effects on total revenue:
1. A positive effect, which equals the price P times the additional
unit sold
2. A negative effect, which equals the reduction in the price on all
items previously sold times the number of such items sold (the
reduction in revenue due to the lower price on the items
previously produced)
▪ Second effect is subtracted from the first – therefore the price is
always greater than marginal revenue
Marginal Revenue and Elasticity:
Natasha Warrell
• Marginal revenue is negative when the price elasticity of demand is less than
one
• Monopolist would not produce so much that its marginal revenue was
negative – therefore concluded that a monopoly would never produce a level
of output for which the price elasticity of demand would be less than one
Average Revenue:
Average Revenue: Total revenue divided by quantity
• Use average revenue to show that marginal revenue is less than the price
• Total revenue equals price times quantity – average revenue = (P.Q)/Q = P
• Marginal must be less than the average (average declines) – therefore
because average revenues (prices) decline (demand curve slopes down) the
marginal revenue curve must lie below the demand curve
Finding Output to Maximise Profits at the Monopoly:
• A monopolist will never produce a quantity for which marginal revenue is
negative but that does not mean that it will produce until marginal revenue is
0 – if each additional unit brings in extra revenue the firm will have to look at
the costs of producing that extra unit as well
• Total costs increase as more is produced (at least for high levels of output)
• Marginal costs increases as more is produced (at least for high levels of
output)
Comparing Total Revenue and Total Costs:
• Difference between total revenue and total costs is profits
• Quantity produced increases → both total revenue from selling the product
and the total costs of producing the product increase – eventually profits must
reach a maximum
• Profits are shown as the gap between total costs and total revenue (graph)
Equating Marginal Cost and Marginal Revenue:
• If marginal revenue is greater than the marginal cost of the additional unit –
profits will increase if the unit is produced (therefore should be produced –
total revenue rises more than total costs)
• Monopolist should increase its output as long as marginal revenue is greater
than marginal cost – marginal revenue is decreasing so at some level of
output marginal revenue will drop below marginal cost
• Monopolist should produce up to the level of production where MC = MR
MC = MR at a Monopoly versus MC = P at a Competitive Firm:
Marginal Revenue Equals the Price for a Price-Taker:
• For a competitive firm: total revenue = PQ
• Competitive firm can not affect the price – therefore when the quantity sold is
increased by one unit, revenue is increased by the price (marginal revenue
equals the price for a competitive firm)
• MC = MR rule applies to both monopolies and competitive firms that
maximise profits
A Visual Comparison:
• Monopoly total revenue curve: turn down at higher levels of output
