McConnell 22nd edition

1. CHAPTER 12
Pure Monopoly

2. ©2021 McGraw Hill Education. All rights reserved. No reproduction or further distribution without the prior written consent of McGraw Hill Education.
Chapter Contents
An Introduction to Pure Monopoly
Barriers to Entry
Monopoly Demand
Output and Price Determination
Economic Effects of Monopoly
Price Discrimination
Regulated Monopoly
12-2

3. Conditions of Pure Monopoly
• Three Conditions of Pure monopoly
• Single seller – a sole producer
• No close substitutes – unique product
• Blocked entry – strong barriers to entry
• Price maker: Without any competition, a pure
monopolist can control over price.
LO12.1 12-3

4. Examples of Monopoly
• Public utility companies
• Natural gas
• Electric
• Cable television
• Near monopolies
• Intel
• Windows OS
• Professional sports teams
LO12.1 12-4

5. Barriers to Entry
• Barriers to entry are factors that prevent firms from
entering the industry:
• Economies of scale
• Legal barriers to entry like patents and licenses
• Ownership or control of essential resources
• Pricing and other strategic barriers
LO12.2 12-5

6. Economies of Scale: The Natural Monopoly Case
• Under economies
of scale, a long-
run average total
cost is decreasing.
• A larger firm can
produce at lower
cost.
0
Averagetotalcost
Quantity
10
15
$20
50 100 200
ATC
LO12.2 12-6

7. Natural Monopoly
• A natural monopoly exists when the technology for
producing a good or service enables one firm to meet the
entire market demand at a lower price than two or more
firms could.
• With economies of scale, a long-run average total cost
decreases as a firm increases its production.
• It is more efficient for an economy to have one firm operates
in market.
12-7

8. Legal Barriers to Entry
• A legal monopoly is a market in which competition and
entry are restricted by granting of a public franchise,
government license, patent, or copyright.
• Book, music, movie
• Drug, software
• Taxicab
• Medical doctor, lawyer
12-8

9. Control of Essential Resources
• A monopoly can arise in a market in which competition and
entry are restricted by the concentration of ownership of a
natural resource.
• DeBeers
• Standard Oil
12-9

10. Monopoly and Market
• The pure monopolist is the industry
• Monopolist demand curve is the market demand curve
• No supply curve: Monopolist chooses a point on market
demand curve.
• Assume that a sole objective of monopolist is to maximize
its profit.
LO12.3 12-10

11. Monopoly Demand Schedule
Revenue and Cost Data of a Pure Monopolist
Revenue Data Cost Data
(1)
Quantity of
Output
(2)
Price (Average
Revenue)
(3)
Total Revenue
(1) X (2)
(4)
Marginal
Revenue
(5)
Average
Total Cost
(6)
Total Cost,
(1) X (5)
(7)
Marginal
Cost
(8)
Profit [+] or
Loss [-]
0 $172 $ 0
$162
142
122
102
82
62
42
22
2
-18
$ 100
$ 90
80
70
60
70
80
90
110
130
150
$ -100
1 162 162 $190.00 190 -28
2 152 304 135.00 270 +34
3 142 426 113.33 340 +86
4 132 528 100.00 400 +128
5 122 610 94.00 470 +140
6 112 672 91.67 550 +122
7 102 714 91.43 640 +74
8 92 736 93.75 750 -14
9 82 738 97.78 880 -142
10 72 720 103.00 1030 -310
LO12.3 12-11

12. Price and Marginal Revenue in Pure Monopoly
• Monopolist can freely increase
or decrease its price without
worrying about competition.
• Because the market demand
curve is downward sloping,
when monopolist increases its
production, the market price
should decrease.
• A price change may increase or
decrease its total profits,
depending on price elasticity of
demand.
D
Gain = $132
Loss = $30
LO12.3 12-12
0 1 2 3 4 5 6 Q
$142, 3 units
$132, 4 units$142
132
P

13. Monopoly Demand and Price
• Demand curve is downward-sloping
• Marginal Revenue curve is below the demand curve.
• Marginal revenue will be less than price.
• Monopolist sets price in the elastic region of the demand
curve where total revenue is increasing.
• In the inelastic region, any increase in production will reduce total
revenue and increase total cost, resulting in decrease in total profit.
• Monopolist chooses a quantity of output where its MC = MR
for profit maximization.
LO12.3 12-13

14. Demand, Marginal Revenue, and Total Revenue for a Pure
Monopolist
Elastic Inelastic
(b)
Total-revenue curve
D
MR
TR
LO12.3 12-14
0 2 4 6 8 10 12 14 16 18 Q
$200
150
100
50
Price
0 2 4 6 8 10 12 14 16 18 Q
$750
500
250
Totalrevenue
(a)
Demand and
marginal-revenue
curves

15. Output and Price Determination Steps
Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing Price, and
Economic Profit (if Any) in Pure Monopoly
Step 1. Determine the profit-maximizing output by finding where MR = MC.
Step 2. Determine the profit-maximizing price by extending a vertical line upward from the output
determined in step 1 to the pure monopolist’s demand curve.
Step 3. Determine the pure monopolist’s economic profit by using one of two methods:
Method 1.
Method 2.
LO12.4 12-15
Find total cost by multiplying the average total cost of the profit-maximizing output by
that output. Find total revenue by multiplying the profit-maximizing output by the
profit-maximizing price. Then subtract total cost from total revenue to determine the
economic profit (if any).
Find profit per unit by subtracting the average total cost of the profit-maximizing
output from the profit-maximizing price. Then multiply the difference by the
profit-maximizing output to determine economic profit (if any).

16. D
MR
ATC
MC
MR = MC
A = $94
Economic
profit
Pm = $122
12-16
Profit
per unit
Qm = 5 units
0 1 2 3 4 5 6 7 8 9 10 Q
$200
175
150
125
100
75
50
25
Quantity
Price,costs,andrevenue
Profit Maximization by a Pure Monopolist
LO12.4

17. Misconceptions of Monopoly Pricing
• Monopolist does not charge the highest possible price.
• Higher price reduces quantity demanded and total revenue in the
elastic region, potentially lowers its total profits.
• Monopolist may make losses.
• If the average total cost is very high due to large fixed cost, and if
the market demand is small, then it may not be able to charge price
high enough to make profits.
LO12.4 12-17

18. 0
D
MR
ATC
MC
MR = MC
Loss AVCPm
Qm
A
12-18
Loss
per unit
Quantity
The Loss-Minimizing Position of a Pure Monopolist
• By choosing Q at MR
= MC, monopolist is
minimizing its loss.
• If the market is larger
(market demand
curve shifts to the
right) or ATC is lower,
then the monopolist
can make profits.
V
LO12.4
Price,costs,andrevenue(dollars)

19. Monopoly and Efficiency
• Resources are allocated efficiently when marginal benefit
equals marginal cost.
• An efficient output is at point where monopolist’s MC curve
crosses market demand curve (market demand reflects
marginal utility of consumers).
• Purely competitive market produce at MC = P.
• Monopolist produces less than the efficient output.
• Deadweight loss due to under-production
• Loss of consumers surplus
12-19

20. Inefficiency of Pure Monopoly Relative to a
Purely Competitive Industry
• Monopolist produces less than output in purely competitive market (Qm < Qc).
• Monopolist charge higher price than purely competitive market (Pm > Pc).
• Monopolist’s ATC is higher than minimum ATC of purely competitive firms.
(a)
Purely competitive market
(b)
Pure monopoly
D
D
S = MC
MC
P = MC =
minimum ATC
MR
Pc
Qc
Pc
Pm
QcQm
a
b
cd
LO12.5 12-20
0 Q
P
MR = MC
P
0
Efficiency loss
Q

21. Economic Effects of Monopoly
• Monopoly market has many economic effects beside
loss of efficiency.
• Income transfer
• Cost complications (Potential benefits)
• Economies of scale
• Simultaneous consumption
• Network effects
• X-inefficiency
• Rent-seeking behavior
• Technological advance
LO12.5 12-21

22. Income Transfer
• Income transfer: Monopolist increases its profit at cost of
loss of consumer surplus.
• Because it creates a deadweight loss, transferring profits
from monopoly to consumers does not offset all losses of
consumers.
12-22

23. Cost Complications
• Economies of scale: Monopolist can achieve lower average total cost.
• Network effects: a value of a product increases as a number of users
increases.
• Technological advance: Only large firms can engage in large scale R&D.
• X-inefficiency: A monopolist may not have an incentive to minimize its
cost.
• Rent-seeking behavior: A monopolist spends on activities to acquire or
maintain legal barriers to entry from government.
• Technological advance: Lack of competition may impede technological
advancement.
12-23

24. Assessment and Policy Options
• To reduce the problems created by monopoly, the
government may
• Antitrust laws: Break up the firm.
• Regulate it: Government determines price and quantity.
• Ignore it: Let time and markets get rid of monopoly.
• New technology and new products
• Foreign competition
LO12.5 12-24

25. Global Perspective 12.1
LO12.5 12-25
COMPETITION FROM FOREIGN MULTINATIONAL
CORPORATIONS

26. Price Discrimination
• Price discrimination
• Charging different buyers different prices
• Different prices are not based on cost differences
• Conditions for success
• Monopoly power
• Market segregation
• No resale
• Examples
• First class vs. Economy class
• Movie theaters & Amusement parks
• Lunch & dinner menu at restaurant and Happy hours
• Coupons
• Bulk-buyer discount (Warehouse) & Buyer membership (Amazon Prime)
LO12.6 12-26

27. How Price Discrimination Works
• Monopolist can increase its profit by charging a high price to
those consumers who are willing to pay high (high MB) and
charging a low price to those consumer who are not willing to
pay high (low MB)
• Monopolist can increase its profit by charging a high price to
inelastic demand and a low price to elastic demand.
12-27

28. Price Discrimination Applied to Different Groups of Buyers
MC = ATC MC = ATC
Qb
Qs
Ps
Pb
P P
MRb MRs
Db Ds
(a) Small businesses (b) Students
Economic profit (a)
Economic profit (b)
LO12.6 12-28
Q 00 Q
One price for all

29. Regulated Monopoly
• Natural monopolies which operate under economies of scale.
• Socially optimal price
• Set price equal to marginal cost: P = MC
• Monopolist incurs losses because ATC > MC under decreasing ATC.
• Fair return price
• Set price equal to average total cost: P = ATC
• Guarantee normal profits to monopolist.
• Dilemma of regulation
• Socially optimal price or fair return price
• X-inefficiency problem
LO12.7 12-29

30. Rate Regulation of a Natural Monopoly
Monopoly
price
Fair-return
price
Socially
optimal
price
Pr
D
r
f
b
a
Pf
Pm
Qm Qf Qr
MR
MC
ATC
LO12.7 12-30
0
Quantity
Priceandcosts(dollars)

31. Last Word: Personalized Pricing
• “Big Data” available to Internet retailers.
• Ability to set a price according to consumer’s perceived
ability to pay.
• Based on your online buying habits, backgrounds, and
preferences.
• Personalized pricing strategy can fail when consumers
comparison shop.
12-31

32. Monopoly Power in the Internet Age
• Google dominates search
• Facebook dominates social media
• Amazon dominates as an online retailer
• Barriers of entry
• Network effects of being large attract more users
• Economies of scale
12-32