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Seventh Edition In this chapter,
Principles of look for the answers to these questions
Economics )
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9 • Why do monopolies arise?
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N. Gregory Mankiw n
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e • Why is MR < P for a monopolist?
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W • How do monopolies choose their P and Q?
• How do monopolies affect society’s well-being?
CHAPTER Monopoly • What can the government do about monopolies?
15 • What is price discrimination?
Modified by Joseph Tao-yiWang
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Introduction Why Monopolies Arise
A monopoly is a firm that is the sole seller of a The main cause of monopolies is barriers
product without close substitutes. to entry—other firms cannot enter the market.
In this chapter, we study monopoly and contrast Three sources of barriers to entry:
it with perfect competition. 1. A single firm owns a key resource.
The key difference: E.g., DeBeers owns most of the world’s
A monopoly firm has market power, the ability diamond mines
to influence the market price of the product it 2. The govt gives a single firm the exclusive right
sells. A competitive firm has no market power. to produce the good.
E.g., patents, copyright laws, rice wine
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Why Monopolies Arise Monopoly vs. Competition: Demand Curves
3. Natural monopoly: a single firm can produce In a competitive market,
the entire market Q at lower cost than could the market demand curve
several firms. slopes downward. A competitive firm’s
Example: 1000 homes But the demand curve P demand curve
need electricity Cost Electricity for any individual firm’s
ATCslopes product is horizontal
AATTCC iiss lloowweerr iiff downward due at the market price.
oonnee ffiirrmm sseerrvviicceess to huge FC and The firm can increase Q D
aallll 11000000 hhoommeess $80 small MC without lowering P,
tthhaann iiff ttwwoo ffiirrmmss $50 ATC so MR= P for the
eeaacchh sseerrvviiccee Q competitive firm.
550000 hhoommeess.. 500 1000 Q
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1
Monopoly vs. Competition: Demand Curves ACTIVE LEARNING 1
A monopoly’s revenue
A monopolist is the only Ikari Coffee is the
seller, so it faces the only on NTU campus Q P TR AR MR
market demand curve. A monopolist’s seller of cappuccinos. 0 $180 n.a.
To sell a larger Q, P demand curve The table shows the 1 160
the firm must reduce P. market demand for
Thus, MR≠ P. cappuccinos. 2 140
Fill in the missing 3 120
spaces of the table. 4 100
D What is the relation 5 80
Q between P and AR? 6 60
Between Pand MR?
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ACTIVE LEARNING 1 Ikari Coffee’ D and MR Curves
Answers P, MR
Here, P = AR, Q P TR AR MR Q P MR $200
same as for a 0 $180 $ 0 n.a. 0 $180 160 Demand curve(P)
competitive firm. $160 $160 120
Here, MR < P, 1 160 160 $160 120 1 160 80
2 140 280 140 2 140 120 40
whereas MR= P 80 80
for a competitive 3 120 360 120 3 120 0
firm. 4 100 400 100 40 40 -40 MR
0 4 100 0 -80
5 80 400 80 –40 5 80 -120
6 60 360 60 6 60 –40 0 1 2 3 4 5 6 7 Q
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Understanding the Monopolist’s MR Profit-Maximization
Increasing Q has two effects on revenue: Like a competitive firm, a monopolist maximizes
Output effect: higher output raises revenue profit by producing the quantity where MR = MC.
Price effect: lower price reduces revenue Once the monopolist identifies this quantity,
To sell a larger Q, the monopolist must reduce it sets the highest price consumers are willing to
the price on all the units it sells. pay for that quantity.
Hence, MR < P It finds this price from the D curve.
MRcould even be negative if the price effect
exceeds the output effect (e.g., when Ikari Coffee
increases Q from 5 to 6).
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2
Profit-Maximization The Monopolist’s Profit
1. The profit- Costs and Costs and
Revenue MC Revenue MC
maximizing Q
is where P As with a P ATC
MR= MC. competitive firm, ATC
2. Find P from the monopolist’s
the demand D profit equals D
curve at this Q. MR (P – ATC) x Q MR
Q Quantity Q Quantity
Profit-maximizing output
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A Monopoly Does Not Have an S Curve CASE STUDY: Monopoly vs. Generic Drugs
A competitive firm Patents on new drugs The market for
takes P as given give a temporary Price a typical drug
has a supply curve that shows how its Q depends monopoly to the seller.
on P. P
When the M
A monopoly firm patent expires, P =MC
is a “price-maker,” not a “price-taker” the market C
Q does not depend on P; becomes competitive, D
Qand Pare jointly determined by generics appear. MR
MC, MR, and the demand curve. Q Quantity
M Q
Hence, no supply curve for monopoly. C
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The Welfare Cost of Monopoly The Welfare Cost of Monopoly
Recall: In a competitive market equilibrium, Competitive eq’m: Price Deadweight
P= MCand total surplus is maximized. quantity = Q
C loss MC
In the monopoly eq’m, P > MR = MC P= MC
The value to buyers of an additional unit (P) total surplus is P
exceeds the cost of the resources needed to maximized P= MC
produce that unit (MC). Monopoly eq’m: MC
quantity = Q D
The monopoly Q is too low – M
could increase total surplus with a larger Q. P> MC MR
Thus, monopoly results in a deadweight loss. deadweight loss Q Q
M C Quantity
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3
Price Discrimination Perfect Price Discrimination vs.
Single Price Monopoly
Discrimination: treating people differently based Here, the monopolist Consumer
on some characteristic, e.g. race or gender. charges the same Price surplus
Price discrimination: selling the same good price (PM) to all Deadweight
buyers. P loss
at different prices to different buyers. M
The characteristic used in price discrimination A deadweight loss
results. Monopoly MC
is willingness to pay (WTP): profit D
A firm can increase profit by charging a higher MR
price to buyers with higher WTP.
Q Quantity
M
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Perfect Price Discrimination vs. Price Discrimination in the Real World
Single Price Monopoly
Here, the monopolist In the real world, perfect price discrimination is
produces the Price Monopoly not possible:
competitive quantity, profit No firm knows every buyer’s WTP
but charges each Buyers do not reveal it to sellers
buyer his or her WTP.
This is called perfect MC So, firms divide customers into groups
price discrimination. based on some observable trait
The monopolist D that is likely related to WTP, such as age.
captures all CS MR
as profit. Quantity
But there’s no DWL. Q
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Examples of Price Discrimination Examples of Price Discrimination
Movie tickets Discount coupons
Discounts for seniors, students, and people People who have time to clip and organize
who can attend during weekday afternoons. coupons are more likely to have lower income
They are all more likely to have lower WTP and lower WTP than others.
than people who pay full price on Friday night. Need-based financial aid
Airline prices Low income families have lower WTP for
Discounts for Saturday-night stayovers help their children’s college education.
distinguish business travelers, who usually have Schools price-discriminate by offering
higher WTP, from more price-sensitive leisure need-based aid to low income families.
travelers.
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