1. Monopoly
Dr. Andrew McGee
Simon Fraser University

2. Monopoly Assumptions & Implications
1. Single seller of a single good (many buyers)
– Something prevents entry into this market,
resulting in a single seller
2. Monopolist chooses an output level
– Monopolist is not a price taker; monopolist faces
the entire market demand curve
– Maintained assumption: monopolist maximizes
profit

3. Monopoly and market power

4. Monopoly profits
• Unlike in perfect competition, the monopolist
can make positive profits in the long run
because no other firms can enter to compete
and lower the market price
• What are these barriers to entry?

5. Barriers to entry
1. Exclusive control of a natural resource
2. Exclusive rights to use a product or technology
– Patents (granted by governments)
3. Exclusive franchise rights or licenses
– Often granted by governments
– Lead to localized monopolies
4. Network effects – products become more valuable
when more people use and consume them
– More complementary goods and services (e.g., repairs)
available
5. Economies of scale – lead to natural monopolies
– Electricity and other utilities

6. Natural monopolies
AC
MCP
Q
Suppose Q’ represents a level of output larger than
the entire potential market demand at any price P.
Costs per unit of production are falling over the entire
range of potential equilibrium output levels. This
market will likely be served by a single firm. Why? Any
existing firm can always lower its costs per unit below
those of a new entrant with presumably smaller
output and set a low price that the new entrant finds
unprofitable but which is profitable for the larger firm.
Q’
In this way, the existing firm can
always deter entry. This
situation, wherein average costs
are falling over a wide range of
output levels, is known as a
natural monopoly.
Industries requiring large investments in
capital infrastructure (which results in high
MC for early units of output but lower and
declining MC thereafter) tend to be natural
monopolies. For instance, utility companies.

7. Persistence of monopolies in the LR
• Which barriers to entry are likely to persist in
the LR?
– Firms can find substitutes for important inputs or
develop synthetics
– Patents expire
– Franchise rights & licenses can be revoked
– New technologies can upend existing networks
• Beta vs. VHS, CDs and iTunes, iTunes & “the cloud”

8. Persistence of monopolies in the LR
• Natural monopolies may survive in the LR in
the absence of major technological change
• Technological change is the enemy of
monopoly
• Even natural monopolies can be displaced by
technological change
– Land lines & cell phones, electricity & solar
panels?

9. Profit Maximization & Monopolies

10. Profit Maximization & Monopolies

11. Profit Maximization & Monopolies
P
Q
MC
D
MR
PM
QM Q*
Notice that the monopolist produces less
output than the industry would produce if it
were perfectly competitive (QM<Q*). Notice
also that as a result the monopoly price is
higher than the perfectly compeitive
Notice also that the gains from trade to society are not maximized. All of the units QM
through Q* cost society less than society values them. The triangle above is (roughly) the
deadweight loss to society. This occurs because the monopolist is not maximizing social
welfare but rather his own profits. This highlights one of the primary virtues of perfectly
competitive markets: despite the absence of a central planner explicitly trying to
maximize social welfare, the market achieves the socially optimal result through the self-
interested decisions of many parties.
Deadweight loss

12. Efficiency & Monopoly
• Monopolies do not achieve allocative
efficiency as the previous slide indicates
• Monopolies are also not productively efficient
insofar as they do not produce at the output
level minimizing costs per unit
P
Q
MC
AC
D
QM
MR

13. Monopoly Supply Curve
• There is none.
• For any given demand, there is a unique profit-
maximizing price-quantity pair for the
monopolist. The only thing that would cause the
monopolist’s price and output to change would
be a change in consumer demand, which would
change the monopolist’s marginal revenue.
Supply curves, however, plot the change in
quantity supplied at different prices. Here,
quantity supplied varies not with price but with
consumer demand, so there is no well-defined
supply curve.

14. Price discrimination
• A monopoly engages in price discrimination if
it sells otherwise identical units of output at
different prices
• Examples: student & senior ticket prices at the
movies—the movie is the same for all viewers
• Non-examples: differences in insurance
premiums for different drivers—different
drivers present different risks and hence the
insurance product they receive differs

15. Law of one price
• If buyers are able to costlessly exchange goods
amongst themselves, then a homogeneous
good must sell everywhere for the same price
• Law of one price not satisfied with price
discrimination
– Buyers must not be able to practice arbitrage
• Example: senior citizens hawking seniors
tickets outside of a movie theater

16. First-degree (perfect) price
discrimination
• Selling to each buyer at the maximum price he or she is
willing to pay
• Requires being able to identify each buyer and know their
willingness to pay
• The demand curve becomes the marginal revenue curve
• Under perfect price discrimination, the social surplus is
maximized (gains from trade are exhausted). The
monopolist, however, extracts the whole surplus.
• Consumers are indifferent between consuming the
monopolist’s product and going without it
• Perfect price discrimination is mainly a theoretical
construct. In practice, the other types of price
discrimination are much more common. Not surprising
given the information a monopolist must have about all
consumer in order to engage in perfect price discrimination

17. First-degree (perfect) price
discrimination
P
Q
D=MR
Each consumer (or group of consumer) pays
a different price. Consumers enjoy no
consumer surplus.
MC
As with any profit maximizing firm, the
monopolist sets MC=MR

18. Third degree price discrimination
through market separation
• Far more likely than knowing each consumer’s
willingness to pay is that a firm can separate its
customers into different geographic markets. If
(1) it knows that the willingness to pay (demand
elasticity) differs in these markets and (2) can
prevent customers in one market from re-selling
to customers in another market, it can and will
sell its output for different prices in these
different markets
• Examples: foreign & domestic sales, differences in
provinces, urban & rural markets
• Welfare effect of 3rd degree price discrimination
is ambiguous

19. 3rd degree price discrimination

20. 3rd degree price discrimination
D
D
MR MR
P P
Q Q
MC
PM2
PM1
QM1 QM2
What if marginal costs differed in the two markets?

21. 3rd degree price discrimination

22. 2nd degree Price Discrimination
• Suppose a monopolist doesn’t know much about
individual preferences (willingness to pay)
• Allow consumers to separate themselves by
offering different prices at different quantities
purchased
• Accomplished through quantity
discounts, minimum purchase requirements, and
tie-in sales
• Again requires the absence of arbitrage
opportunities

23. 2nd degree Price Discrimination
P
Q
D
P1
P2
P3
Q1 Q2 Q3
If you purchase 0 through Q1 units, pay P1. If you purchase Q1
through Q2 units, pay P2. If you purchase Q2 through Q3
units, pay P3. And so on.

24. Regulating a monopolist
DMR
Q
P
MC
AC
PU
QU
PL
Regulating a monopolist poses a dilemma: allow the
monopolist to underprovide the good or service or
subsidize the monopoly indefinitely
Qoptimal
The regulated price will be somewhere in this
range. The monopolist must be able to earn a
positive profit or it will shutdown. At Pr, this
firm would earn zero profit (P=AC). This is the
ideal price from the economist’s point of view.
Pr
Unfortunately calculating Pr is tricky because what we observe in reality are accounting
and not economic profits. The regulator must determine what a fair rate of return to the
monopolist would be. That is, what accounting profits (>0) would be required for the
monopolist to earn zero economic profit?