Economic Analysis

for Business
Session XII: Monopoly
Instructor
Rijan Dhakal
9851069004
dhakalrijan2010@gmail.com

Introduction
A monopoly is a firm that is the sole
seller of a product without close
substitutes.
The key difference:
market power: the ability to influence
the market price of the product it sells.
A competitive firm has no market
power.

Why Monopolies Arise

The main cause of monopolies is
barriers
to entry other firms cannot enter the
market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the worlds
diamond mines
2. The govt gives a single firm the exclusive
right to produce the good.
E.g., patents, copyright laws

Why Monopolies Arise

3. Natural monopoly: a single firm can produce
the entire market Q at lower ATC than could
several firms.
Cost

Electricity
Economies of
scale due to
huge FC

$80
$50

ATC
500

1000

Monopoly: Demand Curves

A monopolist is the only
seller, so it faces the
market demand curve.
To sell a larger Q,
the firm must reduce P.

A monopolists
demand curve

Thus, MR P.

A monopolys revenue
Moonbucks is
the only seller of
cappuccinos in
town.
The table shows
the market
demand for
cappuccinos.
Fill in the missing
spaces of the
table.
What is the
relation between
P and AR?

$4.50

4.00

3.50

3.00

2.50

2.00

1.50

TR

AR

MR

n.a.

Answers
Here, P = AR,
same as for a
competitive firm.
Here, MR < P,
whereas MR = P
for a competitive
firm.

TR

AR

$4.50

$0

n.a.

4.00

$4.00

3.50

3.50

3.00

3.00

2.50

10

2.50

2.00

10

2.00

1.50

1.50

MR
$4
3
2
1
0

Moonbucks D and MR Curves

P, MR
$5
4
3
2
1
0
-1
-2
-3
0

Demand curve (P)

MR

Profit-Maximization
1. The profitmaximizing Q
is where
MR = MC.

Costs and
Revenue

MC

2. Find P from
the demand
curve at this Q.

MR

Quantity

Profit-maximizing output

Numerical Problems and

Solutions
1) Suppose the Total Cost for the Monopoly(TC) = 500 + 20Q2
Demand Equation (P) = 400 20Q
Total Revenue (TR) = 400Q 20Q2
What is the profit maximizing price and quantity?

Numerical Problems and

Solutions
1) Suppose the Total Cost for the Monopoly(TC) = 500 + 20Q2
Demand Equation (P) = 400 20Q
Total Revenue (TR) = 400Q 20Q2
What is the profit maximizing price and quantity?
Solution:
MR = dTR / dQ = 400 -40Q
MC = dTC / dQ = 40Q
Profit Maximizing price is achieved when MR =MC
Or, 400 40Q = 40Q
Therefore, Q =5 (Profit maximizing output)
Putting the value of Q in demand equation
Profit Maximizing Price P = 300.

Case Study: For your Reference

Patents on new drugs give a temporary monopoly to
the seller.
When the patent expires, the market becomes
competitive,
generics appear.
Follow the case study from Mankiw Book for your
reference.

The Welfare Cost of

Monopoly
Competitive eqm:
quantity = QE

Price

Deadweight
MC
loss

P = MC

total surplus is
maximized

Monopoly eqm:
quantity = QM
P > MC
deadweight loss

P
P = MC
MC
D

MR

QM QE

Quantity

Price Discrimination

Price discrimination is the business

practice of selling the same good at
different prices to different buyers.

Some examples:
Movie tickets
Airline prices
Discounts
Need-based financial aid

Monopolys Pricing Decision

Single Price (without price
discrimination)
With price discrimination

Monopoly without price discrimination (single

price)
Single Price
Price
Discrimination
Here, the monopolist
charges the same price
PM
(PM) to all buyers in all
markets.
MC

Consumer
surplus
Deadweight
loss

Monopoly
profit

A deadweight loss
results.

D
MR

QM

Quantity

Price Discriminating Monopoly

Here, the monopolist
Price
produces the
competitive quantity, but
charges each buyer his
or her WTP in different
markets.
MC
This is also called
perfect price
Discrimination.
The monopolist captures
all CS
as profit.
But theres no DWL.

Monopoly
profit

D
MR

Quantity

Public Policy Toward Monopolies

Increasing competition with antitrust laws
US: Sherman Antitrust Act (1890), Clayton
Act (1914)
Nepal: Fair Competition Bill (2004)
Regulation
Govt agencies setting price

Public ownership
Doing nothing

Market Structure Problems

2) Consider a monopolist sells in two markets and has constant
marginal cost equal to $2 per unit. The demand and marginal
revenue equations for two markets are:
PI = 14 -2QI : MRI = 14 -4QI
PII= 10 QII : MRII = 10 -2QII
a) Using third degree discrimination, find profit maximizing
prices and quantities, combined profit from both market.
b) What is the profit maximizing price and quantity and total
profit without price discrimination.
Note:
1st degree: Charging maximum price for each unit sold.
2nd degree: Different prices depending upon quantities of goods bought by
consumers.
3rd Degree: Separating consumer market and charge separate prices.

Market Structure Problems

Solution:
a) Marginal Cost =$2 per unit. The demand and marginal
revenue equations for two markets are:
PI = 14 -2QI : MRI = 14 -4QI
PII= 10 QII
: MRII = 10 -2QII
Profit maximizing is possible when MRI = MRII =MC
So, for Market I:
14 -4QI = 2. Therefore, QI = 3
For Market II: 10 2QII = 2. Therefore, QII = 4
Substituting values of QI and QII in PI and PII, we have
PI = 8 and PII = 6
Profit in Market1 = TR TC = (PI x QI) (MC x QI) = 24 6 =
$18
Profit in MarketI1 = TR TC = (PII x QII) (MC x QII) = 24 8 =
$16

Market Structure Problems

Solution:
b) Finding demand functions in terms of quantities:
QI = 7 P/2
QII = 10 P
Total demand: Q = (7 P/2) + (10 P) = 17 3P/2 .(i)
Total demand in terms of P = 34/3 2Q/3 ..(ii)
Therefore,
TR = P x Q = (34/3 2Q/3)Q = 34Q/3 2Q2/3
MR = 34/3 4Q/3
Now,
MR = MC
34/3 4Q/3 = 2
Therefore, Q = 7
Substituting the value of Q in Eqn. (ii), P = $6.67
So, Total Profit = TR TC = (PxQ) (MCxQ) = 46.69 14 =
$32.69

Thank you