Chapter 13

Monopoly and Antitrust

Policy

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Imperfect Competition
and Market Power
An imperfectly competitive industry is an industry in
which single firms have some control over the price of
their output.
All firms in an imperfectly competitive market have one
thing in common: they exercise Market power which is
the imperfectly competitive firms ability to raise price
without losing all demand for its product.
Imperfect competition DOES NOT MEAN that there is no
competition in the industry- firms can differentiate their
products, advertise, improve quality, cut prices etc.
For a firm to exercise control over price of its output, it
must be able to limit competition in the industry
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Defining Industry Boundaries

Several types of market structures exist:
1.Monopoly- an industry with a single firm in which
entry of new firms is blocked
2. Oligopoly- an industry in which there is a small
number of firms , each large enough to have an
impact on market price of the output
3. Monopolistic Competition- an industry with many
producers and free entry and in which firms
differentiate their products
The ease with which consumers can substitute for a
product limits the extent to which a monopolist can
exercise market power.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Pure Monopoly
A pure monopoly is an industry with a single
firm that produces a product for which there are
no close substitutes and in which significant
barriers to entry prevent other firms from
entering the industry to compete for profits.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Barriers to Entry
Things that prevent new firms from entering and
competing in imperfectly competitive industries
include:

1. Government franchises, or firms that become

monopolies by virtue of a government directive
2. Patents or barriers that grant the exclusive use of
the patented product or process to the inventor.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Barriers to Entry
3. Economies of scale and other cost advantages
enjoyed by industries that have large capital
requirements. A large initial investment, or the
need to embark in an expensive advertising
campaign, deter would-be entrants to the
industry
4. Ownership of a scarce factor of production: If
production requires a particular input, and one
firm owns the entire supply of that input, that firm
will control the industry.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Price: The 4th Decision Variable

Firms with market power must decide:
1.

how much to produce,

2.

how to produce it,

3.

how much to demand in each input market, and

4.

what price to charge for their output.

- However, this does not mean that market power allows a firm
to charge any price it likes
- To sell its product, a firm must produce something that people
want and sell it at a price they are willing to pay
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Price and Output Decisions in Pure

Monopoly Markets

To analyze monopoly behavior we assume that:

1. Entry to the market is blocked
2. Firms act to maximize profit
3. The pure monopolist buys in competitive input

markets, i.e., it is a price taker in input market

4. On the cost side, a pure monopolist does not differ at

all from a perfect competitor- both choose the

technology that minimizes cost; hence difference arise
on the revenue side (demand side)
5. The monopoly faces a known demand curve
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Demand in Monopoly Market

In perfect competition, demand curve is a
horizontal line; marginal revenue is equal to price
of output
With one firm in a monopoly market, there is no
distinction between the firm and the industry;
In a monopoly market, the firm = the industry
Hence the market demand curve is the demand
curve facing the firm and total quantity supplied in
the market is what the firm decides to produce.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Demand in Monopoly Market

Few more assumptions:
A Monopolistic firm cannot price discriminate- it sells its
products to all buyers at the same price (price
discrimination means selling to different buyers or groups
of consumers at different prices)
Monopoly faces a known demand curve, i.e., firm has
enough information to predict how households will react to
different price
By knowing the demand curve it faces, the firm must
simultaneously choose both quantity of output to supply
and price of the output.hence a monopolist chooses the
point on market demand curve where it wants to be
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Demand in Monopoly Market

The demand curve facing a perfectly competitive firm is perfectly

elastic; in a monopoly, the market demand curve is the demand curve
facing the firm and the total quantity supplied in the market is what the
monopoly firm decides to produce

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Marginal Revenue Facing a Monopolist

Marginal Revenue Facing a Monopolist
(1)
QUANTITY

(2)
PRICE

(3)
(4)
TOTAL REVENUE MARGINAL REVENUE

$11

10

$10

$10

18

24

28

30

30

28

24

18

10

10

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Marginal Revenue Curve

Facing a Monopolist
For a monopolist, an
increase in output
involves not just
producing more and
selling it, but also
reducing the price of its
output to sell it.
At every level of output
except one unit, a
monopolists marginal
revenue is below price.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Marginal Revenue and Total Revenue

A monopolists marginal
revenue curve shows the
change in total revenue
that results as a firm
moves along the
segment of the demand
curve that lies exactly
above it.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Price and Output Choice for a ProfitMaximizing Monopolist

A profit-maximizing
monopolist will raise
output as long as
marginal revenue
exceeds marginal
cost (like any other
firm).
The profit-maximizing
level of output is the
one at which
MR = MC.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Absence of a Supply

Curve in Monopoly
A monopoly firm has no supply curve that is
independent of the demand curve for its product.
A monopolist sets both price and quantity, and the

amount of output supplied depends on both its

marginal cost curve and the demand curve that it
faces.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Monopoly in the short and long run

Distinction between SR and LR in monopoly is
not very important
There may be a possibility of the monopoly firm
incurring loss in the short run
If the firm can minimize losses by operating in
the short run, it will do so
If losses are incurred in the long run, it will go out
of business
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Price and Output Choices for a Monopolist

Suffering Losses in the Short-Run
It is possible for a
profit-maximizing
monopolist to
suffer short-run
losses.
If the firm cannot
generate enough
revenue to cover
total costs, it will
go out of
business in the
long-run.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Perfect Competition and

Monopoly Compared
In a perfectly competitive industry in the long-run,
price will be equal to long-run average cost. The
market supply is the sum of all the short-run marginal
cost curves of the firms in the industry.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Perfect Competition and

Monopoly Compared

Relative to a competitively organized industry, a

monopolist restricts output, charges higher prices,
and earns positive profits.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Collusion and Monopoly Compared

Collusion is the act of working with other
producers in an effort to limit competition and
increase joint profits.
When firms collude, the outcome would be

exactly the same as the outcome of a monopoly

in the industry.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Social Costs of Monopoly

Monopoly leads to
an inefficient mix of
output.
Price is above
marginal cost, which
means that the firm
is underproducing
from societys point
of view.
2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

The Social Costs of Monopoly

The triangle ABC
measures the net
social gain of moving
from 2,000 units to
4,000 units (or
welfare loss from
monopoly).

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair

Price Discrimination
Price discrimination means charging different
prices to different buyers.
Perfect price discrimination occurs when a firm
charges the maximum amount that buyers are
willing to pay for each unit.

2002 Prentice Hall Business Publishing

Principles of Economics, 6/e

Karl Case, Ray Fair