Robert F. Mulligan
WESTERN CAROLINA UNIVERSITY COLLEGE OF BUSINESS
Department of Economics, Finance, & International Business
ECON 231 Chapter 25 MONOPOLY
FUNDAMENTAL QUESTIONS
1. What is monopoly?
2. How is a monopoly created?
3. What does the demand curve for a monopoly firm look like, and why?
4. Why would someone want to have a monopoly in some business or activity?
5. Under what conditions will a monopolist charge different customers different prices for the same product?
6. How do the predictions of the models of perfect competition and monopoly differ?
Key Terms
monopoly local monopoly predatory dumping rent seeking
monopoly firm (monopolist) regulated monopoly deadweight loss fair rate of return
barrier to entry monopoly power potential competition
natural monopoly dumping X-inefficiency
1. The Market Structure of Monopoly
1.a. Market definition: A monopoly is the only supplier of a product and sells a product for which there are no close substitutes.  The U.S. Postal Service and public utilities as examples of monopolies in the United States.
1.b. The creation of monopolies
1.b.1. Economies of scale: A large public utility generating electricity is an example of a monopoly resulting from economies of scale.

1.b.2. Actions by firms: BurroughsWellcome's patenting the drug AZT provided it with a monopoly.

1.b.3. Government: New York City's issuing a limited number of taxi medallions creates a monopoly.

1.c. Types of monopolies: A natural monopoly grows out of economies of scale and demand conditions; its LRATC curve slopes continually downward. A local monopoly is the only producer in a geographic area. A regulated monopoly is a firm whose price and production are controlled by government. Monopoly power is reflected in the firm's ability to set prices.

Public utilities are natural monopolies with much power to set prices if not regulated. In a town with one gas station, the gas station is a local monopoly with large monopoly power. The local telephone company is a natural, regulated, and local monopoly.
2. The Demand Curve Facing a Monopoly Firm
Because the monopolist is the sole producer of a product, its demand curve is the industry demand curve.
2.a. Marginal revenue: Marginal revenue equals the changes in total revenue caused by producing one more unit of output.
Price exceeds MR because the monopolist must lower the price to increase sales. This is important: a monopolists MR is downward-sloping below its demand curve.

2.a.1. Marginal and average revenue: AR = TR/Q = price. The AR curve is the demand curve. If AR falls, then MR is less than AR. Thus, in monopoly, P exceeds MR. Elasticity and total revenue: If price elasticity exceeds 1, as price is lowered, TR increases. If price elasticity is less than 1, as price is lowered, TR falls.

Monopoly firms always operate in the elastic region of the demand curve.
3. Profit Maximization
MR = MC
3.a. What price to charge?
Drawing a vertical line from where MR = MC up to the demand curve gives the profit maximization product price.
3.b. Monopoly profit and loss
The vertical distance from ATC to the demand curve shows profit per unit. This distance multiplied by Q generates total profit (area of the rectangle). So P must exceed ATC for profits to exist; thus a monopolist could experience losses in the short run if ATC exceeded P. The monopolist would make economic profit even in the long run because of barriers to entry.
3.c. Monopoly myths: A monopoly is not all powerful. The monopolist cannot charge any price it wants. The monopolist must earn at least normal profits to remain in business in the long run.
4. Price Discrimination
Price discrimination occurs when different customers are charged different prices for the same product but the difference is not due to cost differentials. The firm tries to extract more consumer surplus.
4.a. Necessary conditions for price discrimination: The firm cannot be a price taker; the firm must be able to separate customers according to price elasticity; the buyer must have different elasticities of demand; and the firm must be able to prevent resale of the products/services from one customer to another.
4.b. Examples of price discrimination: Students are charged different tuition rates at public universities depending on whether they live in or out of state. Airlines charge less for weekend flights than for weekday flights.
4.c. The theory of price discrimination: The firm will charge a price in each market so as to equalize the MR earned in each market.
4.d. Dumping: When an identical good is sold to foreign buyers for a lower price than the price charged to domestic buyers, it is called dumping. Predatory dumping is intended to drive rival firms out of business.
5. Comparison of Perfect Competition and Monopoly
5.a. Costs of monopoly: Inefficiency: The monopolist charges a higher price and produces a smaller quantity than the perfectly competitive firm would.
Deadweight loss occurs: The consumer enjoys less consumer surplus under monopoly than under perfect competition. The monopoly firm enjoys a larger producer surplus than the competitive firm would.
5.b. The deadweight loss may be overstated.
5.b.1. Potential competition: This causes the monopolist to lower prices, thereby lessening deadweight loss.
5.b.2. Government intervention: Government scrutiny lessens deadweight loss.
5.b.3. Economies of scale: Large firms can produce at a lower cost, thereby diminishing deadweight loss.
5.c. The deadweight losses may be understated.
5.c.1. Higher costs and X-inefficiency: The absence of entry and rivalry allows the firm to operate inefficiently, causing consumer surplus to fall.
5.c.2. Rent seeking: This comprises activities taken to transfer wealth from one group to another.
Monopolies can use their above-normal profits for rent seeking. Monopoly oil companies spend some of their profits lobbying for higher import taxes on foreign oil.

5.c.3. Innovation: Monopolies may not have the market incentive to initiate new products or production techniques because there is no potential rivalry.

5.d. Supply and the monopoly firm: Only a supply point, not a supply curve, exists for the monopoly firm.
5.e. Regulation: Regulatory commissions have allowed public utilities to charge a fair-rate-of-return price.
Opportunities for Discussion
1. What types of price discrimination have you experienced (for example, out-of-state vs. instate tuition differences, lower ticket prices at movie theaters during the week, coupons used at a supermarket)?
2. Write a short essay comparing and contrasting the results of monopoly and perfect competition. Discuss your essay in class.
3. List examples of the different types of monopolies discussed in section 1.c. from which you have bought products or services.