We have now examined two extreme types of market structure – perfect competition and monopoly. While many sectors of the economy operate in a way that is close to the competitive paradigm, very few are pure monopolies in that they have no close substitute products. Even firms like Microsoft, or De Beers, that supply a huge percentage of the world market for their product would deny that they are monopolies and would argue that they are subject to strong competitive pressures from smaller or ‘fringe’ producers. As a result we must look upon the monopoly paradigm as a useful way of analyzing markets, rather than being an exact description of the world. Accordingly, our next task is to examine how sectors with a few, several or multiple suppliers act when pursuing the objective of profit maximization. Many different market structures define the real economy, and we will concentrate on a limited number of the more important structures in the next chapter.
KEY TERMS
Monopolist: is the sole supplier of an industry’s output, and therefore the industry and the firm are one and the same.
Natural monopoly: one where the ATC of producing any output declines with the scale of operation.
Marginal revenue is the change in total revenue due to selling one more unit of the good.
Average revenue is the price per unit sold.
Allocative inefficiency arises when resources are not appropriately allocated and result in deadweight losses.
Price discrimination involves charging different prices to different consumers in order to increase profit.
A cartel is a group of suppliers that colludes to operate like a monopolist.
Rent seeking is an activity that uses productive resources to redistribute rather than create output and value.
Invention is the discovery of a new product or process through research.
Product innovation refers to new or better products or services.
Process innovation refers to new or better production or supply.
Patent laws grant inventors a legal monopoly on use for a fixed period of time.
EXERCISES
- Consider a monopolist with demand curve defined by P = 100 - 2Q. The MR curve is MR = 100 - 4Q and the marginal cost is MC = 10+Q.
- Develop a diagram that illustrates this market.
- Compute the profit-maximizing price and output combination.
- Imagine we have a monopolist who wants to maximize revenue rather than profit. She has the demand curve P = 72 - Q, with marginal revenue MR = 72 - 2Q, and MC = 12.
- Graph the three functions.
- Calculate the price she should charge in order to maximize revenue. [Hint: where the MR = 0.]
- Compare her total revenue with the revenue obtained under profit maximization.
- How much profit will she make when maximizing total revenue?
- In this question you will see why we never consider a supply curve for a monopolist – in the way that is done in perfect competition. So suppose the monopolist faces a demand
curve P = 72 - Q and a MR curve MR = 72 - 2Q. The Marginal cost is MC = Q.
- Find the profit maximizing output and price.
- Now suppose that the demand curve shifts to become P = 60-(1/3)Q and thus MR = 60-(2/3)Q. The MC remains the same. Establish that the profit maximizing price is the same for this demand curve as the one in part (a). You have now shown that there is not a unique relationship between cost and demand for the monopolist because the same price in this example is consistent with profit maximization with two different demand curves.
- Suppose that the monopoly in Question 2 has a large group of plants. Consider what could happen if each of these plants became a separate firm, and acted competitively. In
this perfectly competitive world you can assume that the MC curve of the monopolist becomes the industry supply curve.
- What output would be produced in the industry?
- What price would be charged in the marketplace?
- Compute the gain to the economy in dollar terms as a result of the DWL being eliminated [Hint: it resembles the area ABF in Figure 10.13].
- A monopolist faces a demand curve P = 64 - 2Q and MR = 64 - 4Q. His marginal cost is MC = 16.
- Graph the three functions and compute the profit maximizing output and price.
- Compute the efficient level of output (where MC=demand), and compute the DWL associated with producing the profit maximizing output rather than the efficient output.
- Suppose the government gave the monopolist a subsidy of $4 per unit produced. The MC would be reduced accordingly to $12 from $16. Compute the profit maximizing output level and the deadweight loss associated with this new output. Explain intuitively why the DWL has changed.
- In the text example in Table 10.1, compute the profit that the monopolist would make if he were able to discriminate between every buyer and charge each buyer their reservation price.
- A monopolist is able to discriminate perfectly among his consumers – by charging a different price to each one. The market demand curve facing him is given by P=72 - Q. His
marginal cost is given by MC = 24 and marginal revenue is MR = 72 - 2Q.
- In a diagram, illustrate the profit-maximizing equilibrium, where discrimination is not practiced.
- Calculate the equilibrium output if he discriminates perfectly.
- If he has no fixed cost beyond the marginal production cost of $24 per unit, calculate his profit in each pricing scenario.
- A monopolist faces two distinct markets A and B for her product, and she is able to insure that resale is not possible. The demand curves in these markets are given
by
and 
. The marginal cost is constant: MC = 4. There are no fixed costs.
- Calculate the profit maximizing price and quantity in each market.
- Compute the total profit made as a result of this discriminatory pricing.
- A monopolist with a demand curve given by P = 240 - 2Q has a cost structure made up of a fixed cost of $500 and a marginal production cost of MC = 40.
- When maximizing profit, how much profit will she make?
- Suppose now that she can outsource some of her assembly work to a plant in Indonesia, and this reduces her marginal production cost to $32 per unit, but also increases her fixed cost to $750. Should she outsource?
- In the preceding question, prior to being able to outsource, imagine that the supplier is concerned about entry, and must spend $2,000 in lobbying to maintain her position as
a monopolist.
- Can the firm still make a profit?
- What is the maximum amount the firm could afford to spend on lobbying with the objective of maintaining the monopoly position?
- A concert organizer is preparing for the arrival of the Grateful Living band in his small town. He knows he has two types of concert goers: one group of 40 people, each
willing to spend $60 on the concert, and another group of 70 people, each willing to spend $40. His total costs are purely fixed at $3,500.
- Draw the market demand curve faced by this monopolist.
- Draw the MR and MC curves.
- With two-price discrimination what will be the monopolist’s profit?
- If he must charge a single price for all tickets can he make a profit?
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