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Week 11 · Chapter

Chapter 11 — Monopoly

Principles of Microeconomics Free sample edition

The module's primary reading · ~40–50 minutes · Objective 6 (analyze perfect competition and monopoly with the profit-maximizing rules (P = MC for a price taker; MR = MC for a monopolist), the shutdown rule, long-run entry and exit, and the deadweight loss of market power), with Objective 4 (measure consumer surplus, producer surplus, and market efficiency, and analyze price ceilings, price floors, taxes, and subsidies, including who bears a tax and the deadweight loss) · Read it first this week; the lecture, the slide deck, the tutorial, the quiz, and the Model Workshop all build on it.

In plain language

This week you meet a seller with no rivals at all: a monopoly (the only seller of something buyers cannot easily replace). You will see why such a seller cannot raise its price without losing some buyers, and why that makes each extra sale worth less to it than the price it charges. You will use the same profit rule as last week to choose how much the seller offers, then read its price from what buyers will pay. Last, you will measure what buyers lose when one seller controls a market, and weigh antitrust (the laws that police competition) as a debate rather than a settled answer.

Why you already care about this

Picture a small town on an island. One ferry runs to the mainland, and there is no bridge and no second boat. If you need to see a doctor, buy parts for a shop, or get to a job across the water, you ride that ferry at whatever fare it posts. If the fare goes up by 2 dollars, you cannot walk to the next dock, because there is no next dock.

Last week's chair workshop lived in the opposite world. It sold the same chair as dozens of rivals, so it took the market price and chose only how many chairs to make. The ferry has no rivals, so it chooses its fare too. You might expect a seller like that to charge a huge price. It does not, and the reason is the most useful idea in this chapter: to sell more tickets, the ferry has to cut the fare for everyone.

By the end of this chapter you will be able to:

  • name the barriers that protect a monopoly and explain why a natural monopoly arises;
  • compute marginal revenue from a revenue table and show that it is below the price;
  • choose a monopolist's output with MR = MC and read its price from the demand curve;
  • compare the monopoly outcome with the competitive one and compute the deadweight loss;
  • state the Lerner index in words and name the three conditions for price discrimination;
  • lay out the case for vigorous antitrust enforcement and the case for restraint without picking a winner.

Carry this sentence with you: MR = MC picks the quantity; demand picks the price.

Where we are

  • Already covered: Week 6 measured consumer surplus as a triangle and showed that the competitive quantity gives the largest total surplus. Week 7 called the lost surplus a deadweight loss. Week 9 built cost tables, and Week 10 taught marginal revenue, the rule MR = MC, and its price-taker form, P = MC.
  • This week: the monopoly and its barriers to entry; marginal revenue below the price; MR = MC with the price read from demand; monopoly profit; the deadweight loss of monopoly; the Lerner index; price discrimination; and natural monopoly and antitrust.
  • How they connect: Week 10's rule still decides the quantity, but the monopolist's marginal revenue is no longer its price, and Week 6's surplus triangles measure what that costs buyers.
  • Where we're going next: Week 12 moves from a seller with no rivals to markets with many sellers of slightly different products, and to markets with only a few rivals.

Two ideas carry over directly. From Week 10: marginal revenue is the change in total revenue from selling one more unit, and every profit-maximizing firm produces where marginal revenue equals marginal cost. From Week 6: consumer surplus is the area below the demand curve and above the price, a triangle you compute as one half times its base times its height. This week those two tools meet in one market.

1. Name what makes a monopoly

Think about why your island town might have only one ferry. Maybe the ferry company owns the only dock on the island. Maybe the town grants a single license to run boats across. Maybe the crossing costs so much to set up that one boat can carry everyone more cheaply than two boats sharing the riders. Each of those reasons keeps a second seller out.

  • A monopoly is a market with a single seller of a product that has no close substitutes, protected by barriers that keep rivals from entering.
  • Barriers to entry are obstacles that stop new firms from starting to sell in a market, such as control of a key resource, patents and licenses, or economies of scale that let one firm serve the market most cheaply.

Here are the three barriers you will meet, each with an everyday case from a town like yours.

  • A key resource. A firm that owns the only dock, the only mine, or the only spring of a certain water can keep others out.
  • Patents and licenses. A patent gives an inventor the sole legal right to sell a new medicine or device for a period of years. A license, such as a city's permit to run the only ferry or taxi service, can do the same.
  • Economies of scale. Some goods cost far less per unit when one firm makes all of them.

That last barrier needs its own two definitions.

  • Economies of scale are the pattern in which a firm's average cost per unit falls as it produces more, so a larger firm can supply each unit more cheaply than a smaller one.
  • A natural monopoly is a market in which economies of scale are so large that one firm can serve all buyers at a lower cost than two or more firms could, so a single seller arises without any legal barrier.

A town's water system is the classic case. Laying one set of pipes under every street costs a great deal, but once the pipes are in, each extra household costs little to serve. Two rival water companies digging up the same streets would each pay for a full set of pipes. Section 10 comes back to natural monopoly and what the law does about it.

An honesty note about this week's model: the ferry is a classroom example built for this course, not a real company, and its numbers are illustrative. Real firms rarely have no substitutes at all. Even an island ferry competes a little with a private boat or with staying home. The model is the clean extreme case, the mirror image of last week's price taker.

Misconception check. Students often think a monopoly means any big company. Size is not the test. The cure: a monopoly is the only seller of a product with no close substitutes. A huge firm with many rivals is not a monopoly, and a tiny ferry with none is one.

2. Read the ferry's demand

Last week the chair workshop faced a flat demand line: it could sell any number of chairs at the market price. The ferry is the whole market, so it faces the whole market's demand curve, which slopes down. The more tickets it wants to sell, the lower the fare has to be.

Write P for the fare in dollars a ticket and Q for the quantity in hundreds of tickets a day, so Q = 8 means 800 tickets. The ferry's demand is P = 20 − Q. At a fare of 20 dollars no one rides. Each 1-dollar cut in the fare draws another hundred riders a day.

  • Market power is a seller's ability to raise its price above marginal cost without losing all of its buyers, which a monopolist has and a price taker lacks.

Worked example — fares and total revenue on the ferry. Read each fare off the demand curve, then multiply by the quantity. Total revenue is TR = P × Q, in hundreds of dollars a day.

  1. Fares. P = 20 − Q gives 19, 18, 17, 16, 15, 14, 13, 12, 11, and 10 dollars for 1 to 10 hundred tickets.
  2. Total revenue. 19 × 1 = 19, 18 × 2 = 36, 17 × 3 = 51, 16 × 4 = 64, 15 × 5 = 75, 14 × 6 = 84, 13 × 7 = 91, 12 × 8 = 96, 11 × 9 = 99, and 10 × 10 = 100.

In words: revenue climbs fast at first, then more and more slowly, and it barely moves between 9 and 10 hundred tickets. Each fare cut wins new riders but also cuts what every existing rider pays.

Picture the graph with hundreds of tickets along the horizontal axis and dollars a ticket up the vertical axis. The demand curve is a straight line that starts at 20 dollars on the vertical axis and slopes down to the right, falling 1 dollar for each extra hundred tickets. It would reach zero at 20 hundred tickets.

Misconception check. Students often think the ferry, with no rivals, faces no demand limit at all. The demand curve says otherwise. The cure: at a fare of 20 dollars the ferry sells nothing, and each higher quantity needs a lower fare. A monopolist chooses a point on the demand curve, not a point above it.

3. Compute marginal revenue from the revenue table

When the chair workshop sold one more chair, it gained the full price. When the ferry sells one more hundred tickets, it gains the new fare on those riders but loses a little on every rider it already had. That is why marginal revenue falls below the price.

Write MR for marginal revenue, the change in total revenue from one more hundred tickets, measured in dollars a ticket.

Worked example — marginal revenue for the ferry. Subtract each total revenue from the next.

  1. The differences. 19 − 0 = 19, 36 − 19 = 17, 51 − 36 = 15, 64 − 51 = 13, 75 − 64 = 11, 84 − 75 = 9, 91 − 84 = 7, 96 − 91 = 5, 99 − 96 = 3, and 100 − 99 = 1.
  2. Why the second hundred adds only 17. To sell 2 hundred tickets the fare drops from 19 to 18 dollars. The second hundred riders bring in 18. The first hundred now pay 1 dollar less each. So MR = 18 − 1 = 17, below the fare of 18.

In words: after the first hundred tickets, every extra hundred adds less to revenue than its own fare, because the fare cut reaches every rider. Marginal revenue falls by 2 for each extra hundred tickets, twice as fast as the fare falls.

Dataset N: the ferry's fare, total revenue, and marginal revenue for 0 to 10 hundred tickets a day (illustrative)
Q (hundreds of tickets) Fare P (dollars) Total revenue (hundreds of dollars) Marginal revenue (dollars a ticket)
0 20 0 —
1 19 19 19
2 18 36 17
3 17 51 15
4 16 64 13
5 15 75 11
6 14 84 9
7 13 91 7
8 12 96 5
9 11 99 3
10 10 100 1

On the graph, marginal revenue is a second straight line, MR = 20 − 2Q. It starts at the same point as demand, 20 dollars on the vertical axis, but slopes down twice as steeply, so it lies below the demand curve at every quantity after zero. Each row of the table sits on that line at the middle of its step: the step from 7 to 8 hundred tickets adds 5, and 20 − 2 × 7.5 = 5.

In practice (your tools). In Google Sheets, type 0 to 10 in cells A2 to A12 for the quantity. In cell B2 type =20-A2 for the fare and drag it down to B12. In cell C2 type =A2*B2 for total revenue and drag it down. In cell D3 type =C3-C2 for marginal revenue and drag it down to D12. Column D shows 19, 17, 15, and so on down to 1. In Desmos, type y = 20 - x and y = 20 - 2x to see the two lines start together and spread apart.

Misconception check. Students often think marginal revenue equals the price for every firm, as it did last week. That held only because a price taker never has to cut its price to sell more. The cure: ask whether selling more means a lower price for everyone. If it does, marginal revenue is below the price.

4. Apply the output rule: MR = MC

You now know what each extra hundred tickets adds to the ferry's revenue. It also needs to know what each one adds to cost. In this model the ferry's marginal cost is a constant 4 dollars a ticket: fuel, crew time, and wear for carrying one more rider.

Write MC for marginal cost, in dollars a ticket. The rule is the one from Week 10: every profit-maximizing firm produces where MR = MC, selling each extra unit that adds at least as much to revenue as to cost. The rule has not changed; only the marginal revenue has.

Worked example — how many tickets the ferry sells. Compare each step's marginal revenue with the marginal cost of 4.

  1. Steps 1 to 8. Marginal revenue is 19, 17, 15, 13, 11, 9, 7, and 5, each at least 4, so each step adds to profit.
  2. The 9th hundred tickets. Its marginal revenue is 3, and 3 < 4, so selling it would add 4 dollars a ticket of cost for only 3 of revenue.
  3. The same answer on the line. Set MR = 20 − 2Q equal to 4. Then 2Q = 16, so Q = 8.

In words: the ferry sells 8 hundred tickets a day. The 8th hundred adds 5 to revenue and 4 to cost, while the 9th would add only 3 to revenue, so the ferry stops at 8.

On the graph, draw a flat marginal-cost line at 4 dollars. The marginal-revenue line crosses it at 8 hundred tickets. That crossing sets the quantity. It does not set the price, which is the next section's job.

Misconception check. Students often apply P = MC to the ferry and set the fare where demand meets the 4-dollar marginal cost. P = MC is the price taker's form of the rule, true only when marginal revenue equals the price. The cure: for a monopolist, MR = MC picks the quantity, and MR is below the price.

5. Read the price from the demand curve

The ferry has chosen 8 hundred tickets. If you ran it, what fare would you post? The highest fare at which riders will buy exactly 8 hundred tickets, which the demand curve gives.

Worked example — the ferry's fare and profit. Go up from the quantity to the demand curve, then compute profit.

  1. The fare. P = 20 − 8 = 12 dollars a ticket.
  2. Profit per ticket. The fare of 12 minus the marginal cost of 4 leaves 12 − 4 = 8 dollars a ticket.
  3. Profit. (12 − 4) × 8 = 8 × 8 = 64 hundred dollars a day.
  4. The check. Total revenue is 96, and the cost of 8 hundred tickets is 4 × 8 = 32, so 96 − 32 = 64.
  5. Nearby quantities. At 7, profit is (13 − 4) × 7 = 63. At 9, it is (11 − 4) × 9 = 63.

In words: the ferry sells 800 tickets a day at 12 dollars each and earns a profit of 64 hundred dollars a day. Selling one hundred fewer or one hundred more tickets earns 63, so 8 hundred is the best choice. In this classroom model every ticket costs the same 4 dollars to provide, so profit here is the fare's markup over cost times the quantity.

On the graph, from 8 hundred tickets go straight up past the crossing of MR and MC at 4 dollars until you reach the demand curve at 12 dollars. The profit is a rectangle: its height runs from the marginal-cost line at 4 up to the fare of 12, and its width runs from zero to 8 hundred tickets. Its area, 8 × 8 = 64, is the day's profit.

Notice what limits the ferry. It could post a fare of 15 dollars, but then riders would buy only 5 hundred tickets. It could post 20 dollars and carry no one. Demand, not the ferry's wishes, sets the menu of fare-and-quantity pairs it can choose from.

Misconception check. Students often read the monopoly price off the marginal-revenue line, at 4 dollars, where MR meets MC. That point gives the quantity only. The cure: after you find Q with MR = MC, go up to the demand curve for the price. Riders pay what demand says they will pay for 8 hundred tickets, 12 dollars.

6. Find the competitive benchmark

To judge the monopoly, you compare it with what a competitive market would do. Imagine the same crossing served by many small boats, each a price taker with the same 4-dollar marginal cost. Then the market runs where price equals marginal cost, the P = MC outcome from Week 10.

Worked example — the competitive outcome on the ferry's demand. Set the fare equal to marginal cost and solve for the quantity.

  1. Set P = MC. 20 − Q = 4.
  2. Solve. Q = 20 − 4 = 16 hundred tickets.
  3. The price. P = 4 dollars a ticket.

In words: a competitive crossing would carry 16 hundred tickets a day at a fare of 4 dollars. The monopoly carries 8 hundred versus 16 hundred, half as many riders, at 12 dollars versus 4, three times the fare.

On the graph, the competitive outcome is where the demand curve crosses the flat marginal-cost line at 4 dollars, far to the right of the monopoly's 8 hundred tickets. The gap between 8 and 16 hundred tickets is the set of trips the monopoly does not sell.

Misconception check. Students often think the monopoly sells less because it has higher costs. In this model the costs are the same 4 dollars a ticket either way. The cure: the monopoly sells less because its marginal revenue falls below the fare, so it stops selling while riders would still pay more than the cost.

7. Measure the deadweight loss of monopoly

Week 6 showed that a competitive market gives the largest total surplus. Week 7 called any surplus lost to a smaller quantity a deadweight loss. The ferry gives you a fresh case of both ideas, and the surplus triangles from Week 6 measure it.

Write CS for consumer surplus, the area below the demand curve and above the price, and DWL for deadweight loss, the surplus lost on the tickets that are no longer sold. Both are in hundreds of dollars a day.

Worked example — the surplus split on the ferry. Compute consumer surplus at each outcome, then the profit and the loss.

  1. Consumer surplus, competitive. 1⁄2 × 16 × (20 − 4) = 1⁄2 × 16 × 16 = 128.
  2. Consumer surplus, monopoly. 1⁄2 × 8 × (20 − 12) = 1⁄2 × 8 × 8 = 32.
  3. The ferry's profit. 64, the rectangle from Section 5.
  4. Deadweight loss. 1⁄2 × (16 − 8) × (12 − 4) = 1⁄2 × 8 × 8 = 32.
  5. The check. 32 + 64 + 32 = 128.

In words: riders lose 128 − 32 = 96 hundred dollars a day of surplus. Of that, 64 moves to the ferry as profit, a transfer from riders to the owner. The other 32 goes to no one: it is the value of trips riders would have paid for at more than their cost, which never happen.

The ferry's surplus at the competitive and monopoly outcomes, in hundreds of dollars a day (illustrative)
Outcome Quantity (hundreds of tickets) Fare (dollars) Consumer surplus Ferry's profit Deadweight loss
Competitive 16 4 128 0 0
Monopoly 8 12 32 64 32

Picture the graph in three pieces, all between the vertical axis and the demand curve, above the 4-dollar line. The top piece is a small triangle above the 12-dollar fare out to 8 hundred tickets: riders' surplus, 32. Below it is the profit rectangle from 4 to 12 dollars and from zero to 8 hundred tickets: 64. To its right is a triangle between 8 and 16 hundred tickets, bounded above by the demand curve and below by the 4-dollar line: the deadweight loss, 32.

A caveat about what the model counts: the deadweight loss is a positive result about the size of the pie, not a verdict on whether the owner deserves the profit. Whether the 64 should stay with the ferry is a normative question, about fairness, that the model cannot settle.

Misconception check. Students often call the monopolist's profit the deadweight loss, since both come out of riders' surplus. Profit is a transfer: riders lose it and the owner gains it. The cure: the deadweight loss is only the surplus no one gets, the triangle on the trips never sold. Here that is 32, not 64.

8. Measure market power with the Lerner index

Some sellers you buy from have a little market power and some have a great deal. Economists want one number that says how much. In 1934 the economist Abba Lerner proposed measuring it by the markup.

  • The Lerner index is a measure of market power equal to the markup of price over marginal cost as a share of the price; it is zero for a price taker and grows as market power grows.

In symbols, the Lerner index is (P − MC) ⁄ P.

Worked example — the ferry's Lerner index. Subtract marginal cost from the fare, then divide by the fare.

  1. The markup. 12 − 4 = 8 dollars a ticket.
  2. As a share of the fare. (12 − 4) ⁄ 12 = 8 ⁄ 12, which is two-thirds.

In words: two-thirds of every ferry fare is markup over the cost of carrying one more rider. For last week's chair workshop, price equaled marginal cost, so its index was zero. The bigger the share of the price that is markup, the more market power the seller has.

Misconception check. Students often read a high Lerner index as proof of a high profit. The index measures the markup on each sale, not the total profit, which also depends on how many units sell and on any fixed costs. The cure: say what the index measures in words, the share of the price above marginal cost.

9. Recognize price discrimination

Movie theaters often charge students less than other adults for the same seat at the same show. Airlines charge different fares for the same flight depending on when you book. The seat costs the seller the same either way. So why the different prices?

  • Price discrimination is selling the same good at different prices to different buyers for reasons unrelated to cost, which requires market power, a way to sort buyers by willingness to pay, and a way to prevent resale.

Here are the three conditions, with the theater as the case.

  1. Market power. A seller in perfect competition has to charge the going price, so it cannot charge anyone more. The theater, as the only cinema showing that film nearby, can.
  2. A way to sort buyers. Students, on average, will pay less for a ticket than other adults. A student ID sorts them at the box office.
  3. A way to prevent resale. If students could buy cheap tickets and resell them to everyone else, the higher price would collapse. Checking the ID at the door stops that.

Now you can test the ferry against these conditions. It has market power. If islanders, who ride daily, will pay less per trip than visitors, a resident pass could sort them. A name on the pass would stop resale. A ferry that charged each group a different fare could carry more riders than the single-fare monopoly, because it would no longer have to cut the fare for everyone to win the price-sensitive riders.

Pause and reflect — choose one. Pick either prompt; they count the same.

  • (a) Think of a discount you have used, such as a student, senior, or early-booking price. In two sentences, say how the seller sorted you into that group and how it kept others from reselling the discount.
  • (b) Think of a price you paid that seemed higher than what someone else paid for the same thing. In two sentences, say which of the three conditions let the seller charge you more.

Misconception check. Students often think any price difference is price discrimination. A delivery that costs more to a farther town reflects a higher cost, not discrimination. The cure: price discrimination means different prices for the same good for reasons unrelated to cost, and it needs all three conditions.

10. Weigh natural monopoly and antitrust

Go back to the town's water system from Section 1. One set of pipes serves everyone more cheaply than two. Breaking it into rivals would raise cost, so in a natural monopoly the usual answer is not more sellers. Governments often regulate a natural monopoly's price or run the service themselves, and the details of that regulation go beyond this course.

For other monopolies, and for firms that try to become one, the United States has antitrust law. Here is what the Federal Trade Commission's guide to these laws describes, as factual background.

  • The antitrust laws are the federal laws that police competition in the United States, chiefly the Sherman Act of 1890 and the Federal Trade Commission Act and Clayton Act of 1914.
  • The Clayton Act is a federal antitrust law of 1914 whose Section 7 prohibits mergers and acquisitions whose effect may be to substantially lessen competition or to tend to create a monopoly.

The Clayton Act's own words bar mergers whose effect "may be substantially to lessen competition, or to tend to create a monopoly." The Readings & Resources page links the agency's plain-language guide.

How hard should the government enforce these laws? That is a contested policy question, and economists disagree. Here are the two cases, each at full strength.

  • The case for vigorous enforcement. The ferry shows the positive result: a monopoly sells less at a higher price than a competitive market, and the lost trips are a deadweight loss. Supporters of strong enforcement argue that blocking mergers that would create market power, and breaking up existing monopolies, protects buyers and output. Their normative claim is that buyers' gains should come first.
  • The case for restraint. Some large firms are large because they produce cheaply, and economies of scale can mean lower costs than many small rivals could reach. Patents deliberately grant temporary market power as a reward for invention, and the promise of profit can drive new products. Supporters of restraint argue that heavy enforcement can punish success and slow innovation. Their normative claim is that long-run gains from scale and invention should weigh heavily.

Both sides accept the model's positive result about a given monopoly's output and price. They disagree about how often real markets look like that model, how large the gains from scale and invention are, and how to weigh current buyers against future products. This course gives no verdict; the choice rests on evidence about particular markets and on values.

Pause and reflect — choose one. Pick either prompt; they count the same.

  • (a) In two or three sentences, state the strongest point for vigorous enforcement and label which part is positive and which is normative.
  • (b) In two or three sentences, state the strongest point for restraint and label which part is positive and which is normative.

Misconception check. Students often think the economics of monopoly settles the antitrust debate, because the model shows a deadweight loss. The model shows the loss for a given market structure; it does not say how real markets compare with it or how to weigh scale and invention. The cure: keep the positive result and the normative choice apart.

11. Check the classic wrong turns

Most mistakes you will see this week come from carrying last week's price-taker shortcuts into a market with one seller. A short routine catches them.

  • Step one: does selling more mean a lower price? For a monopolist, yes, so marginal revenue is below the price.
  • Step two: how many? Sell each unit whose marginal revenue is at least marginal cost; MR = MC.
  • Step three: what price? Go up from that quantity to the demand curve, never to the marginal-revenue line.
  • Step four: what does it cost buyers? Compare with the competitive outcome at P = MC and compute the deadweight-loss triangle.

Worked example — checking a classmate's work. A classmate writes: "The ferry has no rivals, so it charges whatever it wants. It sets P = MC, so the fare is 4 dollars. And its deadweight loss is its profit, 64."

  1. The 'whatever it wants' claim. Demand limits the ferry: at 20 dollars it sells nothing, and to sell 8 hundred tickets it can charge at most 12.
  2. The P = MC claim. P = MC is the price taker's rule. The ferry uses MR = MC, which gives 8 hundred tickets, and reads its fare from demand, 12 dollars.
  3. The deadweight-loss claim. Profit, 64, is a transfer from riders. The deadweight loss is 1⁄2 × (16 − 8) × (12 − 4) = 32.

In words: the corrected statement is "the ferry sells 8 hundred tickets where MR = MC, charges the 12 dollars that demand allows, earns 64 in profit, and leaves a deadweight loss of 32."

Misconception check. Students often think a monopolist can raise its price without losing any riders. Every point on the demand curve trades a higher fare for fewer riders. The cure: a monopolist picks the best point on demand; it never escapes the curve.

Key terms

  • Monopoly — A market with a single seller of a product that has no close substitutes, protected by barriers that keep rivals from entering. (first used: 1. Name what makes a monopoly)
  • Barriers to entry — Obstacles that stop new firms from starting to sell in a market, such as control of a key resource, patents and licenses, or economies of scale that let one firm serve the market most cheaply. (first used: 1. Name what makes a monopoly)
  • Economies of scale — The pattern in which a firm's average cost per unit falls as it produces more, so a larger firm can supply each unit more cheaply than a smaller one. (first used: 1. Name what makes a monopoly)
  • Natural monopoly — A market in which economies of scale are so large that one firm can serve all buyers at a lower cost than two or more firms could, so a single seller arises without any legal barrier. (first used: 1. Name what makes a monopoly)
  • Market power — A seller's ability to raise its price above marginal cost without losing all of its buyers, which a monopolist has and a price taker lacks. (first used: 2. Read the ferry's demand)
  • Lerner index — A measure of market power equal to the markup of price over marginal cost as a share of the price; it is zero for a price taker and grows as market power grows. (first used: 8. Measure market power with the Lerner index)
  • Price discrimination — Selling the same good at different prices to different buyers for reasons unrelated to cost, which requires market power, a way to sort buyers by willingness to pay, and a way to prevent resale. (first used: 9. Recognize price discrimination)
  • Antitrust laws — The federal laws that police competition in the United States, chiefly the Sherman Act of 1890 and the Federal Trade Commission Act and Clayton Act of 1914. (first used: 10. Weigh natural monopoly and antitrust)
  • Clayton Act — A federal antitrust law of 1914 whose Section 7 prohibits mergers and acquisitions whose effect may be to substantially lessen competition or to tend to create a monopoly. (first used: 10. Weigh natural monopoly and antitrust)

Summary

  • A monopoly is the only seller of a product with no close substitutes.
  • Barriers to entry: a key resource, patents and licenses, or economies of scale.
  • A monopolist must cut its price to sell more, so marginal revenue is below the price.
  • Every firm, the monopolist included, maximizes profit where MR = MC.
  • The monopolist reads its price from the demand curve at that quantity.
  • Compared with competition, a monopoly sells less at a higher price.
  • Monopoly profit is a transfer; the deadweight loss is surplus no one gets.
  • The Lerner index is the markup over marginal cost as a share of the price.
  • Price discrimination needs market power, sorting, and no resale.
  • How hard to enforce antitrust law is a normative choice economists debate.

Check your understanding

Work these before looking at the answers — they are ungraded, and the answers (with reasoning) are at the bottom of the page.

  1. The only snack kiosk at a remote mountain trailhead (an illustrative case) faces demand P = 14 − Q, where Q is boxes of trail mix a day. Compute its total revenue and marginal revenue for 1 to 6 boxes, and explain why marginal revenue for the 3rd box is below its price.
  2. Each box costs the kiosk 6 dollars, a constant marginal cost. Use MR = MC to find how many boxes it sells, read its price from demand, and compute its profit.
  3. If many sellers with the same 6-dollar cost competed at the trailhead, how many boxes would sell, and at what price? Compute the deadweight loss of the kiosk's monopoly and check that the pieces add up.
  4. A concert hall in a small city charges students less than other adults for the same seat, and staff check a student ID at the door. Name the three conditions for price discrimination and say which of them the ID check handles.

Answers (worked reasoning — read after attempting)

  1. The prices for 1 to 6 boxes are 13, 12, 11, 10, 9, and 8 dollars, so total revenue is 13, 24, 33, 40, 45, and 48 dollars. Marginal revenue subtracts each total from the next: 13, 11, 9, 7, 5, and 3 dollars. The 3rd box sells for 11 dollars, but to sell it the kiosk cuts the price by 1 dollar on the first 2 boxes, so MR = 11 − 2 = 9, below the price of 11.
  2. Marginal revenue is 7 for the 4th box, at least the cost of 6, and 5 for the 5th box, below 6, so the kiosk sells 4 boxes. Its price is P = 14 − 4 = 10 dollars, read from demand, not 6. Profit is (10 − 6) × 4 = 16 dollars a day. Setting the price at the 6-dollar cost would be the P = MC slip.
  3. Competition runs at P = MC: 14 − Q = 6, so Q = 8 boxes at 6 dollars. The deadweight loss is 1⁄2 × (8 − 4) × (10 − 6) = 8 dollars a day. Consumer surplus is 1⁄2 × 8 × 8 = 32 under competition and 1⁄2 × 4 × 4 = 8 under the monopoly, and 8 + 16 + 8 = 32. The profit of 16 is a transfer, not part of the loss.
  4. The three conditions are market power, a way to sort buyers by willingness to pay, and a way to prevent resale. The hall has market power as the only venue for that show nearby. The student ID does the other two jobs: it sorts students, who on average will pay less, from other adults, and checking it at the door stops a cheap student ticket from being resold to someone else.

Next up in this module: the Readings & Resources page, the lecture tutorial, the practice set, and the quiz — and next week the game-theory model shows how a seller behaves when it faces a few rivals instead of none.

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