Monopoly

This is Unit Eight of Principles of Microeconomics, part two of two: what monopoly costs, charging different buyers different prices, and how monopoly power ends. Part one ended with the monopolist's choice: the quantity where marginal revenue meets marginal cost, and a price read from demand above it. This part sets that choice beside the competitive one on the same curves. The difference is the withheld output, and the objection economists raise is to that output, not to the high price by itself. By the end you will be able to refute the three myths and compare monopoly with competition on the same curves. To compute the output shortfall, name the two failures, and compute the deadweight loss. To separate the transfer from the loss. To define price discrimination, state its conditions, and say which group pays more. And to state both sides on innovation, say why monopoly power is fragile, and run one market twice.

Two entries setting monopoly against competition: three myths, and the comparison on one set of curves.

Three things monopoly is not.

MIC 0718 Three Myths About Monopoly

A monopolist cannot charge whatever it wants, because demand holds it. It does not charge all the market will bear, or it would sell one unit. And profit is not guaranteed: a patented drug nobody will pay for earns its holder nothing. Market power is the power to choose a point on the demand curve, not to move it.

The comparison with competition.

MIC 0719 Monopoly Against Competition on the Same Curves

Take one market demand curve and one marginal cost curve. A competitive industry produces where price equals marginal cost; a monopolist produces where marginal revenue equals marginal cost, less, and charges more. Six thousand doses at six dollars under competition; four thousand at eight under monopoly. The comparison holds costs fixed: the same technology, sold by many firms or by one.

Five entries on what is lost: the shortfall, the two failures, the triangle, computing it, and the rectangle beside it.

Measuring the gap.

MIC 0720 The Output Shortfall

From a demand schedule and a marginal cost schedule, find two quantities. The competitive quantity is where the demand price equals marginal cost, the largest quantity for which buyers pay at least what the unit costs. The monopoly quantity is where marginal revenue equals marginal cost. The output shortfall is the difference, and the price gap is the demand price at the smaller quantity minus the demand price at the larger; state both, since the exam asks for either. The medicine's demand price falls from eleven to four dollars across one to eight thousand doses while marginal cost rises two, two, three, four, five, six, seven, eight. Demand price meets marginal cost at six thousand, both six dollars; marginal revenue meets marginal cost at four thousand, at eight dollars. The shortfall is two thousand doses a week and the price gap two dollars. Marginal cost is the competitive supply curve, and the loss to society is the two thousand withheld, not the four thousand still made.

Why the shortfall is a failure.

MIC 0721 The Inefficiency of Monopoly

At the monopoly quantity price exceeds marginal cost: buyers value another unit above its cost and it goes unmade, failing allocative efficiency; doses worth seven dollars that cost five go unmade. The firm also sits above minimum average cost, failing productive efficiency. The objection is the missing output, not the high price by itself; the price is the symptom.

The loss as an area.

MIC 0722 The Deadweight Loss of Monopoly

The deadweight loss of monopoly is the surplus lost on the units between the monopoly and competitive quantities: a triangle between demand and marginal cost over that range, for the medicine from four thousand to six thousand doses. It is the same triangle as a tax's or a ceiling's; every failure to reach price equals marginal cost has one.

Computing it.

MIC 0723 Computing the Deadweight Loss

With straight-line demand and marginal cost, the deadweight loss is a triangle. Its base is the output shortfall, competitive quantity minus monopoly quantity; its height is the gap between the demand price and marginal cost at the monopoly quantity, since that gap closes to zero at the competitive quantity. Deadweight loss is one half of base times height, with the shortfall and the gap computed first. The medicine's monopoly quantity is four thousand doses and its competitive quantity six thousand, a shortfall of two thousand; at four thousand the demand price is eight dollars and marginal cost four, a gap of four. One half times two thousand times four is four thousand dollars a week of value that nobody receives. Measure the height at the monopoly quantity, where the gap is widest, not at the competitive quantity, where it is zero, and do not confuse the triangle with the profit rectangle: the profit is a transfer from buyers, the triangle is value lost to everyone.

The transfer.

MIC 0724 The Transfer to the Monopolist

Beside the deadweight loss sits a rectangle: the higher price on units still sold, moved from consumers to the monopolist. A transfer, not a loss, and whether it is fair is an equity question; two dollars extra on four thousand doses is eight thousand a week moved to the firm. Efficiency counts the triangle; equity argues about the rectangle.

Three entries on price discrimination: what it is, when it is possible, and which group pays more.

Charging different buyers different prices.

MIC 0725 Price Discrimination

Price discrimination is charging different prices to different buyers for the same good when the cost of serving them is the same, and a price setter does it to raise profit above the single-price result: student and senior fares, weekend airfares, children's tickets. Different prices for different costs, such as delivery, are not discrimination. The test is same good, same cost, different price.

When it is possible.

MIC 0726 Three Conditions for Price Discrimination

A firm can discriminate only if it is a price setter, can tell the groups apart, and can stop the low-price buyers from reselling to the high-price ones. An airline can check identification; a grocer cannot tell a vegetarian from anyone else. A perfectly competitive firm fails the first test outright, so discrimination is a symptom of market power.

Which group pays more.

MIC 0727 Which Group Pays More

Given two groups with different price elasticities, the discriminating firm charges the group with the less elastic demand the higher price and the more elastic group the lower. The logic is the total revenue test run on each group separately: raising the price on the inelastic group raises its revenue, cutting the price for the elastic group raises its revenue, and both raise profit. Classify each group, assign prices in that order, and check that both conditions for discrimination hold. A theater's evening audience is business travelers with few alternatives, elasticity about half; its matinee audience is students with many, elasticity about two. It should charge the evening audience more and the matinee audience less, eighteen dollars and nine, say, rather than a single fourteen: the evening rise cut a few sales and raised revenue, the matinee cut drew many students and raised revenue too, with marginal cost per seat near zero. The assignment runs on elasticity, not on ability to pay as such, and the scheme collapses if students can resell evening tickets or the groups cannot be told apart.

Three entries to close: both sides on invention, how monopoly power ends, and the unit's capstone, one market run twice.

Monopoly and innovation.

MIC 0728 Innovation and the Quiet Life

The prospect of monopoly profit spurs invention, which is the case for patents. Once protected, a monopolist may slacken, since nothing forces it to improve; one economist's line is that the best of all monopoly profits is a quiet life. Both effects are real, their balance is contested, and the course reports both positions and takes neither, since the evidence varies by industry.

How monopoly power ends.

MIC 0729 Monopoly Power Is Fragile

Monopoly profit invites attack: new technologies, substitutes and entrants chip at every barrier. A market open to entry by close substitutes is contestable, and a lone firm in it prices as if rivals were near. Long-distance telephony, cable television and mail delivery each lost their monopolies. A monopoly today describes a moment; the barrier's durability is the real question for policy.

One market, run twice.

MIC 0730 The Same Market, Run Twice

The clearest way to see what monopoly costs is to run one market twice, competitive and then monopolized, on the same demand and costs. Under competition, market supply is the marginal cost curve and the market clears where the demand price equals marginal cost: every unit worth at least its cost is made, consumer surplus is the whole triangle under demand and above the price, and producer surplus is the area above marginal cost and below it. Under monopoly the firm produces where marginal revenue equals marginal cost, a smaller quantity at a higher price, and three things change. Consumers who still buy pay more, and that money moves to the monopolist: a transfer. Consumers who no longer buy lose their surplus, and so do the producers who would have made those units: the deadweight loss. And the monopolist's profit is the transfer plus its surplus on the units still sold, minus fixed cost. The medicine, with demand from eleven to four dollars, marginal cost two through eight, fixed cost ten thousand. Competition: six thousand doses at six dollars, consumer surplus fifteen thousand, producer surplus fourteen thousand, total twenty-nine. Monopoly: four thousand at eight dollars, consumer surplus six thousand, the firm's surplus on what it sells twenty-one thousand, total twenty-seven. Eight thousand of consumer surplus became the firm's, a transfer; two thousand vanished, the deadweight loss on the fifth and sixth thousand doses, worth seven and six dollars to buyers and costing five and six. Three cautions. The two runs use the same marginal cost curve, so the difference is structure alone. The transfer is not the loss: the eight thousand still exists, in the firm's hands. And on a table of whole units the triangle is a staircase, so the two thousand here is the exact loss on these rows, while the smooth-curve formula gives four thousand for straight lines through the same points; either is acceptable with the method stated.

Look at what you can now do. You can say that a monopolist is held by demand, does not charge all the market will bear, and is not guaranteed a profit, and you can set its choice beside the competitive one on the same curves: less output, higher price. You can compute the output shortfall and the price gap, name the two efficiency failures, and find the deadweight loss as half the shortfall times the gap at the monopoly quantity. You can keep the transfer rectangle apart from the loss triangle: efficiency counts the triangle, equity argues about the rectangle. You can define price discrimination as same good, same cost, different price, state its three conditions, and charge the less elastic group more. And you can report both sides on innovation without a verdict, say why monopoly power describes a moment, and run one market twice to show exactly where the surplus goes. Unit nine takes up the markets in between, where a few firms or many close substitutes set prices.