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Introduction
States have various licensing requirements for
individuals who wish to practice specific professions.
For example, Ohio requires a $100 license fee to
become a kick boxer. Other states mandate specific
education requirements for interior designers.
What are the economic effects of these and other legal
requirements for entry into a profession?
Chapter 24 will explore the answer to this question.

Copyright ©2014 Pearson Education, Inc. All rights reserved.

24-2

Learning Objectives
• Identify situations that can give rise to monopoly
• Describe the demand and marginal revenue
conditions a monopolist faces
• Discuss how a monopolist determines how much
output to produce and what price to charge
• Evaluate the profits earned by a monopolist
• Understand price discrimination
• Explain the social cost of monopolies


24-3

Chapter Outline
•
•
•
•
•
•
•

Definition of a Monopolist
Barriers to Entry
The Demand Curve a Monopolist Face
Elasticity and Monopoly
Cost and Monopoly Profit Maximization
Calculating Monopoly Profit
On Making Higher Profits: Price
Discrimination
• The Social Cost of Monopolies

24-4

Did You Know That ...
• Private hospitals are among the most profitable
companies in the U.S.?
• A common characteristic among the most
profitable private hospitals is that they are all the
only large, full-service hospitals located within the
regions surrounding the cities in which they are
based.
• In this chapter, you will learn the reasons for
substantial profits earned by a monopoly, a
business that is the only seller.


24-5

Definition of a Monopolist
• Monopolist
– A single supplier of a good or service for which
there is no close substitute
– The monopolist therefore constitutes the entire
industry


24-6

Barriers to Entry
• Question
– How does a firm obtain monopoly power?

• Answer
– Barriers to entry that allow the firm to make
long-run economic profits
– Barriers to entry are restrictions on who can
start as well as stay in business.


24-7

International Example: The Canadian
Wheat Monopoly
• In Canada, the Canadian Wheat Board is the
only entity permitted by law to sell the
wheat produced by the country’s farmers.
• It purchases the harvest from all farmers
and then acts as the sole supplier.
• This is an example of monopoly.


24-8

Barriers to Entry (cont'd)
• Barriers to entry include:
– Ownership of resources without close substitutes
– Economies of scale
– Legal or governmental restrictions


24-9

• Ownership of resources without close
substitutes
– The Aluminum Company of America (ALCOA) at
one time owned most of of the world’s bauxite


24-10

• Economies of scale
– Low unit costs and prices drive out rivals
– The largest firm can produce at the lowest
average total cost


24-11

• Natural Monopoly
– A monopoly that arises from the peculiar
production characteristics in an industry
– It usually arises when there are large economies
of scale
– One firm can produce at a lower average cost
than can be achieved by multiple firms


24-12

Figure 24-1 The Cost Curves That Might Lead
to a Natural Monopoly


24-13

• Legal or governmental restrictions
– Licenses, franchises, and certificates of
convenience
– Examples include
• Electrical utilities
• Radio and television broadcasting


24-14

Policy Example: Waging Economic War on
Children’s Lemonade Stands
• Some children who become entrepreneurs by
opening a neighborhood lemonade stand find
themselves confronted with law-enforcement
officials requiring payment of a license fee.
• Typically, these children give up the lemonade
business and search for other income-generating
opportunities in the neighborhood.


24-15

• Legal or governmental restrictions
– Patents
• Intellectual property

– Tariffs
• Taxes on imported goods

– Regulation
• Government enforcement of safety and quality


24-16

The Demand Curve a Monopolist
Faces
• The monopolist faces the industry demand
curve because the monopolist is the entire
industry


24-17

Faces (cont'd)
• Recall that under perfect competition
– Firm faces perfectly elastic demand curve, it is a
price taker
– The forces of supply and demand establish the
price per unit
– Marginal revenue, average revenue, and price
are all the same


24-18

Faces (cont'd)
• Marginal revenue equals the change in total
revenue due to a one-unit change in the
quantity produced and sold


24-19

Faces (cont'd)
• Perfect competition versus monopoly
– The perfect competitor doesn’t have to worry
about lowering price to sell more
– In a purely competitive situation, the firm
accounts for a small part of the market
• It can sell its entire output, whatever that may be, at
the same price


24-20

Faces (cont'd)
• Perfect competition versus monopoly
– The more the monopolist wants to sell, the lower
the price it has to charge on the last unit sold
– To sell the last unit, the monopolist has to lower
the price because it is facing a downward sloping
demand curve


24-21

Figure 24-2 Demand Curves for the Perfect
Competitor and the Monopolist


24-22

Faces (cont'd)
Monopoly

Perfect Competition

Single seller

Many sellers

Faces entire
industry demand

Faces perfectly
elastic demand

Must lower price
to sell more

Must produce more
to sell more

Not all units sold for
same price (MR < P)

All units sold for same
price (P = MR)


24-23

Elasticity and Monopoly
• The monopolist faces a downward-sloping
demand curve (its average revenue curve)
• That means that it cannot charge just any
price with no changes in quantity (a
common misconception) because,
depending on the price charged, a different
quantity will be demanded


24-24

Figure 24-3 Marginal Revenue: Always
Less Than Price


24-25

Elasticity and Monopoly (cont'd)
• Question
– If a monopoly raises price, what will happen to
quantity demanded?

• Hint
– Remember how consumers respond to a change
in price


24-26

• Recall
– A monopolist is a single seller of a well-defined
good or service with no close substitute
• Think of some imperfect substitutes.

– The demand curve slopes downward because
individuals compare marginal satisfaction to cost


24-27

• After all, consumers have limited incomes
and unlimited wants
• The market demand curve, which the
monopolist alone faces in this situation,
slopes downward because individuals
compare the marginal satisfaction they will
receive to the cost of the commodity to be
purchased


24-28

Costs and Monopoly Profit
Maximization
• We assume profit maximization is the goal
of the pure monopolist, just as it is for the
perfect competitor


24-29

Maximization (cont'd)
• Perfect competitor has only to decide on the
profit-maximizing output rate because price
is given
– The perfect competitor is a price taker

• For the pure monopolist, we must seek a
profit-maximizing price output combination
– The monopolist is a price searcher


24-30

• Price Searcher
– A firm that must determine the price-output
combination that maximizes profit because it
faces a downward-sloping demand curve


24-31

• We can determine the profit-maximizing
price-output combination with either of two
equivalent approaches:
– By looking at total revenues and total costs
or
– By looking at marginal revenues and marginal
costs


24-32

• Total revenues-total costs approach
– Maximize the positive difference between total
revenues and total costs

• Marginal revenue-marginal cost approach
– Profit maximization will also occur where
marginal revenue equals marginal cost


24-33

• Question
– Why produce where marginal revenue equals
marginal cost?

• Answer
– This is where the greatest positive difference
between total revenue and total cost occurs


24-34

Figure 24-4 Monopoly Costs,
Revenues, and Profits, Panel (a)


24-35

Figure 24-4 Monopoly Costs, Revenues, and
Profits, Panels (b) and (c)


24-36

• Producing past where MR = MC
– Result is that incremental cost will exceed
incremental revenue

• Producing less than where MR = MC
– The monopolist is not maximizing profits through
this approach either


24-37

Figure 24-5 Maximizing Profits


24-38

Cost and Monopoly Profit Maximization
(cont’d)
• Real-World Informational Limitations
– Price searching by a less-than perfect competitor
is a process
– A monopolist can only estimate the actual
demand curve and make an educated guess
when it sets its profit-maximizing profit
– For the perfect competitor, price is given already
by the intersection of market demand and supply


24-39

Example: Trial and Error Yields Profits
from Monopoly Time in the Air
• Since the late 2000s, airlines have been taking
advantage of their position as monopoly sellers
during the duration of flights.
• In addition to charging for checked bags, snacks,
and pillows, some airlines are now experimenting
with fees for more comfortable seats.
• Other airlines offer “travel concierge” services that
assist passengers with booking items in their
destination cities.
• As monopoly providers, airlines are searching for
prices that will maximize profits.


24-40

Calculating Monopoly Profit
• Monopoly profit is given by the shaded area
in Figure 24-6, which is equal to total
revenues (P × Q) minus total costs
(ATC × Q)


24-41

Figure 24-6 Monopoly Profit


24-42

Calculating Monopoly Profit (cont'd)
• No guarantee of profits
– The term monopoly conjures up the notion of a
greedy firm ripping off the public
• If ATC is everywhere above AR, or demand
– No price-output combination allows the monopolist to
cover costs


24-43

Figure 24-7 Monopolies: Not Always
Profitable


24-44

Policy Example: The U.S. Rail Monopoly that
Subsists on Taxpayer Handouts
• Amtrak has a near-monopoly on U.S. intercity rail
service. Nevertheless, it continues to suffer
economic losses.
• To keep passenger rail lines operating, the federal
government provides a subsidy to cover Amtrak’s
losses.
• So even though Amtrak charges loss-minimizing
prices, the revenues generated from passenger
fares are less than total costs.


24-45

Discrimination
• Price Discrimination
– Selling a given product at more than one price,
with the difference being unrelated to
differences in cost


24-46

Discrimination (cont'd)
• Price Differentiation
– Establishing different prices for similar products
to reflect differences in marginal cost in
providing those commodities to different groups
of buyers


24-47

Discrimination (cont'd)
• Necessary conditions for price
discrimination
1. The firm must face a downward-sloping
demand curve
2. The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with
predictably different elasticities of demand
3. The firm must be able to prevent resale of the
product or service


24-48

Example: Why Students Pay Different Prices to
Attend College
• Out-of-pocket tuition rates for any two college
students can differ by considerable amounts, even
if the students happen to major in the same
subjects and enroll in many of the same courses.
• The reason for this is that colleges offer students
diverse financial aid packages depending on their
“financial need.”
• To document their “need” for financial aid, students
must provide detailed information about family
income and wealth. This information helps the
college determine the prices that different families
are most likely to be willing and able to pay, so
that it can engage in price discrimination.

24-49

Figure 24-8 Toward Perfect Price Discrimination in
College Tuition Rates


24-50

The Social Cost of Monopolies
• Comparing monopoly with perfect
competition
– Let’s assume a monopolist comes in and buys up
every single perfect competitor
– Notice the monopolist produces a smaller
quantity and sells at a higher price


24-51

The Social Cost of Monopolies
(cont'd)
• Comparing monopoly with perfect
competition
– Monopolists raise the price and restrict
production compared to a perfectly competitive
situation
– Consumers pay a price that exceeds the
marginal cost of production and resources are
misallocated in such a situation


24-52

What If . . . Governments protect local retailers
from “big-box” retailers such as Wal-Mart and
Target?

• When local activists succeed in opposing the
opening of a new retailer, they also serve to
protect local stores from competition.
• This means that local sellers can charge
prices higher than what would prevail under
perfect competition.


24-53

Figure 24-9 The Effects of Monopolizing
an Industry


24-54

You Are There: Seeking Higher Rents from
Souvenir Vendors in Atlanta
• For the past 20 years, Stanley Hambrick and Larry
Miller have been paying an annual rent of $250 to
operate a vending stand at Turner Field, where
they sell baseball souvenirs and T-shirts.
• Now, Atlanta has granted monopoly rights for the
vending space to a property-management
company. Rental rates now range from $500 per
month to $1,600 per month, depending on the
location of the vending stand.
• Vendors now face monopoly rents as much as 77
times higher than what they used to pay.


24-55

Issues & Applications: The U.S. Occupational
License Explosion

• In states across the land, licensing rules
have been expanding with each passing
year.
• Table 24-1 on the next slide lists some of
the occupations that require licenses in at
least a few U.S. states.


24-56

Table 24-1 Selected Occupations Requiring
Licenses in Some U.S. States


24-57

Issues & Applications: The U.S.
Occupational License Explosion (cont’d)
• To obtain an occupational license, people
typically must pay a fee and engage in a
period of study. These licenses create
monopoly profits for incumbents already
established in the profession.
• After controlling for other determinants of
incomes, economists have found licensing
requirements can boost incomes by 15
percent.


24-58

Summary Discussion of Learning
Objectives (cont'd)
• Why a monopoly can occur
– Barriers to entry

• Demand and marginal revenue conditions
faced by a monopolist
– Because the monopolist constitutes the entire
industry, it faces the entire market demand
curve.
– Marginal revenue is less than price.


24-59

Objectives (cont'd)
• How a monopolist determines how much
output to produce and what price to charge
– Seeks to maximize its economic profits
– Produces where marginal revenue equals
marginal cost
– Charges maximum price for the amount of
output where MR = MC


24-60

Objectives (cont'd)
• A monopolist’s profits
– Profit earned by monopolist is equal to the
difference between the price it charges and its
average production cost times the amount of
output it produces and sells.
– Monopolist typically earns positive economic
profits.


24-61

Objectives (cont'd)
• Price discrimination
– Selling at more than one price with the price
differences being unrelated to differences in
production costs.
– Monopolist sells some of its output at higher
prices to consumers with less elastic demand.


24-62

Objectives (cont'd)
• Social cost of monopolies
– Price exceeds marginal cost.
– The price is higher and output is lower for a
monopolist as compared to a perfectly
competitive industry.


24-63

Appendix G: Consumer Surplus in a
Perfectly Competitive Market

• Given the market clearing price that
prevails in the perfectly competitive market,
consumer surplus is:
– the difference between the total amount that
consumers would have been willing to pay and
the total amount that they actually pay


24-64

Figure G-1 Consumer Surplus in a Perfectly
Competitive Market


24-65

Appendix G: How Society Loses from
Monopoly

• Deadweight Loss
– The portion of consumer surplus that no one in
society is able to obtain in a situation of
monopoly
– No one in society, not even the monopoly, can
obtain this deadweight loss


24-66

Appendix G: How Society Loses from
Monopoly (cont’d)

• As a result of monopoly, consumers are
worse off in two ways:
– The monopoly profits that result constitute a
transfer of a portion of consumer surplus away
from consumers to the monopolist
– The failure of the monopoly to produce as many
units as would have been produced under
perfect competition eliminates consumer surplus
that otherwise would have been a benefit to
consumers


24-67

Figure G-2 Losses Generated by Monopoly


24-68

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