Microeconomics

   
Lecturer: Yong EL
BEcon (Hons), MEcon, PhD (Econ)    

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SJ13203
All contents are strictly copyrighted.
Microeconomics Lecture 10
SJ13203 Monopoly
Course Professor: Yong EL

Source: Pexels
Quick Info: How powerful is the Walt Disney Company?
2018 Net Income = $15.71 billion (Source: Wikipedia) 3

2018 Net Income = $16.57 billion

(Source: Wikipedia) Pexels Images
Microsoft

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Pexels Images
by public accusation
Walt Disney

Own over 25
holdings in the
world. A monopoly!!

E.g., Marvel Entertainment,

ESPN Inc., HK Disneyland
Resort
 Variations of Market Structure
4

Perfect Imperfect
Competition Competition

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Monopoly Oligopoly
Price Taker: Perfectly Competitive Market
Seller Buyer 5

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Pexels Image You
 Price Determiner: Monopoly Market
Seller Buyer 6
Entire population
in country A

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One steel
producer in the
steel industry
 7
Notes**
• The diagram shows that there is only one firm in the
industry that supplies steels and there are no close
substitutes.

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• Because all buyers have no other choices but to buy
steels from the same producer and there are no close
substitutes, the producer obtains the market power to
manipulate the market price.

**Students are required to make comprehensive notes for revision and examination.
 Factors Leading to a Monopoly
8
Control of Raw Material

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Legal Protection Barriers to
A other
producer candidate
firms to enter
the market.
Economies of Scale

Government Franchise
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Notes**
• Control of Raw Material: If raw materials for steels such as
carbon and iron are controlled by one company, this prohibits
other candidate firms from entering the market and competing
with the company.

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• Legal Protection: Intellectual property such as patents can be
used as a legal right to produce a commodity. Other candidate
firms are prevented from producing the same product. There
are three types of patents (based on the US Patent and
Trademark Office):
 Utility patents: include new and useful development in the form of
process, machine, article of manufacture, or composition of matter,
or any improvement.
 Design patents: include new, original, and ornamental design for an
article of manufacture.
 Plant patents: include invention, discovery, and asexual
reproduction of any distinct new variety of plant.

**Students are required to make comprehensive notes for revision and examination.
 10
Notes**
• Economies of Scale: The firm’s long-run average cost
decreases as output increases. Higher production is usually
accompanied by increased specialisation among workers, hence
improving efficiency and productivity and eventually reducing

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cost per unit of output. This happens typically to a natural
monopoly such as water, electrical, gas, and transportation
firms.
• Government Franchise: Franchise means a system by which a
firm is granted the legal right to operate a business. In
franchising, the government provides the firm a license to
operate a particular business. Licensees must meet minimum
standards of competency. The license protects the licensee from
threats of competition. The license can be obtained by a
professional association (e.g., a group of pharmaceutical
providers), which confers this professional body a monopoly
power.

**Students are required to make comprehensive notes for revision and examination.
 11
Quiz
• Name the several barriers to entry to a monopoly
market.

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 Total Profit

• Total profit is the different between total revenue (TR) and 12

total cost (TC).
Total profit = Total revenue (TR) – Total cost (TC)

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• In the short run,
Total profit = TR – Short-run total cost (STC)

• The equation implies that total profit can be positive (means

pure profit) or negative (means loss).
 Total Revenue

• The total revenue (TR) is a linear line under perfect 13

competition because we assume that there is only one price
(TR is calculated using the same formula for all types of
market structure).
• The total revenue increases at a decreasing rate under

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monopoly for each additional unit of output.

Total revenue = Price per unit (P) x quantity (q)

 Marginal and Average Revenue
• Because monopoly has control over market price, the price 14
and average revenue are not equal to the marginal revenue.
• Under perfect competition, P = AR = MR:
• Under monopoly:

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Price per unit (P) = Average revenue (AR) ≠ Marginal revenue (MR)

MR = ΔTR/Δq, where ΔTR decreases for each additional output.

Average revenue (AR) = total revenue / total output

Average revenue (AR) = P x (q/q)
Average revenue (AR) = P
 15
Proof: Why P ≠ MR under monopoly?

P Demand (Q) TR ΔQ ΔTR MR

10 25

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9 50
8 75
7 100
6 125

MR = ΔTR / ΔQ
Value (RM)
Figure 1 16

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MR = AR
P (perfectly
competitive)

AR (monopoly)

Output
0 (unit)
MR (monopoly)
 17
Notes**
• In a perfectly competitive market, the firm’s AR is equal
to P, but AR = P is constant for all levels of output.

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• In a monopoly market, the firm’s AR is equal to P, but
AR = P is negatively related with output levels. This
means the lower the price, the lower the AR or quantity
demanded (AR = demand curve).
• Because MR is obtained by dividing the change in TR by
the change in total output, the value of MR is smaller
than the AR as the level of output increases.

**Students are required to make comprehensive notes for revision and examination.
 Equilibrium Condition under Monopoly
• The firm’s objective is to maximise profit. 18
• To achieve this objective, the firm produces until its marginal
revenue (MR) is equal to its marginal cost (MC).

Marginal revenue (MR) = Marginal cost (MC)

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• This is different from the equilibrium condition under perfect
competition, known as the marginal pricing equilibrium.

Marginal revenue (MR) = Marginal cost (MC)

OR
Price (P) = Marginal cost (MC)
Value (RM)
Figure 2 19
MC

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P*

e
AR

Output
0 q* (unit)
MR
 20
Notes**
• The equilibrium condition (MR = MC) indicates point e
where the MR curve crosses the MC curve.

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• Because AR = P, we must identify the monopoly price
using the AR curve, which is identified to be P*.

**Students are required to make comprehensive notes for revision and examination.
 Profit
Value (RM)
Figure 3 21
MC

AC

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x
P* AVC

C0 y

z
C1
e

AR

Output
0 q* (unit)
MR
 22
Notes**
• From the equilibrium point, e, we have identified the
monopoly price at P*.

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• The firm’s total revenue is 0-P*-x-q*. The firm’s total
cost is 0-C0-y-q*. Thus, the total profit is P*-x-y-C0.
• Which area represents the total fixed cost?
• Which area represents the total variable cost?

**Students are required to make comprehensive notes for revision and examination.
 Normal Profit
Value (RM)
Figure 4 23
AC
MC

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AVC

x
P*

y
C

e
AR

Output
0 q* (unit)
MR
 24
Notes**
• From the equilibrium point, e, we have identified the
monopoly price at P*.

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• The firm’s total revenue is 0-P*-x-q*. The firm’s total
cost is 0-P*-x-q*. Thus, the total profit is zero.
• Total fixed cost = P*xyC.
• Total variable cost = 0Cyq*.

**Students are required to make comprehensive notes for revision and examination.
 25
Quiz
• Draw a simplified graph for a monopoly that incurs loss.
Identify TR, TC, TFC, TVC, and total profit.

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 Profit in the Long Run
26
• In the long run, the monopoly will enhance/improve its
production cycles in order to sustain profit.
• As we have discussed in Lecture 9, the production cycles
can be represented by the tangency of the short-run
average cost curves (SAC) to the long-run average cost

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curve (LAC).
• In addition, because there is restriction to enter the
monopoly market, the monopoly will turn loss or normal
profit in the short run into pure profit in the long run. If the
firm has been in pure profit in the short run, the monopolist
will sustain this profit in the long run.
Value (RM)
Figure 5 27

SMC0

SAC0

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P0 w
C0 x

e0 AR

MR
0 q0
Output
(unit)
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Notes**
• The equilibrium is established at MR = MC, point e 0, in
the short run. The output level is q 0.

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• At q0, the price level (P0) is higher than the short-run
average cost (C0).
• The short-run total profit is equal to area P0-w-x-C0.

**Students are required to make comprehensive notes for revision and examination.
Value (RM)
Figure 6 29

SMC0

SAC0

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P0 w
C0 x

SAC1 LAC
e0
AR

MR
0 q0
Output
(unit)
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Notes**
• In the long run, the monopoly develops and enhances
its production cycles (e.g., SAC1).

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• The graph is simplified by showing only two cycles
(SAC0 and SAC1). The number of cycle (SAC) developed
by the monopoly over the long run will form the long-
run average cost curve (LAC).

**Students are required to make comprehensive notes for revision and examination.
Value (RM)
Figure 7 31

SMC0

SAC0

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P0 w
x SMC1
C0
P1 y LMC
SAC1 LAC
e0 z
C1 AR

e1
MR
0 q0 q*
Output
(unit)
 32
Notes**
• The long-run equilibrium is established when LAC is
equal to LMC, which is point e1. The output level
increases to q*.

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• At q* (where SMC = LMC = MR), the tangency point of
SAC1 and LAC (point z) show the average cost per unit
at C1, which is lower than the price (P 1).
• The long-run total profit is equal to area P 1-y-z-C1,
which is a bigger amount of profit that that in the short
run, P0-w-x-C0.

**Students are required to make comprehensive notes for revision and examination.
 Monopoly and Allocation Efficiency

• Why does a monopoly not produce at the minimum level of 33

average cost?
• The monopoly produces until the level where the AC is still
decreasing, indicating an allocation inefficiency because
resources are not allocated in the way that minimises the

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production cost.
• Consequently, output level is less than it should be to
maximise social welfare in comparison with firms under
perfect competition.
 Profit
Value (RM)
Figure 8 34
MC

AC

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x
P0

P1
y

e
AR

Output
0 q0 q1 (unit)
MR
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Notes**
• At the equilibrium point (e), the monopoly produces at
quantity q0.

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• If the monopoly is willing to produce at the minimum
point of AC, the output level would be q 1, which is
higher than q0. The society would be benefited (social
welfare increases).
• However, the monopoly is not willing to meet this
socially desirable level of output. Beyond q 0, MC is
larger than MR, indicating that it is not profitable for
the monopoly to produce beyond q0.

**Students are required to make comprehensive notes for revision and examination.
 Monopoly and Social Welfare
Value (RM)
Figure 9 36

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x
PM

EM EC LAC = LMC
PC

AR

Output
0 qM qC (unit)
MR
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Notes**
• The graph shows the social deficiency of monopoly when
compares it to the social benefit under perfect competition.
• Assume initially this firm is a perfectly competitive firm, the

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equilibrium is established at point E C , where AR (Dc) = LMC (=
LAC = Sc). The output level is qC.
• If the firm monopolises the market and now becomes a
monopoly, and assume that the firm can reuse the constant
LMC and LAC in production. However, the equilibrium would
be LMC = MR at point EM. The firm now earns a total profit of
PM-x-EM-PC.
• The area, x-EC-EM, is the loss of social welfare. Because 0-a-EC-
qC is the total social value, area a-EC-Pc is the total consumer
surplus under perfect competition. The transformation into a
monopoly market reduces the total consumer surplus to area
a-x-PM.

**Students are required to make comprehensive notes for revision and examination.
 Monopoly and Price Discrimination

• Price discrimination means the firm charges consumers at 38

different prices of a commodity for different quantities or at
different markets.
• There are three degrees of price discrimination.
First Degree: Consumers are charged with the highest price

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•
per unit of a commodity.
• Second Degree: Consumers are charged with a lower price
for purchasing each additional block of a commodity.
• Third Degree: Consumers are charged with a higher price of a
commodity at one of more markets where the demand is less
elastic. The MR is equalised among the markets.
Price (RM) Price (RM)
Market 1 Market 2

Figure 10 39
15

10
Dc2
7

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MR1 Dc1 MR2

0 7 0 10
Output (unit) Output (unit)

Price (RM)

Firm

11 Dc
8 AC
7
MC
MR
Output (unit)

0 17
 40
Notes**
• The graph presents the case of third-degree price discrimination.
• The upper two graphs represent two markets where the price
elasticity of demand is different (as shown by the Dc curves).

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 Market 1 is more price inelastic than Market 2.

• The monopoly firm’s demand curve (Dc) and MR curve are derived by
summing the Dc and MR curves horizontally from the two markets.
 The slopes of the MR and Dc for the monopolist are between the MR and Dc of
the two markets.

• The firm achieves equilibrium at MR = MC (the lower graph) where 17

units of output are produced (7 units from market 1 and 10 units from
market 2).
• Because the cost per unit is RM8 (lower graph). The total cost is
RM136 (RM8 x 17 units). Since the total revenue is RM187 (RM11 x 17
units). Thus, the firm earns a total profit of RM51(RM187 – RM 136).

**Students are required to make comprehensive notes for revision and examination.
 41
Notes**
• When the firm practices price discrimination, it is
possible to increase profit above RM51.

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• Assume the price determined in market 1 is RM15
(from MC = MR1) and the price determined at market 2
is RM10 (from MC = MR2). That means the total
revenue from market 1 is RM105 and the total revenue
from market 2 is RM100. Because the total cost is
RM136, the total profit is RM69, which is RM18 higher
(RM69 – RM51) than if the firm does not practice price
discrimination.

**Students are required to make comprehensive notes for revision and examination.
 End of Lecture 10
42

An inspirational quote for you:

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‘Accept the challenges so that you can feel the
exhilaration of victory.’
(George S. Patton)

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