Lecture 17: Monopoly
Suggested questions and exercises (Pindyck and Rubinfeld, Ch.10).
Questions: 1, 2, 3 ,5
Exercises: 6, 8, 9, 11, 15, 16
Additional Discussion Question (Based on Past Midterms and Finals).
A monopolist is producing at a point at which marginal cost exceeds marginal
How should it adjust its output to increase profit?
When marginal cost is greater than marginal revenue, the incremental cost of
the last unit produced is greater than incremental revenue.
The firm would
increase its profit by not producing the last unit.
It should continue to reduce
production, thereby decreasing marginal cost and increasing marginal revenue,
until marginal cost is equal to marginal revenue.
We write the percentage markup of prices over marginal cost as (P - MC)/P.
profit-maximizing monopolist, how does this markup depend on the elasticity of
Why can this markup be viewed as a measure of monopoly power?
We can show that this measure of market power is equal to the negative
inverse of the price elasticity of demand.
The equation implies that, as the elasticity increases (demand becomes more
elastic), the inverse of elasticity decreases and the measure of market power
Therefore, as elasticity increases (decreases), the firm has less
(more) power to increase price above marginal cost.
Why is there no market supply curve under conditions of monopoly?
The monopolist’s output decision depends not only
on marginal cost, but also
on the demand curve.
Shifts in demand do not trace out a series of prices and
quantities that we can identify as the supply curve for the firm.
in demand lead to changes in price, output, or both.
Thus, there is no one-to-
one correspondence between the price and the seller’s quantity; therefore, a
monopolized market lacks a supply curve.
5. What are some of the different types of barriers to entry that give rise to
Give an example of each.
irm’s ability to exercise monopoly power depends on how easy it is for
other firms to enter the industry.
There are several barriers to entry, including
exclusive rights (e.g., patents, copyrights, and licenses) and economies of scale.
These two barriers to entry are the most common.
Exclusive rights are legally
granted property rights to produce or distribute a good or service.
economies of scale lead to “natural monopolies” because the largest producer
can charge a lower price, driving competition from the market. For example, in
the production of aluminum, there is evidence to suggest that there are scale
economies in the conversion of bauxite to alumina.
U.S. v. Aluminum
Company of America
, 148 F.2d 416 , discussed in Exercise 8, below.)