Chapter 10 Monopoly, Cartels, and Price Discrimination: Study Notes

Chapter 10: Monopoly, Cartels, and Price Discrimination

10.1 A Single-Price Monopolist

This section explores the characteristics and behavior of a monopolist, focusing on revenue concepts and profit maximization in the short run.

• Monopoly: A market structure containing a single firm.

• Monopolist: The only seller in a market, able to exercise maximum market power.

• Demand Curve for a Monopolist: The monopolist faces the entire (downward-sloping) market demand curve, as it is the sole producer.

Revenue Concepts for a Monopolist

• Total Revenue (TR): The total income from sales, calculated as: $TR = p \times Q$ where p is price and Q is quantity sold.

• Average Revenue (AR): Revenue per unit sold: $AR = \frac{TR}{Q} = p$

• Marginal Revenue (MR): The additional revenue from selling one more unit: $MR = \frac{\Delta TR}{\Delta Q}$

• The MR curve lies below the demand curve because the monopolist must lower the price to sell additional units.

Table: Computing Average and Marginal Revenue

Price (AR)	Quantity Sold (Q)	Total Revenue (TR)	Change in TR	Marginal Revenue (MR)
10	10	100	-	-
9	20	180	80	8
8	30	240	60	6
7	40	280	40	4
6	50	300	20	2
5	60	300	0	0
4	70	280	-20	-2
3	80	240	-40	-4
2	90	180	-60	-6
1	100	100	-80	-8

Additional info: Demand is elastic when MR > 0 and inelastic when MR < 0.

Short-Run Profit Maximization

• Rule 1: The firm should not produce unless price > average variable cost (AVC).

• Rule 2: The firm should produce the output level where $MR = MC$ (marginal cost).

• For a monopolist, the profit-maximizing output is where $MC = MR$ and price is set above MC ($p > MC$).

• Unlike competitive firms, a monopolist does not have a supply curve because it chooses its price.

• Profits can be positive, negative, or zero, depending on the relationship between price and average total cost (ATC).

Comparison: Competitive Industry vs. Monopoly

• Competitive Industry: $MC = MR = p$

• Monopoly: $MC = MR$

• A monopolist produces less output and charges a higher price than a competitive market.

The Inefficiency of Monopoly

• Monopolists reduce output below the competitive level, decreasing economic surplus.

• Restriction of output creates a deadweight loss for society.

• Monopoly leads to an inefficient market outcome.

Anti-trust Policies

• Designed to promote competition by breaking up monopolies, prohibiting anti-competitive mergers, and penalizing collusion (cartels).

Entry Barriers and Long-Run Equilibrium

Monopoly profits can persist in the long run due to effective entry barriers, which can be natural or created.

• Natural Barriers:

  • Economies of Scale: Only one firm can efficiently cover costs at minimum efficient scale (MES).

  • Setup Cost: High initial capital investment required (e.g., public utilities).

• Created Barriers:

  • Actions by existing firms (e.g., organized crime).

  • Government regulation (e.g., patents, copyright laws, Canada Post).

Exercise Example

• Calculate profit-maximizing price and output for a monopolist.

• Determine average total cost per unit at profit-maximizing output.

• Calculate profit.

• Compare with competitive market outcomes.

• Identify deadweight loss area resulting from monopoly output decision.

The Very Long Run and Creative Destruction

Technological change and innovation can erode entry barriers over time. Joseph Schumpeter argued that monopoly profits incentivize innovation, leading to creative destruction—the process by which new innovations replace old monopolists.

• Creative Destruction: Replacement of one monopolist by another through innovation.

• Monopoly can be a driver of long-run economic progress.

10.2 Cartels as Monopolies

Cartels are groups of firms that collude to act like a monopoly, maximizing joint profits by restricting output and raising prices.

• Cartelization: Reduces output and raises price compared to perfect competition.

Problems that Cartels Face

• Cartels are unstable because members have an incentive to cheat by secretly increasing output.

• If all members cheat, prices fall toward competitive levels and joint profits decrease.

• Enforcing output restrictions and preventing entry is difficult; cartels rarely last long.

Global Cartel Examples

• OPEC: Restricts oil output to raise prices; faces cheating and competition from non-members.

• Diamond Trading Company (DeBeers): Controls a large share of the diamond market by purchasing from smaller producers.

10.3 Price Discrimination

Price discrimination occurs when a producer charges different prices for different units of a product, not due to cost differences, but because consumers value the product differently.

• Any firm with market power and a downward-sloping demand curve can potentially price discriminate.

Conditions for Price Discrimination

• Firm must have market power.

• Consumers must differ in their valuations of the product.

• Firm must be able to prevent arbitrage (resale between consumers).

Examples of Price Discrimination

• Weekend vs. midweek airline fares

• Business-class vs. economy-class fares

• Negotiated discounts on furniture

• Higher tuition for law students than economics students

• Different movie ticket prices for adults, seniors, and students

Different Forms of Price Discrimination

• Among Units of Output: Charging different prices for different units sold (e.g., bulk discounts, loyalty cards). Perfect price discrimination: Seller captures all consumer surplus; $MR = p = demand$.

• Among Market Segments: Charging different prices to identifiable groups with different elasticities of demand (e.g., students vs. non-students, business vs. leisure travelers).

Table: Numerical Example of Profitable Price Discrimination

Pa	Qa	TRa	TCa	Profits	Pb	Qb	TRb	TCb	Profits
9	30	270	120	150	9	42	378	168	210
10	28	280	112	168	10	36	360	180	180
11	26	286	104	182	11	30	330	180	150
12	24	288	96	192	12	24	288	192	96
13	22	286	88	198	13	18	234	162	72
14	20	280	80	200	14	12	168	120	48
15	18	270	72	198	15	6	90	24	66

Additional info: By charging $14 in segment A and $10 in segment B, total profit is $416, compared to $392 with a single price.

Hurdle Pricing

• Consumers self-select into market segments by overcoming a 'hurdle' (e.g., redeeming coupons, buying paperback instead of hardback).

• Examples: Hardback vs. paperback books, coupons, rebates, price reductions over time for new technology.

The Consequences of Price Discrimination

• Increases firms' profits.

• For price discrimination by the unit, output and efficiency may increase.

• Consumer surplus may decrease, but some consumers may benefit if output increases.

• For discrimination among market segments, output may not increase; consumer surplus changes depend on elasticity of demand in each segment.