Chapter 10
How Monopolies Work
Supplemental Instruction
Iowa State University / Leader: / Veronica
Course: / Econ 101
Instructor: / Kreider
Date: / 12-2-14
  1. A Monopoly is either:
  2. a market in which only one firm sells a product with no close substitutes; or
  3. the single firm that sells in that market.
  4. Fill in the Table:

Definition / Picture or Example / Type of Monopoly / Type of Monopoly Definition
Reasons Monopolies Emerge / Economies of Scale / economies of scale in production causes a firm’s long-run average cost curve to slope downward. That is, the more output the firm produces, the lower will be its cost per unit. / / Natural Monopoly / A monopoly that arises when, due to economies of scale, a single firm can produce for the entire market at lower cost per unit than could two or more firms.
Legal Barriers / Government Placed Barriers allowing a monopoly by creating barriers to entry
To Support Research and Development / Patent:
Copyright. / Sometimes:
government franchise / A government-granted right to be the sole seller of a product or service.
(anyone that enters will be prosecuted)
often grant franchises when they think the market is a natural monopoly
Network Externalities / Additional benefits enjoyed by all users of a good or service because others use it as well. / Facebook, postal service, Windows
  1. Fill in the blank:
  2. Monopoly, face a downward-sloping demand curve, marginal revenue is less than the price of output. Therefore, the marginal revenue curve will lie below the demand curve.
  3. Monopolists are price-markers. There choose Q where MR=MC, but mark price up above MC.
  4. A monopoly makes a profit when P > ATC
  5. A monopoly suffers a loss when P < ATC
  6. Its total profit/loss at the best output level equals the area of a rectangle with height equal to the distance between P and ATC and width equal to the level of output.
  7. monopoliesmay earn economic profit in the long run.
  1. Looking at the Figure to the right:
  2. What is the profit-maximizing price the monopoly will charge?

P = $8

  1. What is the profit/loss the monopoly will make/suffer?

Profit = ($8 - $6) * 4 million

= $8million

  1. How much would the monopoly be willing to spend to keep their patent?

Up to $8 million

  1. Looking at the Figure to the right:
  2. What is the profit-maximizing price the monopoly will charge?

P = $3

  1. What is the profit/loss the monopoly will make/suffer?

Loss = ($3 – $3.5) * 8 million

= $4 million

  1. Would it be smart for them to produce less at a quantity of 4 million? Why?

No.

Loss = ($4 –$5) * 4 million

= 4 million. They would make a greater loss by changing quantity to 4 million

  1. Should this monopoly produce or shutdown in the short run? In the long run?

Short Run you don’t know because you don’t know the AVC.

Long Run shut down because P < ATC

  1. Looking at the Figure to the right:
  2. What is the profit-maximizing price the monopoly will charge?

P= $3

  1. What is the profit/loss the monopoly will make/suffer?

Profi = ($3 - $2.5 ) * 8 million

=$4 millon

  1. How much would the monopoly be willing to spend to keep their patent?

$4 million