L1 Monopoly

Loughborough Business School Intermediate Microeconomics Lecture Notes

Overview

  • Course: Intermediate Microeconomics (ECB002)

  • Semester: Semester 2

  • Lecture Number: Lecture 18

  • Topic: Monopoly and its Consequences

  • Lecturer: Huw Edwards

  • Institution: Loughborough University

  • Date: Winter/Spring 2026

Page 1

  • Introduction to Loughborough Business School and details of the course.

Page 2

Topics Covered

  • Monopoly and its consequences as explored in Perloff Chapter 11 and Varian Chapter 32.

Page 3

Historical Figures in Monopolies

  • John D. Rockefeller (1839-1937): Established dominance in the oil industry.

  • J.P. Morgan (1837-1913): Influential in banking and corporate finance.

  • Henry Ford I (1863-1937): Revolutionized automobile manufacturing with mass production.

Page 4

Contemporary Monopolies

  • Discussion on how modern technology has led to new monopolistic entities, reminiscent of historical 'robber barons'.

Page 5

Nature of Monopoly Power

  • Clarification that industries dominated by mega-corporations do not conform to perfect competition.

  • Inquiry into the consequences of such oligopolies and adjustments needed in economic theory to accommodate them.

Page 6

Understanding Monopoly Power

  • Pure Monopolies: Explained as either natural monopolies or those enabled by technological dependencies.

  • Natural Monopolies: Occur due to significant economies of scale or network effects leading to reliance on a single supplier (e.g., Windows OS).

Page 7

Legal Monopolies

  • Firms may have monopoly power due to legal or patenting reasons.

  • Example: Patents on medicines that restrict others from producing a drug for a specified duration.

Page 8

Key Assumptions of Monopoly

  1. Price-Makers: Sellers can set prices rather than take them.

  2. Non-Strategic Behavior: Sellers do not strategize based on competitors since they face no rivals.

  3. Entry Barriers: Complete barriers prevent new firms from entering the industry.

  4. Price-Takers on Buyer Side: Buyers must accept whatever price the monopolist sets.

Page 9

Total and Marginal Revenue

  • Total Revenue Formula:
    R = P imes Y
    where $R$ is total revenue, $P$ is price, and $Y$ is output.

  • Marginal Revenue Formula: rac{dR}{dY} = P + Y rac{dP}{dY}

    • Note: The last term is negative for monopolists, indicating they must lower prices on existing sales to increase sales volume.

Page 10

Sales Dynamics for Monopolists

  • Firms must balance two effects:

    • Fall in Sales (Demand)

    • Rise in Unit Price (Price-side adjustment)

Page 11

Marginal Revenue Curve Illustration

  • Diagram including:

    • PM: Price of monopoly

    • P: Price on demand curve

    • MRM: Marginal revenue curve for the monopolist

    • Notes on the Harberger Triangle illustrating welfare loss due to monopolistic practices.

Page 12

Relation to Elasticity

  • Condition for maximization: MC = dR/dY = P + Y rac{dP}{dY}

    • Relates price elasticity with marginal cost and revenue:
      MC = P rac{(1 + 1/ ext{ε})}{ ext{where ε is the price elasticity}}

    • Definitions: Price elasticity is defined as a negative number.

Page 13

Elasticity Values

  • Examples of elasticity:

    • -2, -4, -1

    • Calculation examples:

    • When ε = -2: 1/(1-(1/2))=2

    • When ε = -4: 1/(1-(1/4))=4/3

    • When ε = -1: 1/(1-(1/1)) = ext{infinity}

Page 14

Lerner Index

  • Definition of the Lerner Index: L = rac{(P - MC)}{P} = - rac{1}{ ext{ε}}

    • Interpretation: A higher Lerner index indicates greater monopoly power in pricing.

Page 15

Effects of Taxation on Monopolists

  • Tax implementation on a monopolist:

    • Specific tax ($£t$ per unit output):

    • Original price set as:
      P = rac{MC}{1 + 1/ ext{ε}}

    • Post-tax pricing:
      P' = rac{(MC + t)}{1 + 1/ ext{ε}}

    • Price increase can exceed the tax amount due to monopoly pricing strategies.

Page 16

Profit Implications of Taxation

  • Despite raised prices due to tax, monopolist profits typically decline as illustrated in the supplied demand and marginal revenue graphs.

  • Profit Loss: Changes in demand, marginal revenue, and cost illustrate adjusted profit dynamics.

Page 17-20

Efficiency Effects of Monopoly

  • Consumer Surplus Loss: On the demand and marginal cost diagram highlighting consumer surplus lost when monopolistic pricing occurs.

  • Producer Surplus Transfer: Explains producer surplus transfers and loss associated with monopolistic behavior.

  • Deadweight Loss: Repeated illustrations of welfare loss due to monopoly pricing, emphasizing inefficiencies in markets.

Page 21

Sources of Monopoly Power

  • Definition of a Natural Monopoly: A scenario where one firm can supply the total market output at a lower cost than multiple firms could while considering fixed costs.

Page 22

Characteristics of Natural Monopolies

  • Examples include public utility sectors such as:

    • Water Supply

    • Electricity Distribution

    • Gas Distribution

    • Telecommunication Networks

    • Broadcasting Services

  • Regulatory Importance: Segregating natural monopoly functions from competitive areas to encourage competition.

Page 23

Government Actions Affecting Monopolies

  • Examples of government-sponsored monopolies include:

    • Patents: Offering temporary monopoly benefits to incentivize R&D.

    • Duration of patents raises discussions on optimal longevity before competition resumes.

Page 24

Policy Responses to Monopolies in the UK

  • Institutional bodies regulating monopolies:

    • Competition Commission

    • Regulatory Bodies (e.g., OFWAT, OFGEM).

Page 25

Optimal Price Regulation

  • Figure: Optimal Price Regulation depicted with market demand, price per unit calculations, and regulated demand affecting units produced.

Page 26

Challenges in Regulation

  • Identified issues in regulatory landscapes:

    • Firms possess advanced knowledge and can manipulate information presented to regulatory bodies.

    • Illustrates potential distortions in firm behavior when subjected to governmental pricing regulations.