BUSS1040 · Economics For Business Decision Making
Monopoly, Price Discrimination & Monopolistic Competition
Topic 6 is the heaviest micro chapter and a large slice of the exam's hard 80%. The monopolist is a price-maker with MR < P; the workhorse shortcut is that for linear demand P = a − bQ, MR = a − 2bQ (same intercept, twice the slope), and profit-max is MR = MC. From there flow the monopoly DWL, the three degrees of price discrimination (perfect, menu, separate markets), the two-part tariff, natural-monopoly regulation, and the monopolistic-competition long-run tangency. It is examined as multi-part calculation: find Qm, Pm, profit, DWL, and the discriminating prices.
What this chapter covers
- 011. The price-maker: faces market demand, MR < P (output effect + price effect)
- 022. MR shortcut: for P = a − bQ, MR = a − 2bQ; profit-max where MR = MC ⇒ Qm, then read Pm off demand
- 033. Monopoly profit = Qm(Pm − ATC) = TR − TC, shown as a profit box
- 044. Monopoly DWL = ½(Qc − Qm)(demand − MC at Qm); Qc from P = MC
- 055. Price discrimination requirements: market power, no resale (no arbitrage), info on WTP
- 066. First-degree (perfect): charge each unit its WTP ⇒ D = MR, efficient q, CS = 0, DWL = 0
- 077. Two-part tariff: per-unit price = MC, fixed fee F = consumer surplus at p = MC
- 088. Second-degree (menu/self-selection) and third-degree (MRA = MRB = MC, higher price in the more inelastic market)
- 099. Natural monopoly (falling ATC) and monopolistic competition (LR tangency: P = ATC, P > MC, excess capacity)
Single-price monopoly: quantity, price, profit and deadweight loss
- 1 markMarginal revenue from the shortcut: for P = 120 − 2Q, MR = 120 − 4Q (same intercept, twice the slope).
- 3 marksProfit-max where MR = MC: 120 − 4Q = 12 + 2Q ⇒ 108 = 6Q ⇒ Qm = 18. Read price off demand: Pm = 120 − 2(18) = 84.
- 2 marksProfit = TR − TC = 84×18 − (60 + 12×18 + 18²) = 1512 − (60 + 216 + 324) = 1512 − 600 = 912.
- 1 markEfficient quantity where P = MC: 120 − 2Q = 12 + 2Q ⇒ 108 = 4Q ⇒ Qc = 27.
- 2 marksAt Qm = 18, demand price = 84 and MC = 12 + 2(18) = 48, a gap of 36. DWL = ½(Qc − Qm)(gap) = ½(27 − 18)(36) = ½(9)(36) = 162.
Key terms
- Price-maker / marginal revenue
- A monopolist sets price along the whole market demand, so selling more requires a lower price on all units; marginal revenue is below price, MR < P. For linear demand P = a − bQ, MR = a − 2bQ.
- Monopoly profit-max (MR = MC)
- The monopolist chooses Qm where MR = MC, then sets price Pm by reading the demand curve at Qm. Profit = Qm(Pm − ATC) = TR − TC, drawn as a rectangle (the profit box).
- Monopoly deadweight loss (DWL)
- The lost total surplus from restricting output below the competitive Qc: DWL = ½(Qc − Qm)(demand price − MC, both at Qm). The monopoly profit is a transfer from consumers, not deadweight loss.
- Price discrimination (and its requirements)
- Charging different prices to capture more surplus. It needs three conditions: market power, the ability to prevent resale (no arbitrage), and information to separate buyers by willingness to pay.
- First-degree (perfect) price discrimination
- Charging each unit its exact willingness to pay, so the demand curve becomes the firm's MR. Output reaches the efficient level (D = MC), DWL = 0, but consumer surplus = 0 — the firm captures all surplus.
- Two-part tariff
- A pricing scheme with a per-unit price plus a fixed fee. The efficient version sets the per-unit price equal to MC (so the buyer consumes the efficient quantity) and the fixed fee equal to the consumer surplus at p = MC, extracting all surplus with zero DWL.
- Third-degree price discrimination
- Charging different prices in separable markets, equalising marginal revenue across them at marginal cost: MRA = MRB = MC. The more inelastic market is charged the higher price.
- Natural monopoly & monopolistic competition
- A natural monopoly has continuously falling ATC (large fixed cost), so one firm serves the market most cheaply; P = MC is efficient but loss-making, while P = ATC breaks even. Monopolistic competition has many differentiated firms whose free entry drives the long-run outcome to demand tangent to ATC: zero profit but P > MC and excess capacity.
Monopoly, Price Discrimination & Monopolistic Competition FAQ
Why is marginal revenue below price for a monopolist, and what is the MR shortcut?
A monopolist faces the whole downward-sloping demand, so to sell one more unit it must lower the price on ALL units, not just the last one. The extra revenue (output effect, +P) is partly offset by the price cut on existing units (price effect, −), so MR < P. For a linear demand P = a − bQ there is a clean shortcut: MR has the same intercept and twice the slope, MR = a − 2bQ. You set MR = MC to find Qm, then read Pm off the demand curve — a step students often get wrong by reading price off the MR line.
How do I compute the monopoly deadweight loss?
DWL is the triangle of lost surplus from producing too little. Find the monopoly quantity Qm (from MR = MC) and the efficient quantity Qc (from P = MC). At Qm, measure the vertical gap between the demand price and MC. Then DWL = ½ × (Qc − Qm) × (that gap). Crucially, the monopoly PROFIT is not part of the DWL — it is a transfer from consumers to the firm. The DWL is only the surplus that disappears because output is restricted from Qc down to Qm.
What is the difference between the three degrees of price discrimination?
First-degree (perfect): charge each unit its exact willingness to pay — demand becomes MR, output is efficient, but the firm takes all surplus (CS = 0). Second-degree (menu/self-selection): offer versions or quantity discounts so buyers reveal their type by what they choose (e.g. basic vs premium). Third-degree (group/market): split buyers into separable markets and set a different price in each, equalising MR across markets at MC (MRA = MRB = MC), with the more inelastic market paying more. All three need market power, no resale, and information.
How does a two-part tariff differ from a single monopoly price?
A single-price monopolist restricts output to Qm and earns a profit box but leaves a DWL. A two-part tariff sets the per-unit price equal to MC, so the customer buys the EFFICIENT quantity (no DWL), and then charges a fixed entry fee equal to the consumer surplus at that price — capturing that surplus as profit. So the two-part tariff is both more efficient (zero DWL) and more profitable for the firm than a single price, which is why gyms, clubs and amusement parks use it.
How is Topic 6 examined?
As the exam's biggest multi-part short-answer block, and heavily in MCQ. Expect to: use MR = a − 2bQ to find Qm and Pm; compute monopoly profit and DWL; set up a two-part tariff (per-unit price = MC, fee = CS); solve third-degree pricing across two markets (MRA = MRB = MC, higher price in the inelastic market); and describe natural-monopoly regulation or the monopolistic-competition long-run tangency. Because roughly 80% of the final is weighted to Topics 6–12, this chapter alone can decide a grade.
Exam move
Treat Topic 6 as the chapter to over-prepare. Build muscle memory for the core loop: write MR = a − 2bQ, set MR = MC for Qm, read Pm off demand, then profit = Qm(Pm − ATC) and DWL = ½(Qc − Qm)(demand − MC at Qm), with Qc from P = MC. Keep a one-page menu of the price-discrimination cases and what each does to efficiency and surplus: perfect (efficient, CS = 0), two-part tariff (p = MC, F = CS, DWL = 0), third-degree (MRA = MRB = MC, inelastic market dearer). Be ready to argue, not just compute — why MR < P, why the monopoly profit is a transfer rather than DWL, and why monopolistic competition ends with zero profit yet excess capacity. Work every monopoly question in the practice finals, because the patterns recur as multi-part problems and this is where the heaviest marks sit.
