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11.1 PROFIT MAXIMIZATION BY A MONOPOLIST 443

APPLICA TION 11.1
Is the DeBeers Diamond Monopoly

Forever? 2 monds are formed when carbon is under intense
pressure under the Earth’s surface for hundreds of
millions of years. Recently, scientists have discovered
DeBeers is a South Africa-based company that, until how to create diamonds in less than a week by put-
the late 1990s, had a near monopoly on the sale of ting carbon under extremely high pressure in a labo-
diamonds worldwide. DeBeers had exclusive rights ratory. The first synthetic diamonds were deemed
to mining in Africa, producing about 80 percent of poor substitutes for natural diamonds in jewelry, but
the quantity and over 95 percent of the dollar value they did prove to be excellent substitutes in industrial
of diamonds worldwide. Most diamonds were sold applications (where diamonds are used for cutting
through its London office. By effectively managing a because of their extremely hard surfaces). By 2007,
cartel of the major producers in Africa, DeBeers maxi- synthetic diamonds had captured 90 percent of the in-
mized profits by reducing the quantity of diamonds dustrial diamond market from DeBeers. Worse still for
sold, thereby raising prices. As one might expect, as a DeBeers, makers of synthetic diamonds have improved
near monopolist in the market for newly mined dia- their products to such an extent that they are now
monds, DeBeers made enormous profits for many often indistinguishable from natural diamonds, even
years. to professional jewelers.
New developments since that time have threat- It will be interesting to see what effects synthetic
ened DeBeers’s monopoly. DeBeers also had the rights diamonds will have on the market for diamonds in
to sell diamonds mined in the Soviet Union. However, jewelry. Currently, most jewelers and customers have
when the Soviet Union collapsed, DeBeers was unable a strong preference for natural diamonds, even
to enforce those agreements. The flow of Russian though synthetic ones are chemically identical and
diamonds increased dramatically, outside of DeBeers’s are indistinguishable. Apparently, the “authenticity”
control. Several jewelry companies, including Tiffany, of natural diamonds still has sentimental value. The
integrated backward into mining to avoid acquiring market price of synthetic diamonds for jewelry is
diamonds from DeBeers. In 2004 Namibia passed a law about 30 percent of the price for natural diamonds.
requiring miners to sell a percentage of their diamonds However, preferences may change over time as con-
to local polishers, also outside of DeBeers’s influence. sumers become more accustomed to synthetic dia-
Other African nations were increasingly challenging monds and see that they are functionally equivalent
the dominance of DeBeers over the distribution and and much cheaper. If that happens, DeBeers will lose
sale of such a valuable commodity mined in their coun- a large part of its market power. DeBeers still controls
tries. DeBeers’s market share has gradually decreased a large fraction of the supply of natural diamonds,
over this time. but it may be forced to dramatically cut prices (and
A new development may be of even greater increase output it is willing to sell) in order to meet
concern for DeBeers: synthetic diamonds. Natural dia- the new competition.

The profit-maximization condition in equation (11.1) is a general one, applying
to both monopolists and perfectly competitive firms. As we showed in Chapter 9, in a
perfectly competitive market, a price-taking firm maximizes profit by producing a
quantity at which marginal cost equals marginal revenue (MC MR), and as we have
just shown, the profit-maximizing monopolist must do the same.

2 David McAdams & Cate Reavis, “DeBeers’s Diamond Dilemma,” Case 07-045, MIT Sloan School of
Management, 2008.