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The market structure of Monopoly

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` A monopoly is a market structure in which thereis a single supplier of a product.

` The monopoly firm (monopolist): M

ay be small or lar ge. Must be the ONLY supplier of the product.

Sells a product for which there are NO closesubstitutes.

` Monopolies are fair ly common: U.S. Postal Service, local utility companies, local cableprovider s, etc.

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` Monopoly i r t str t r   i   ich si le 

f ir  es the e tir e r  et.

` M n lies exist ecause f  arr iers t entr  int

a  ar  et that r event competition.

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` Monopolies often ar ise as a r esult of  arr iers to entr .

` Barri r t tr  : an thing that impedes the abilit of 

f ir ms to begin a new business in an industr  inwhich existing f ir ms ar e earning positive economic 

pr of its.

` Ther e ar e thr ee gener al classes of barr iers to entr  :

Natur al barr iers, the most common being

economies of scale

Actions b fir  ms to  eep other f ir ms out

Gover nment (legal) barrier s

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` In some industr ies, the lar ger the scale of production, the lower the costs of production.

` Entrants are not usually able to enter the market

assured of or capable of a very lar ge volume of production and sales.

` This gives incumbent f irms a signif icantadvantage.

` Examples are electr ic power companies andother similar utility provider s.

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` Entry is barred when one f irm owns an essential resource.

` Examples are inventions, discover ies, recipes,

and specif ic mater ials. Microsoft owns Windows, and has been challenged by

the U.S. Dept. of Justice as a monopolist.

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` Gover nments often provide barr ier s, creating monopolies.

`  As incentives to innovation, gover nments often 

grant patents, providing f irms with legal monopolies on their products or the use of their 

inventions or discover ies for a per iod of 17 year s.

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` Legal barriers, such as patents, pr event others

fr om enter ing the mar  et.

� Soc i ol og i cal  arri r   ± entry is pr evented

by custom or tr adition.

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` N atural barriers ± the f ir m has a unique abilit to 

pr oduce what other f ir ms can¶t duplicate.

� Technol og i cal  arri er  ± the size of the 

market can support only one f ir m.

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` Natural monopoly: A monopoly that ar ises fromeconomies of scale. The economies of scale ar ise from

natural supply and demand conditions, and not from

gover nment actions.

` Local monopoly: a monopoly that exists in a limitedgeographic area.

` Regulated monopoly: a monopoly f irm whose behavior 

is over seen by a gover nment entity.

` Monopoly power : market power, the power to set

pr ices.

` Monopolization: an attempt by a f irm to dominate a

market or become a monopoly.

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` In any market, the industry demand curve is 

downward-sloping. This is the result of the law

of demand.

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` r itical to under standing the prof it maximization of the monopolist is remember ing that themonopolist is the industry because it is the soleproducer.

` Therefore the monopolist confronts a downward-sloping demand curve. The industry demandcurve is the firm¶s demand curve.

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` Recall that the marginal revenue (MR) is:

QTR MR (

(!

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` Remember is that margi nal revenue is the 

change in total r evenue that occurs as a f ir m 

changes its output.

TR=P x QTR=P x Q

MR = Change in Total Revenue/ change in outputMR = Change in Total Revenue/ change in output

Another way to say it is:Another way to say it is:

³how much does your TotalRevenue changes as you increase output´³how much does your TotalRevenue changes as you increase output´

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` MR is less than pr ice for a monopoly f irm.

` The MR is less than pr ice and declines as output

increases because the monopolist must lower the pr icein order to sell more units (because the demand curve

slopes downward).

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` When a monopolist incr eases output, it lowers the 

pr ice on all pr evious units.

 As a result, a monopolist¶s mar ginal 

revenue is always below its pr ice.

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` Whenever MR is greater than AR, AR r ises.

` Whenever MR is less than AR, AR falls.

`  Average revenue is:

P QQP  AR  !

v!

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` Note that the AR is the same as pr ice. In fact, the AR curve is the demand curve.

` With a downward-sloping demand curve,

pr ices fall as output increases. This means that AR falls.

` MR must always e less than AR.

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` ow much should the monopolistic f ir m choose to 

pr oduce if it wants to maximi e pr of it?

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` The f irst thing to r emember is thatmargi nal 

revenue is the change in total r evenue that occurs

as a f ir m changes its output.

TR=P x QTR=P x Q

MR = Change in Total Revenue/ change in outputMR = Change in Total Revenue/ change in output

Another way to say it is:Another way to say it is:³how much does your Total Revenue changes as you increase output´³how much does your Total Revenue changes as you increase output´

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` When a monopolist incr eases output, it lowers the 

pr ice on all pr evious units.

 As a result, a monopolists marginalrevenue is always below its price.

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` In order to maximize prof it, a monopolist

produces the output level at which mar ginal 

cost equals mar ginal revenue.

Producing at an output level whereMR > MC or where MR < MC willyield lower profits.

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Output Price TR MR TC MC ATC Profit

0 36 0 ² 47 ² ±47 

1 33 33 33 48 1 48.00 ±15 

2 30 60 27 50 2 25.00 10 

3 27 81 21 54 4 18.00 27 

4 24 96 15 62 8 15.50 34

5 21 105 9 78 16 15.60 27 6 18 108 3 102 24 17.00 6 

7 15 105 ±3 142 40 20.29 ±37 

8 12 96 ±9 196 56 24.75 ±102 

9 9 81 ±15 278 80 30.89 ±197 

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` The marginal r evenue cur ve is a gr aphical 

measur e of the change in r evenue that occurs in

r esponse to a change in pr ice.

`

It tells us the additional r evenue the f ir m will get by expanding output.

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` If MR > MC , the monopolist gains pr of it by 

incr easing output.

` If MR < MC , the monopolist gains pr of it by 

decr easing output.` If MC = MR , the monopolist is maximi ing pr of it.

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` The MR = MC condition deter mines the quantity a 

monopolist pr oduces.

` The monopolist will charge the maximum pr ice 

consumers ar e willing to pay f or that quantity.` That pr ice is f ound on the demand cur ve.

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` To determine the prof it-maximizing pr ice (where

MC = MR), f ir st f ind the prof it maximizing output.

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MC 

$36

30

24

18

12

60

6

12

Pr ice

1 2 3 4 5 6 7 8 9 10

D

MR 

Monopolist

pr ice

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` Draw the f irm's mar ginal revenue curve.

` Determine the output the monopolist will produce

by the inter section of the MC and MR curves.

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` Determine the pr ice the monopolist will char ge for 

that output.

Determine the average cost at that levelof output.

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` Determine the monopolist's prof it (loss) by

subtracting average total cost from average

revenue (P ) at that level of output and multiply by

the chosen output.

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` The monopolist will make a prof it if pr ice exceeds 

average total cost.

The monopolist will make a normal returnif price equal average total cost.

The monopolist will incur a loss if price is

less than average total cost.

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`  A monopolist can make a prof it.

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`  A monopolist can break even.

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Pr ice MC 

Quantity

P M 

0

MR  D

QM 

 AT C 

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`  A monopolist can make a loss.

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Pr ice AT C MC 

Quantity0

MR  D

QM 

LossP M 

C M B

 A

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` The monopoly f irm will notnot set the pr ice arbitrar ilyhigh, the prof it-maximizing pr ice still corresponds 

to the point where MR=MC.

`

The monopoly f irm¶s market power will allow thef irm to achieve above-normal prof its.

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` A monopolist will suspend operations in theshort run if its pr ice does not exceed the

average var iable cost at the quantity the f irm

produces.

` A monopolist will shut down permanently if revenue is not likely to equal or exceed all costs 

in the long run.

` In contrast, however, if a monopolist makes a

prof it, barr ier s to entry will keep other f irms outof the industry.

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1.  A monopolist can char ge any pr ice it wants andwill reap unseemly prof its by continually

increasing the pr ice.

2.  A monopolist is not sensitive to customer s.

3.  A monopolist cannot make a loss.