Monopoly
A monopoly is a single seller with no close substitutes. Its market power lets it raise prices above cost, with consequences for consumers and efficiency.
What makes a monopoly
A monopoly exists when one firm is the sole seller of a product without close substitutes and entry is blocked. Barriers to entry include control of a key resource, government licences or patents, economies of scale so large that one firm can supply the market most cheaply (natural monopoly), and network effects.
Demand and marginal revenue
A monopolist faces the whole market demand curve, which slopes downward. To sell one more unit, it must lower the price on all units, so marginal revenue is less than price. For a straight-line demand curve, the MR curve has the same intercept but twice the slope.
Choosing output and price
A monopolist maximises profit where MR = MC, then charges the highest price buyers will pay for that quantity, read from the demand curve. It produces less and charges more than a competitive industry with the same costs would.
Worked example
Demand is \(P = 100 - Q\), so \(MR = 100 - 2Q\). Marginal cost is constant at 20. Setting \(MR = MC\): \(100 - 2Q = 20\), so \(Q = 40\) and \(P = 60\). A competitive industry would produce where \(P = MC\): \(100 - Q = 20\), so \(Q = 80\) at a price of 20.
Deadweight loss of monopoly
Because the monopolist produces less than the efficient amount, some trades that would benefit both buyers and sellers do not happen. In the example, units 41 to 80 are each valued above their cost of 20, but are not produced. The lost surplus is the deadweight loss, here (60 - 20) x 40 / 2 = 800.
Price discrimination
A monopolist that can separate customers and prevent resale may charge different prices to different groups, based on willingness to pay. Examples include airline fares, cinema discounts, and software pricing for students. Perfect price discrimination would capture all consumer surplus but eliminate deadweight loss.
Natural monopoly and regulation
Where one firm can serve the market at lowest cost, as with water pipes or electricity grids, governments often regulate prices or run the firm publicly. Regulators may set price equal to average cost so the firm covers costs while producing more than an unregulated monopoly.
Antitrust policy
Competition (antitrust) laws prohibit monopolising markets, price-fixing, and mergers that substantially reduce competition. Authorities in the US, EU, and elsewhere have brought major cases against large technology firms. Patents grant temporary monopolies deliberately, to reward innovation.
Key takeaways
Monopolies arise from barriers to entry. A monopolist's MR is below price, so it produces where MR = MC and charges a price above marginal cost. It produces less and charges more than a competitive market, creating deadweight loss. Price discrimination extracts more surplus. Natural monopolies are often regulated; antitrust laws limit market power.
Flashcard
Single seller, no close substitutes
Check your understanding
Compared with a competitive industry with the same costs, a monopoly: