A monopoly is a market structure in which a single seller of a product with no close substitutes serves the entire market. The significant monopoly power of a firm is measured by examining the cross-price elasticity of demand for its close substitutes.
The difference between monopoly and competition is that the demand curve of a competing firm is horizontal, this is irrespective of the price elasticity of the corresponding market demand curve, while the demand curve of a monopoly firm is simply the downward-sloping demand curve for the entire market.
Sources of Monopoly
The following are factors that may enable a firm to become a monopolist:
Exclusive Control over Important Inputs
Complete or large control over necessary inputs for production can make some companies to be
the sole power in a certain industry since competitors cannot form due to the lack of inputs.
Economies of Scale
If the LAC is downward sloping, it is advisable to have only a single producer in the
market. This is called a natural monopoly since every additional competitor makes production
more costly and wasteful.
A patent is a license from the government that gives the holder exclusive rights to a process, design or a new invention for a designated period of time. Patents can be harmful and beneficial for a market since they give rise to monopolistic powers, but also without them some inventions would simply not occur at all.
When the fraction of consumers owning a certain product passes a critical threshold, network economies can occur which are economies of scale that occur because of a monopoly or natural monopoly power
Government Licenses of Franchises
Government or local authorities can give out licenses for firms in certain areas so they gain
exclusive operation rights. These licenses are ment for industries or areas in which
more than one firm could be potentially harmful, however this licenses come with regulations and restrictions.
Information as a Growing Source of Economies of Scale
The Profit-Maximizing Monopolist
The goal of a monopolist is to maximize economic profit meaning that in the short run he can choose
the level of output for which the difference between total revenue and short-run total cost is
The Monopolist’s Total Revenue Curve
The main difference between a monopolist and a perfect competitor is the variation in total and marginal revenue with the output.
As price falls, the total revenue for a monopolist does not rise linearly with output but instead it reaches a maximum value at the quantity corresponding to the midpoint of the demand curve after which it begins to fall. When the price elasticity of demand is unity, total revenue reaches its maximum value. The vertical distance between short-run total cost and total revenue curves is greatest when the two curves are parallel .
The slope of the total cost curve at any level of output is by definition equal to marginal cost at that output level.
The marginal revenue the slope of the total revenue curve.
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A profit-maximizing monopolist in the short run will choose that level of output Q* for which
The Optimality condition for a monopolist defines how a monopolist maximizes profit by choosing the level of output where marginal revenue equals marginal cost.
The monopolist wants to sell all units for which marginal revenue exceeds marginal cost, so marginal revenue should lie above marginal cost prior to intersection .
Marginal Revenue and Elasticity
The relationship marginal revenue and price elasticity is defined by the equation below:
MQR=P( 1 – 1/? )
This equation shows that less elastic demand with respect to price causes the price to exceed marginal revenue. It also shows that a case of infinite price elasticity causes marginal revenue and price are exactly the same
Graphing Marginal Revenue
Plugging in the price and PED in the function above the MR curve can be plotted. This will prove that the slope of the MR is twice that of the demand curve.
Graphing Interpretation of the Short-Run profit Maximization Condition
The profit maximizing level of output for a monopolist is one where the marginal revenue and marginal cost curves intersect. At that quantity level, the monopolist can charge a price that will yield in an economic profit equal to the rectangle where price hits demand curve from the left and the ATC hits the demand curve from below.
A Profit-Maximizing Monopolist Will Never Produce on the Inelastic Portion of the Demand Curve
A profit-maximizing monopolist never produces an output level of the inelastic portion of the demand curve. The profit-maximizing level of output should always lie on the elastic portion of the demand curve where any more increase in price would cause costs and revenues to decrease.
If the output level lies on the inelastic part of the demand curve, any increase in price will cause profits to go up thus higher production is necessary.
The Profit-Maximizing Markup
The profit-maximizing condition MR = MC combined with the above equation can be used to derive the profit-maximizing markup for the monopolist:
The Monopolist’s Shutdown Condition
The condition for the monopoly to shutdown is where there exists no quantity for which the demand curve lies above the average variable cost curve. In this condition the monopolist should cease production in the short run and also cease production whenever average revenue is less than average variable cost at every level of output.
The local minimum profit point is that point where a firm can earn higher profits by either reducing or expanding production.
The local maximum point it that point where a firm will earn low profits by either reducing or increasing production.
A Monopolist has NO Supply Curve
Monopolists don’t have a supply curve since they are not price takers. When the market demand curve shifts, there is no unique correspondence between price and marginal revenue. A shift in the monopolist’s demand makes the price elasticity of demand at a given price to shift also.The Monopolists’ supply rule is to equate marginal revenue to marginal cost.
Adjustments in the Long Run
It is considered best for a monopolist to produce a quantity for which long-run marginal cost and marginal revenue are equal. Natural monopolies tend to hold high economic profits over longer periods of time.
This is where monopolists charge different prices to different buyers. If price discrimination is possible, some of the consumer surplus can be shifted into the monopolist’s profits.
The Perfectly Discriminating Monopolist
If a producer charges different prices for each unit, he is able to capture all the consumer surplus. The consumer will pay the maximum he would have been willing to pay for each unit and therefore receives no surplus. The marginal revenue curve is exactly the same as the demand curve for a perfectly discriminating monopolist.
Since discrimination is perfect, the price can be reduced to sell additional output without having to cut price on the output sold originally, thus price is same as marginal revenue.
Perfect discriminators produce higher levels of output since they are not concerned with the effect of a price cut on the revenue from output produced.
There is generally a positive consumer surplus under non-discriminating monopolists, but none under the perfect discriminator.
Second-Degree Price Discrimination
This is whereby many sellers post a schedule in which price declines with respect to the quantity bought. It is also known as declining tail-block rate.
Every consumer is offered the same structure, meaning that no attempt is made to tailor charges to differences in elasticity among buyers.
The limitation of rate categories may tend to limit the amount of consumer surplus that can be captured under second degree schemes.
Third-Degree Price Discrimination
This is where a producer sells his goods in two different markets at two different prices. There should be no communication between these two markets since all consumers will want to buy in the market with the cheapest goods.
The Hurdle Model of Price Discrimination
This is an idea in which the most elastic buyers will identify themselves. The hurdle model requires the buyers to first jump over a hurdle in order to obtain a rebate or something similar.
The hurdle model is not perfect as some customers would buy a product if it wasn’t on sale as well as waiting a bit if there is the chance to get it cheaper.
The hurdle model tries to adjust prices according to the elasticities of different buyers like the first discrimination, but it can’t capture all of the consumer surplus.
The Efficiency Loss from Monopoly
This is occurs due to failure of perfect price discrimination , which is also known as deadweight loss from monopoly.
Public Policy Toward Natural Monopoly
The following are objections to the equilibrium price-quantity pair of the single-price natural monopoly:
the fairness objection which is that the producer earns economic profit; and
the efficiency objection, which is that price is above marginal cost leading to lost consumer surplus
The following are options that give response to the fairness and efficiency objections:
State Ownership and Management
Since private firms can’t charge prices lower than average cost and still remain in business in the long run, the single-price firm has to charge more than marginal cost so as to remain in business.
An alternative to get rid of this is state ownership, which may lead to lack of innovation and efficiency. X-inefficiency is a condition in which a firm is not able to obtain maximum output from a given combination of inputs. Nevertheless, the best solution in some cases is having a state-operated natural monopoly.
State Regulation of Private Monopolies
Ownership is left to private firms by the government, providing guidelines and regulations though the rate-of-return regulation defines a regulation .