Monopoly Notes

Imperfect Competition and Market Power: Core Concepts

  • Pure Monopoly:
    • An industry with a single firm.
    • The firm produces a product with no close substitutes.
    • Significant barriers to entry prevent other firms from competing for profits.
  • Barrier to Entry: Something that prevents new firms from entering and competing in imperfectly competitive industries.
    • Government Franchises: A monopoly by virtue of government directive.
    • Patents: A barrier to entry that grants exclusive use of the patented product or process to the inventor.
    • Economies of Scale and Other Cost Advantages
    • Ownership of a Scarce Factor of Production: Example: The DeBeers Company of South Africa controls about 80 percent of the market for uncut diamonds.
  • Price as a Decision Variable:
    • Price is a decision variable for imperfectly competitive firms.
    • Firms with market power must decide:
      • How much to produce.
      • How to produce it.
      • How much to demand in each input market.
      • What price to charge for their output.
    • Output price is not taken as given; the firm has the power to influence it.
  • Assumptions for Analyzing Monopoly Behavior:
    • Entry to the market is blocked.
    • Firms act to maximize profits.
    • Monopoly is a price-taker with respect to inputs of production.
    • No price discrimination.
    • Monopoly faces a known demand curve.
  • Demand in Monopoly Markets:
    • In a monopoly market, there is no distinction between the firm and the industry.
    • The firm is the industry.
    • The market demand curve is the demand curve facing the firm.
    • The total quantity supplied in the market is what the firm decides to produce.
  • Marginal Revenue and Market Demand:
    • For a monopolist, an increase in output involves not just producing more and selling it but also reducing the price of its output to sell it.
  • Monopoly Costs, Revenues, and Profits
    • Producing past where MR = MC, the incremental cost will exceed the incremental revenue.
    • Producing less than where MR = MC, the monopolist is not maximizing profits.
  • Price and Output Decisions in Pure Monopoly Markets
    • All firms, including monopolies, raise output as long as marginal revenue is greater than marginal cost.
    • Any positive difference between marginal revenue and marginal cost can be thought of as marginal profit.
    • The profit-maximizing level of output for a monopolist is the one at which marginal revenue equals marginal cost: MR=MCMR = MC.
    • A monopoly firm has no supply curve that is independent of the demand curve for its product.
    • A monopolist sets both price and quantity, and the amount of output that it supplies depends on both its marginal cost curve and the demand curve that it faces.
  • Monopoly in the Long and Short Run
    • If a firm can reduce its losses by operating in the short run, it will do so.
  • Perfect Competition and Monopoly Compared
    • Relative to a perfectly competitive industry, a monopolist restricts output, charges higher prices, and earns positive profits.
  • The Demand Curve a Monopolist Faces:
    • Single seller
    • Faces entire industry demand
    • Must lower price to sell more
    • Not all units are sold for the same price (MR < P).
  • Perfect Competition
    • Many sellers
    • Faces perfectly elastic demand
    • Must produce more to sell more
    • All units sold for the same price (P=MRP = MR).
  • Elasticity and Monopoly:
    • The monopolist faces a downward-sloping demand curve (its average revenue curve).
    • It cannot charge just any price with no changes in quantity demanded.
  • If a monopoly raises price, quantity demanded will decrease.
    • Remember how consumers respond to a change in price.
    • A monopolist is a single seller of a well-defined good or service with no close substitute.
    • The demand curve slopes downward because individuals compare marginal satisfaction to cost.
    • Consumers have limited incomes and unlimited wants.
    • The market demand curve slopes downward because individuals compare the marginal satisfaction they will receive to the cost of the commodity to be purchased.
  • Collusion and Monopoly Compared
    • Collusion: The act of working with other producers to limit competition and increase joint profits.
  • The Social Costs of Monopoly: Inefficiency and Consumer Loss
    • Monopoly leads to an inefficient mix of output.