Monopoly and Market Power

Monopoly

• Monopoly Definition: A monopoly exists when a single firm sells a product that has no close substitutes.

  • It controls the entire market for that product, having significant market power.

• Monopoly Power: Refers to the ability of a buyer or seller to influence the market price.

  • Characterized by a downward sloping demand curve, meaning as the price decreases, the quantity demanded increases.

• Monopsony: A market condition where there is only one buyer.

• Market Power Sources: Barriers to entry that prevent other firms from entering the market include:

  1. Natural Monopoly:

  • A market structure where it is more efficient for a single firm to produce the total output of the industry.

  1. Patent/Copyright:

  • Offers the owner the legal right to exclude others from making, using, or selling an invention.

  1. Government Regulation:

  • Limits competition by granting a government franchise, providing licenses to operate, or by auctioning off rights to maintain a monopoly.

• Marginal Revenue in Monopoly:

  • Due to the downward sloping demand curve faced by a monopoly, marginal revenue (MR) is always less than the price (P).

Example of Monopolist Decision Making

• A monopolist can either choose the output level or the price but not both simultaneously.

• Profit-maximizing output decision occurs when:
  MC = MR

Welfare Effects of Monopoly

• Profit Maximization by Monopolist:

  • A monopolist maximizes profits by restricting output, leading to a decrease in consumer surplus and an increase in producer surplus.

  • The outcome: there is underutilization of society’s resources, resulting in deadweight loss (DWL).

Consumer Surplus (CS) and Producer Surplus (PS) under monopoly:

• Impact of Restricting Output:

  • A monopolist's restriction of output leads to a different allocation of resources compared to perfect competition, reinforcing the idea of long-run equilibrium being identical to short-run equilibrium.