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Chapter 7
Monopoly
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Monopoly Structure: Monopoly
• A monopoly is one firm that produces the
entire market supply of a particular good
or service.
• Because there is only one firm in a
monopoly industry, the firm is the
industry.
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Monopoly = Industry
• In a monopoly structure, the firm’s
demand curve is identical to the market
demand curve for the product.
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Price versus
Marginal Revenue
• Marginal revenue (MR) is the change in
total revenue that results from a one-unit
increase in quantity sold.
• Price equals marginal revenue only for
perfectly competitive firms.
• Marginal revenue is always less than price
for a monopolist.
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Price versus
Marginal Revenue
• A monopolist can sell additional output
only if it reduces prices.
• The MR curve lies below the demand
curve at every point but the first.
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Figure 7.1
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Profit Maximization
• A monopolist:
– Makes pricing decisions that perfectly
competitive firms cannot make.
– Uses the profit-maximization rule to
determine its rate of output.
– Maximizes profit at the rate of output where
MR = MC.
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Profit Maximization
• The profit maximization rule applies to all
firms:
– A perfectly competitive firm produces the
quantity where MC = MR (= p)
– A monopolist produces the quantity where
MC = MR (< p), as do all imperfectly
competitive firms.
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Figure 7.2
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The Monopoly Price
• The intersection of the marginal revenue
and marginal cost curves establishes the
profit-maximizing rate of output.
• The demand curve tells us the highest
price consumers are willing to pay for that
specific quantity of output.
• Only one price is compatible with the
profit-maximizing rate of output.
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Monopoly Profits
• Total profit equals profit per unit times the
number of units produced.
• Profit per unit = price minus average total
cost:
Profit per unit = p – ATC
• Total profit = profit per unit times
quantity:
Total profit = (p – ATC) x q
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Figure 7.3
• A monopolist
produces less and
charges a higher price
than a competitive
industry.
• A competitive industry
produces 5 units and
sells at $9, while a
monopolist produces
4 units and sells at
$10.
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Barriers to Entry
• Obstacles that make it difficult or
impossible for would-be producers to
enter a particular market.
• Examples include patents, legal
harassment, exclusive licensing, bundled
products, and government franchises.
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Competition versus
Monopoly
• In competition, as well as in monopoly,
high prices and profits signal consumers’
demand for more output.
• In competition, the high profits attract
new suppliers.
• In monopoly, barriers to entry are erected
to exclude potential competition.
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Competition versus
Monopoly
• In competition, production and supplies
expand, and prices slide down the market
demand curve.
• In monopoly, production and supplies are
constrained, and prices don’t move down
the market demand curve.
7-15
Competition versus
Monopoly
• In competition, a new equilibrium is
established, and average costs of
production approach their minimum.
• In monopoly, no new equilibrium is
established, and average costs are not
necessarily at or near a minimum.
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Competition versus
Monopoly
• In competition, economic profits approach
zero, and price equals marginal cost
throughout the process.
• In monopoly, economic profits are at a
maximum, and price exceeds marginal cost
at all times.
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Competition versus
Monopoly
• In competition, the profit squeeze
pressures firms to reduce costs or improve
product quality.
• In monopoly, there is no profit squeeze to
pressure the firm to reduce costs or
improve product quality.
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Near Monopolies
• In duopoly, two firms together produce
the industry output.
• In oligopoly, several firms dominate the
market.
• In monopolistic competition, many firms
each have a monopoly on their own brand
image but must still contend with
competing brands.
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Natural Monopoly
• A natural monopoly is an industry in
which one firm can achieve economies of
scale over the entire range of market
supply.
– Examples include local telephone, cable, and
utility services.
– Having two or more firms produce will require
excessive duplication of production and
distribution equipment.
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How Does the Monopolist
Answer the Questions?
• WHAT? – Less is produced and it is sold at
higher prices.
• HOW? – There is no need to upgrade quality
due to no competition.
• FOR WHOM? – Fewer customers can afford
the product; producer will make greater
profits.
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Contestable Markets
• A contestable market is an imperfectly
competitive industry subject to potential
entry if prices or profits increase.
• How contestable a market is depends not
so much on its structure as it does on its
barriers to entry.
7-22