Literally, monopoly means "single seller." It is a market structure characterized by:
Barriers to entry include legal or natural constraints that protect a firm from potential competitors.
Demand and Supply Analysis
A monopoly faces no competition, and as a result there is no product differentiation. It is a price setter, not a price taker like a firm in perfect competition. Because the monopoly is the only seller in the market, the demand for its product is the market demand curve. It is downward-sloping because demand will decline as price increases.
Marginal Revenue and Price
A monopoly must choose between lower prices with larger quantities sold and higher prices with smaller sales. Although a monopoly can set the price for its products, market forces will determine the quantity sold at alternative prices. To maximize profit, a monopoly must estimate the relationship between price and the quantity of its products demanded.
As the monopoly reduces price in order to expand output and sales, there will be two conflicting influences on total revenue.
These two conflicting forces will result in marginal revenue - the change in total revenue - that is less than the sales price of the additional units. Thus, the marginal revenue curve of the monopoly will always lie below the firm's demand curve, which is also the market's demand curve:
The following example illustrates this concept.
Portico produces beauty soaps.
Marginal Revenue and Elasticity
A single-price monopoly's marginal revenue is related to the elasticity of demand for its good:
A single-price monopoly never produces an output at which demand is inelastic. If it did produce such an output, the firm could increase total revenue, decrease total cost, and increase economic profit by decreasing output.
Price and Output Decision
A monopoly faces the same types of technology constraints as a competitive firm but the monopoly faces a different market constraint. The monopoly selects the profit-maximizing level of output in the same manner as a competitive firm, where MR = MC. Therefore, the monopoly will lower price and expand output until marginal revenue is equal to marginal cost.
The ATC curve tells the analyst the average cost. Economic profit is the profit per unit multiplied by the quantity produced. In the above figure, total revenues P0AQ0O exceed the firm's total costs of DBQ0O at the profit-maximizing output level of Q0. Accordingly, the monopoly is making an economic profit of P0ABD.
Unlike a price taker, the monopoly may earn an economic profit, even in the long run, because the barriers to entry protect the firm from market entry by competitor firms.
Monopoly and Competition Compared
Comparing Output and Price
Compared to perfect competition, monopoly restricts output and charges a higher price.
Regulating Natural Monopoly
When demand and cost conditions create a natural monopoly, government agencies regulate the monopoly.
Without regulation, a monopolist would produce Q0, charge price P0 and maximize profit. It produces the quantity at which marginal revenue equals marginal cost.
Average cost pricing is when the government instructs the monopolist to produce that output where the demand curve intersects the ATC curve. Here, price decreases to P1 and output increases to Q1. Thus, public welfare improves.
This is because the value of the additional production to society (Q0ABQ1) exceeds the cost of the additional production Q0CDQ1 by the area CABD. The firm is making normal profits (zero economic profits) since the price being charged, P1, is just sufficient to cover the average cost per unit.
|achu: economic profits would be called 'excess profits' by insurance industry regulators.|
|steved333: and by Hillary Clinton|
|jackwez: surprised I haven't seen more political refrences...|
|schweitzdm: Can someone explain how to find the values on the graph in the section "Price and Output Decision" - P0AQ0O and DBQ0O?|
|schweitzdm: I believe the graph for "Natural Monopoly" is missing some axis and curve labels.|
| choas69: regulating a natural monopoly has three ways:|
1- average cost pricing.
2- marginal cost pricing.
why weren't the other two mentioned in this LOS?