Monopoly

A monopoly is a market structure where a single seller dominates the market for a product or service.

Monopoly power exists when a firm can influence the market price.

Market Power

Market power is the ability of a firm to increase price by reducing output.

A monopolist can restrict output and charge a higher price to increase profit.

Compared with perfect competition:

where:

$Q_m$

monopoly quantity

$Q_c$

competitive quantity

$P_m$

monopoly price

$P_c$

competitive price

Types of Monopoly

Natural Monopoly

Occurs when very high infrastructure or start-up costs make it inefficient to have many competing firms.

Government Monopoly

A government agency is the sole provider of a particular good or service, sometimes protected by law.

Technological Monopoly

Occurs when a firm controls a technology, manufacturing method, or patent that gives it exclusive production rights.

Geographic Monopoly

Occurs when one firm is the only provider of a good or service in a particular isolated area.

Efficiency of Monopoly

A monopoly restricts output and charges a higher price.

This results in:

• Lower consumer surplus
• Higher producer surplus
• Deadweight loss

Perfect competition maximizes total surplus, while monopoly creates a deadweight loss.

Price Discrimination

Price discrimination is the practice of charging different prices to different buyers for the same or similar product, when the price differences are not based on cost differences.

Conditions for Price Discrimination

1. Market power
2. Separate groups of buyers
3. Different elasticities of demand
4. Resale is not possible

Price discrimination can increase the firm’s revenue and profit.

It can also increase total consumption and reduce deadweight loss.

Government Policy Toward Monopoly

Government may respond to monopoly through:

• Government ownership
• Competition policy
• Regulation
• Measures against price fixing and collusion

Marginal Cost Pricing

An unregulated monopoly sets output where $MR = MC$.

A regulator can force the monopoly to set price equal to marginal cost. Output is then where $MC$ intersects the demand curve ($AR$).

Effects:

• Output increases to the competitive level
• Price falls to $MC$
• Profit falls

Worked Examples

Regulated Monopoly

A monopoly is forced to price at marginal cost. Which statement is incorrect?

• The monopoly sets output where $MC$ intersects $AR$
• The monopolist’s price equals its marginal cost
• The monopoly moves from making a profit to making a loss
• The monopoly reduces its output