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Microeconomics: monopoly

Definition of the term monopoly:

A monopoly is a firm that is the only supplier of a unique good or service in a market.
  • Monopoly markets have barriers to entry, which prevents other firms from entering the market and competing with the monopolistic firm.
  • Since monopolies do not have to compete with other producers, they have a strong influence over the price and quantity in their markets, only limited by consumer's demand.
Factors that cause monopoly power:

  • Geography; a remote and isolated area might only have one grocery store. Because the store lacks competition, it is able to charge significantly higher price for its produce than stores that face competition.
  • Government monopoly; when the government entirely provides a good or service. For example, a local government might decide to have a public trash collection service.
  • Natural monopoly: it exists if and only if a firm experiences extreme economies of scale and is able to serve the market more cheaply than any other firms. Example, utility companies (water,gas, and electricity).
  • Legal barriers; a firm can become a monopoly when the government grants a patent or copyright to a single company.
Monopoly: demand, and marginal revenue

Because the monopolistic firm is the only firm in the market, it faces the entire down sloping demand curve. In this case, the total revenue curve forms a concave parabola (TR= Q*P(Q)). To find the maximum revenue, just find where the MR (marginal revenue) is equal to zero.
  • Revenue is maximized when the demand curve is unit elastic ( equal to 1).

Profit Maximization:

  • Just like in a competitive firm model, a monopolistic firm maximizes its profit by producing where its MC is equal to its MR. 
  • However, unlike a competitive firm, the MR is not equal to the price, instead once the quantity which satisfies the MR=MC relationship is found, plug this quantity (Q*) into the demand function and solve for the price.
  •  Profit corresponds to a rectangular area, where the height is equal to the distance between ATC and the demand curve and the length equals to Q*.

Inefficiency:


  • Productive inefficiency:
    1. A monopoly does not produce at the lowest point on the ATC. Therefore, it is not productively efficient.
  • Allocative inefficiency:
    1. A monopoly price is greater than the marginal cost of production. Therefore, a monopolistic firm will produce less than a market with perfect competition. Notice that a perfectly competitive market produces where MC equals demand. This result in a dead-weight loss created by the monopoly (see graph).


The reader should notice that there is something wrong with my MC curve, since it does not intersect at the minimum of the ATC. This is because I chose to use a function that is similar to the real MC but makes the pattern observed in a monopoly more obvious.

Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 101-106. 





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