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5.3. Monopoly

Introduction

  • Features of a Monopoly Market:
    • Many buyers and only one seller in the market.
    • Goods offered by the monopoly has no close substitutes.
    • Large barrier to enter or exit the market.
    • Monopolies are price makers.
  • Why Monopolies Arise?
    • The fundamental cause of monopoly is barriers to entry. A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it.
    • Monopoly resources: A key resource required for production is owned by a single firm.
    • Government regulation: The government gives a single firm the exclusive right to produce some good or service.
    • The production process: A single firm can produce output at a lower cost than can a larger number of firms (Natural Monopoly) (Economies of Scale).

Monopoly Demand Curve

  • Key difference between a competitive firm & a Monopoly is the ability to influence market price. It comes from the difference of the demand curve they face.
  • Because a competitive firm can sell as much or as little as it wants at the market price, the competitive firm faces a horizontal demand curve at that price.
  • Because a monopoly is the sole producer in its market, its demand curve is simply the market demand curve. Thus, the monopolist faces a downward sloping demand curve.

Monopoly Marginal Revenue

  • A monopolist’s marginal revenue is less than the price of its good, P > MR.
  • Marginal revenue on all units after the first is less than the price.
  • Thus, a monopoly’s marginal - revenue curve lies below its demand curve.
  • Demand & MR of monopoly:
  • Price & Production:
    • Profit Maximizing quantity of output is found where MR=MC.
    • Price is found from the demand curve at that quantity.
    • Here, P>MR & MR=MC.
  • Monopoly Profit:
    • Profit = (P-ATC)Q.
    • Monopoly has the ability of earning positive economic profit in short run & in long run.
  • Loss Making Monopoly:
  • Welfare Cost & Inefficiency of Monopoly:
    • A competitive market produces efficient quantity where demand & supply (MC) curve intersects & P=MC.
    • But monopoly produces lower quantity where MR=MC but P>MC.
    • Therefore, monopoly quantity is inefficient & monopoly generates a deadweight loss.