Monopoly
Highlighted Sections
The Monopolist's Demand Curve - (Back to Top)
A monopoly is a firm that is the ONLY seller of a product
with NO close substitutes. Because of this, the demand curve
for a monopolist's product is the same as the entire market
demand curve for the product. Therefore, when economists
depict a monopoly firm in a graph, the demand curve will be
downward sloping, and will look just like the entire market
demand curve for the product.
Contrast the monopolist's demand curve with the demand curve
facing the firm selling in a competitive market. Competitive
firms exist in a market with MANY firms selling products that
are very close substitutes for each other. As such,
competitive firms are price takers. Because of this,
economists draw the demand curve for a competitive firm's
product as a horizontal line at the market price.
The demand curves for monopolies and competitive firms are
shown in the figure below.
Monopoly Profit Maximization - (Back to Top)
Q: How do monopoly firms maximize profits?
A: The same way as other types of firms. In fact, ALL
firms (competitive, monopoly or otherwise) maximize profits
by producing where MR=MC.
Table #1, below, gives cost and revenue information for a
monopoly firm. The major difference from the previous
chapter (where the firm was competitive) is that the price
of the product (column 2) falls as the output of the firm
increases (column 1). The reason that the price falls is
that monopoly firms are price makers. Also, notice
that for a monopoly firm, marginal revenue (MR) is no longer
equal to the price, but is usually less than the
price.
Table #1 - Revenue and Cost for a Monopoly Firm
Producing Widgets
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Quantity |
Price |
Total |
Total |
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Marginal |
Marginal |
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As with competitive firms, the monopoly firm will
maximize its profit by producing where MR=MC (shown in bold
in table #1). What is different in a monopoly market is that
there is NO entry or exit of firms to drive away economic
profits in the long-run. The situation from table #1 is
depicted in the figure below. Notice that the monopolist is
making economic profits (profits ABOVE the firm's ATC
curve). Because there is NO competition in a monopoly
market, the firm will continue to make these profits in the
long-run.
Notice in the figure below that the size of the gray area
(profits) is equal to $10. The height of the area is $2.5
($13 - $10.5) and the base is 4 units. $2.5/unit times 4
units is equal to the $10 profit from table #1.
Social Costs of Monopoly - (Back to Top)
Because of the market power of monopoly firms, the
equilibrium in a monopoly market yields LESS output of the
product, which is sold at a HIGHER price than in a
competitive market. In the graph of the monopoly
equilibrium, the equilibrium for a competitive market is
also shown. You can find the competitive equilibrium where
the marginal cost (MC) curve intersects both the average
total cost (ATC) curve AND the demand curve. This is the
only point on the MC curve where the competitive firms will
make zero economic profits.
Q: What are the costs to society of having a monopoly
firm?
A: The deadweight loss (shown in red) is the cost to
society. The red area represents consumer and producer
surplus that exists in the competitive equilibrium, but is
not gained by anybody since the monopolist restrict its
output to only 4 units.
(Back to top)