Monopoly
What is Monopoly?
A monopoly is a market structure with a single seller producing a unique product with no close substitutes and significant barriers to entry.
A monopolist is the sole provider of a good or service and faces the entire market demand curve, allowing it to set price above marginal cost. Because of high barriers to entry, other firms cannot enter the market to compete.
Monopoly: a worked example
A monopolist faces demand P = 100 - Q and has a constant marginal cost of $20. Its marginal revenue curve is MR = 100 - 2Q, so setting MR = MC gives 100 - 2Q = 20, or Q = 40, and reading the price off the demand curve gives P = 100 - 40 = $60. A competitive industry with the same costs would produce where P = MC, which is 80 units at a price of $20, so the monopoly withholds 40 units and charges $40 more. The deadweight loss is the triangle between the two outputs: 0.5 x 40 x $40 = $800.
The mistake students make with monopoly
Students say a monopolist can charge whatever price it likes, and picture it at the very top of the demand curve. Being the only seller removes rivals but not the demand curve: every price increase costs the monopolist sales, so it maximizes profit at the quantity where marginal revenue equals marginal cost and then charges the highest price the demand curve will bear at that quantity, not the highest price on the curve. Charging more than that price would shrink profit, not raise it.
Monopoly questions
Why is monopoly inefficient?
A monopoly is allocatively inefficient because it sets price above marginal cost, so units that consumers value more highly than they cost to produce never get made, and that lost mutual gain is the deadweight loss. Compared with a competitive market with identical costs, output is lower and price is higher.
Can a monopoly make a loss?
A monopoly makes a loss whenever average total cost is above the price at its profit-maximizing quantity, which happens when demand for its product is too weak to cover its costs. Being the only seller guarantees a firm the best outcome available given its demand and costs, not a profitable one.
Why is marginal revenue less than price for a monopoly?
Marginal revenue is below price for a monopoly because selling one extra unit means cutting the price on every unit it sells, so the money gained on the new unit is partly cancelled by revenue lost on all the earlier ones. With a straight-line demand curve the marginal revenue curve is twice as steep and meets the quantity axis at half the demand curve's quantity intercept.
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Related terms
Common comparisons
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