Monopoly

The Only Seller

Now, about monopolies…what happens when one company is the only one selling something, and there's nothing anyone can do about it?

Back in the late 1800s, many economists thought monopolies would naturally disappear. The idea was that big profits would attract other companies, break up the monopoly's control, and solve the problem. But Standard Oil proved that wrong. By 1880, John D. Rockefeller controlled more than 90% of oil refining in the US, and he held onto that power for a long time by getting discounts on railroads, selling products at very low prices to ruin competitors (predatory pricing), and buying up similar companies (horizontal integration). Rockefeller had completely controlled the whole process of getting oil from the ground to customers, and other companies couldn't compete.

A monopolist is the only seller of a product with no good alternatives. Unlike a wheat farmer who is up against thousands of almost identical farms, a monopolist has no competition and complete control over the price. This makes them a price maker.

Think of Pfizer and its patent on a very successful cancer drug, or De Beers controlling 85% of the world's rough diamonds until the 1990s, or your local electricity company. In each situation, people either pay the price the company asks or they do without.

What stops other companies from entering the market and competing? It's a barrier to entry:
- Patents give drug companies 20 years to be the only ones selling a drug. AbbVie made over $200 billion from Humira before its patent ran out in 2023.
- Exclusive control of a resource (De Beers had diamond mines in southern Africa for many years).
- Very high startup costs - you aren't going to casually build a second power grid for a city.
- A government license - your local water company likely has a monopoly allowed by the city or town.

If you remove the barrier, the monopoly disappears. This is a common point on Advanced Placement (AP) free-response questions about monopolies in the long run, and students who don't understand it lose points.

Why MR Is Less Than Price

Why does a monopolist's marginal revenue (the money from selling one more) end up being less than the price?

Imagine a company is selling 10 items for $50 each. To sell an 11th item, it has to lower the price to $49…and not just for that new customer. Because the demand for the product goes down as the price goes down, the price of all items has to be $49. The company gets $49 for the extra item, but loses $1 on each of the 10 it was already selling (since people now pay $49 instead of $50). The net gain is $49 - (10 x $1) = $39. That $39 is the marginal revenue, and it's lower than the $49 price.

For a monopolist, marginal revenue is always less than the price. Always.

A perfectly competitive company doesn't have to think about this, because it sells at the market price and doesn't change it. But the monopolist is the market, so changing how much it sells changes the price for everyone. On a graph, the marginal revenue line is below the demand line. With a straight demand line, both start at the same point on the vertical axis, but marginal revenue falls much more quickly. The difference between the price and marginal revenue (MR) is what allows a monopoly to maximize profits, creates the 'deadweight loss' triangle, and fundamentally influences everything in this section.

Profit Maximization: MR = MC

To maximize profit, a monopolist, just like any business, will keep increasing production as long as the revenue from each additional unit is greater than the cost to make it. They stop when MR equals MC. A common mistake on tests is getting the amount to produce confused with the price. If a question on the exam asks you for the monopoly price, and you point to where MR and MC intersect on a chart (the vertical axis), you're incorrect. There are two distinct stages: first, find the quantity where MR = MC - we'll call this Qm. Then, go from Qm up to the demand curve to see the highest price customers will pay; this is Pm.

Consider Pfizer as an example. They don't just look at the point where MR = MC and charge that amount. Pfizer decides how much to make where MR = MC, and then looks at the demand curve to determine what patients (or their insurance) will actually pay for that amount. The price ends up being higher than the cost of production, and often much higher.

This results in less being produced and a higher price than in a competitive market. In a competitive situation, production expands until price is equal to marginal cost. A monopolist stops before that, meaning some people who would have bought the product aren't served.

Deadweight Loss

Someone might be willing to pay $200 for a drug that only costs $30 to make. With competition, that sale happens and both the buyer and seller benefit. But with a monopoly, the company charges $250, and the person gets nothing. That $170 of potential benefit (surplus) is simply lost. No one gets to enjoy it.

If you add up all of that lost benefit across every item between the monopolist's output (Qm) and the competitive output (Qc), you get the 'deadweight loss' triangle. On a graph, this triangle sits between the two output levels and represents transactions that would have happened (buyers valued the item more than the cost to make it) but didn't because of the price.

Importantly, deadweight loss is not the monopolist's profit. Students often get these two mixed up. Profit is a transfer of benefit from the customer to the company; the benefit is just in a different place. Deadweight loss is benefit that disappears entirely – it's gone.

The U.S. Department of Justice uses antitrust laws for this very reason. The bigger the difference between Qm and Qc, the larger the deadweight loss triangle and the more the public loses. Both the 1998 antitrust case against Microsoft and the 2020 case against Google were at their heart about deadweight loss and harm to customers.

Worked Example

Let's say demand is P = 100 - Q and the cost is MC = 10 + 0.5Q. We'll work through the monopoly situation and then compare it to a competitive market.

First, we need to find the MR. With any straight-line demand curve of P = a - bQ, the MR is found by doubling the slope: MR = a - 2bQ.

So, MR = 100 - 2Q.

Now, set MR = MC:

100 - 2Q = 10 + 0.5Q
90 = 2.5Q
Qm = 36 units

To find the price, use the demand curve (don't use MR, that's a frequent mistake!):

Pm = 100 - 36 = $64

In comparison, in a competitive market, price and MC are the same:

100 - Q = 10 + 0.5Q
90 = 1.5Q
Qc = 60 units, Pc = $40

The monopolist makes 24 fewer items (36 versus 60) and charges $24 more ($64 versus $40). Each of the items between Q = 36 and Q = 60 would have created benefit for someone, because people would have paid more for them than it cost to produce them. That lost triangle is the deadweight loss.