Monopoly

Monopoly


A market is described as a monopoly if there is only one producer.

This single firm faces the entire market demand curve. The monopoly must make the decision of how much to produce.

The monopolys output decision will completely determine the goods price.

Causes of Monopoly


Barriers to entry which are factors that prevent new firms from entering a market are the source of all monopoly power. There are two general types of barriers to entry

Technical barriers Legal barriers

Technical Barriers to Entry



A primary technical barrier is when the firm is a natural monopoly because it exhibits diminishing average cost over a broad range of output levels.

Hence, a large-scale firm is more efficient than a small scale firm.

A large firm could drive out competitors by price cutting.

Technical Barriers to Entry



Other technical barriers to entry.

Special knowledge of a low-cost method of production. Ownership of a unique resource. Possession of unique managerial talents.

Legal Barriers to Entry



Pure monopolies can be created by law.

The basic technology for a product can be assigned to only one firm through a patent.


The rational is that it makes innovation profitable and encourages technical advancement.

The government can award an exclusive franchise or license to serve a market.



This may make it possible to ensure quality standards

Profit Maximization


To maximize profits, a monopoly will chose the output at which marginal revenue equals marginal costs. The demand curve is downward-sloping so marginal revenue is less than price.

To sell more, the firm must lower its price on all units to be sold in order to generate the extra demand.

A Graphic Treatment


A monopoly will produce an output level in which price exceeds marginal cost. Q* is the profit maximizing output level in Figure 10.1.

If a firm produced less than Q*, the loss in revenue (MR) will exceed the reduction in costs (MC) so profits would decline.

FIGURE 10.1: Profit Maximization and Price Determination in a Monopoly Market

Price E MC AC P*

A C D MR 0 Q* Quantity per week

A Graphical Treatment

The increase in costs (MC)would exceed the gain in revenue (MR) if output exceeds Q*. Hence, profits are maximized when MR = MC.

Given output level Q*, the firm chooses P* on the demand curve because that is what consumers are willing to pay for Q*. The market equilibrium is P*, Q*.

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