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Introduction to Microeconomics
Market Structures: Monopoly
Introduction
A monopoly exists when there is one firm or seller in the industry. Product differentiation for
the monopoly is absolute across industries as it has no competitors. The Monopoly is a price
maker as it sets the price by having market power. It has the ability to earn super normal
profits in both the short and long run. The monopoly has the highest barrier to entry and to
maintain itself as a monopoly it cannot let other firms enter and compete for a share of the
market. Barriers of entry are categorised by:





Lower costs per unit for an established firm
Ownership of or control over key inputs
Legal Protection
Mergers and Takeovers of entrants by existing monopoly
Monopolies are able to sustain losses longer than entrant
Types of Monopoly
Public and Private Monopolies: Monopolies which are solely owned by the state are
known as public monopolies. A good example in many countries is the national postal
service. A private monopoly is a firm that is solely owned by the private sector.
Discriminating and Non-discriminating Monopolies: A non-discriminating monopoly
sets one price for all consumers. In other words everyone pays the same price per unit of
good. A discriminating monopoly can set different prices for different consumers or for
segments of units. Airline companies are often cited as a good example of a discriminating
monopoly as they discriminate between class, and the number of seats already sold. Through
perfect price discrimination the monopolist captures all the consumer and producer welfare
as the marginal revenue is equal to the demand curve. (We look at this later).
Natural Monopoly: A natural monopoly is where a firm owns a particular resource or
input. It can also be due to the existence of economies of scale where no firm can enter
because it is too costly to compete once the first firm is established.
The economies of scale may not be able to accommodate more than one firm. Even if the
economies of scale were large enough to support another firm or two it will most likely be
unable to start at this large scale. Therefore the first firm to develop the monopoly can cut
its price below the competitors cost as they do not have the same degree of economies of
scales. Eventually the new entrant is forced out of the market because the first firm
undercuts the price below the cost of the new entrant.
If a firm is selling a completely unique product that is differentiated from all similar products
then it will also be difficult for a new firm to enter the market. This is another form of
natural monopoly.
Statutory Monopoly: A statutory monopoly exists where the firm has protection by law
that other firms cannot enter and compete. An example could be a technology firm that gets
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a patent which allows them to be the sole seller of a good for the life of patent. An example
of such a monopoly is Xerox.
In the case of a monopoly the firms demand curve is the industry demand curve. The
demand curve for a monopoly is less elastic or inelastic when we compare it to the other
types of market structure. Remember that when goods are highly substitutable there is a
high elasticity of demand because the consumer will just switch to the substitute if the price
increases. The inelasticity of demand for the good allows the monopoly to adjust price and
the consumers either pay this price or do not consume the good.
Technology Monopoly: This type of monopoly occurs where a firm has control of a
specific manufacturing process or the exclusive right to a certain technology used to
manufacture the product.
Natural Monopoly
$
a
b
D2
LRA
D1
Q
In the diagram above the firm has a economies of scale because the LRAC is downward
sloping. The monopolist will earn super profit when the quantity they produce is between
points a and b where LRAC is below demand. D 2 is the demand curve when there are two
companies in the industry and the market share is divided.
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Profit Maximisation Under a Monopoly
Like firms in other market structures the monopolist will maximise profit where MC=MR.
Unlike firms in other market structures super profits are not competed away. In the long run
the firm will produce the quantity where MR=LRMC.
Profit Maximisation
$
MC
P1=AR
AC
AC
D1
QM
MR
Q
The monopolist will always produce where MC=MR which is denoted as Q M . This results in
higher price and a lower quantity. The monopoly will produce Q M at a price of P 1 . The box
with the dashed lines represents the monopolised maximum profit. This is represented by the
shaded box. The output of the monopolist will be lower than all other forms of competition.
Under perfect competition the price will be lower and the quantity produced higher. The
diagram below illustrates the quantities of an industry with perfect competition and a
monopolised industry. This diagram assumes that firms in competitive markets have the
same AC and MC curves as a monopolist.
Profit Maximisation
$
MC
PM
PPC
AC
D=AR
QM
QPC
Q
MR
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It is easy to notice that under perfect competition the consumer is better off as they pay a
lower price. The monopoly sets higher prices by supplying a lower quantity Q M .
Efficiency and Price Discrimination
The non discriminating monopoly charges one price for all units. Firstly the monopoly sets
marginal revenue equal to marginal cost to determine the level of output and by reading up
the demand curve, the price.
Non Discriminating Monopoly
$
MC
P1=AR
AC
C
B
E
A
F
AC
D
QM
MR
Q
In the above diagram we show the non-discriminating monopoly diagram. A and B represent
the producer surplus, C is the consumer surplus. The areas E and F represent the dead
weight loss, which is a loss of economic efficiency in society. It is reasonable that the
monopolist will command more of the benefit as it has market power.
Non Discriminating Monopoly
$
MC
P1=AR
AC
C
B
A
AC
E
F
D=MR
QM
Q
The price discriminating monopolist will charge different prices to different consumers for
the same product. Essentially the price is amount each consumer is willing to pay. The first
consumer will be charged a higher price than the second consumer and so on as we move
down the MR curve. Eventually the marginal consumer is reached and the consumer at this
point values the good at its marginal cost. Because the MR curve is equal to demand the
revenue gained from each good is equal to the height of the demand curve at that quantity.
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The results of perfect price discrimination is that there is no longer and efficiency as the
dead weight loss is eliminated, however there is no longer any consumer surplus. The
monopolist capture the producer surplus above the marginal cost curve and below the
demand curve, to the left of the quantity Q M .
Comparison to other Market Structures
Characteristic
Number of Firms
Barriers to Entry
Pricing Power
Elasticity of Demand
Ability to earn excess profit
Profit maximisng condition
Market power
Perfect Competition
Monopolistic
Oligopoly
infinite
many
few
none
low
high
none
price setter
price setter
Perfect elasticity relatively elastic (LR) relatively inelastic
none
Yes (SR)
Yes
P=MC=MR
MR=MC
MR=MC
none
low
high
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Monopoly
one
very high
price setter
highly inelastic
Yes
MR=MC
very high