A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.

Examples of Monopoly

No Close Substitutes

Innovation, Technological Change, and Substitutes

Barriers to Entry

Legal Barriers to Entry

A legal monopoly is a market in which competition and entry are restricted by the granting of a public franchise, license, patent or copyright, or in which a firm has acquired ownership of a significant portion of a key resource.

Legal Barriers: Public Franchises and Licenses

Legal Barriers: Patents
and Copyrights

Ownership of a
Key Resource

If a single firm acquires ownership of the supply of a key resource, the firm will be a monopoly since no other firm can produce that output without the key input.

Natural Barriers to Entry

Natural Monopoly, Demand and Average Total Cost

If two or more firms supply the market, the per unit cost will be higher than will be the case if a single firm supplies the entire market.

Examples of
Natural Monopoly

Monopolies are Regulated

Single-Price Monopoly

By contrast, some monopolies charge different prices to different consumers. We will study price discrimination later in this chapter.

Demand and Revenue

Consumers and Monopoly

However, the demand curve for a monopoly's output still slopes downward. Consumers can still choose to purchase less output at a higher price.

Marginal Revenue and Price

Price Elasticity of Demand

The elasticity of demand is the absolute value of the percentage change in the quantity demanded divided by the percentage change in price.

Revenue and Elasticity

Marginal Revenue
and Elasticity

Monopoly Demand
Always Elastic

Price and Output Decisions

An unregulated, single-price, profit-maximizing monopoly will produce and sell the quantity of output that makes marginal revenue equal to marginal cost.

Monopoly Profits

Price Discrimination

Price discrimination is the practice of charging some customers a lower price than others for an identical good or service. Examples:

Perfect Price Discrimination

Perfect price discrimination occurs when a firm charges each consumer the maximum price he or she is willing to pay. Under perfect price discrimination, consumer surplus will be zero.

Price Differences and
Price Discrimination

Price Discrimination and Profit Maximization

Actually, this can increase profits. By charging a higher price to groups with lower demand elasticity, a monopoly can increase its profit.

Price Discrimination and Consumer Surplus

Discriminating Among
Units of a Good

Discriminating Among Individuals

Individual price discrimination occurs when price differences are based on an estimate of the group to which an individual customer belongs.

By charging a higher price to individuals who place a higher value on the good, the producer can obtain some of the consumer surplus.

Between Groups

Price discrimination discriminates between consumers on the basis of age, employment status, or some other easily distinguished characteristic.

Conditions for Successful Price Discrimination

Comparing Monopoly
and Competition

Price and Output

A perfectly competitive industry will produce the quantity of output and charge the price at the equilibrium point where the industry MC curve intersects the demand curve.

A monopoly will produce the quantity of output dictated by the intersection of the MR and MC curves, charging a price set by the demand curve.

Comparison of Monopoly and Perfect Competition

Allocative Efficiency

Allocative Inefficiency of a Single-Price Monopoly

Producer Surplus

Deadweight Loss

Deadweight loss measures allocative inefficiency as the reduction in consumer and producer surplus caused by monopoly restrictions on output.

Single-Price Monopoly

Redistribution: Price Discriminating Monopoly

In the case of a perfect price-discriminating monopoly, there is no deadweight loss, but there is an even larger redistribution from consumers to producers.

Rent Seeking

Rent Seeking and
Social Cost

The social cost is the sum of the deadweight loss and the value of the resources used in rent seeking. This sum is equal to the monopoly's profit.

Gains from Monopoly

Economies of Scale

A firm experiences economies of scale when an increase in its production of a good or service causes a decrease in the average total cost of producing it.

Economies of Scope

Incentives to Innovate

The Case of a Patent

Empirical Evidence