Monopoly

This is Unit Eight of Principles of Microeconomics, part one of two: the single seller, what keeps its rivals out, the demand curve it faces, and how it chooses its price. Unit seven closed on the benchmark: price equals marginal cost, delivered by firms that take the price as given. This unit begins by breaking it. A monopolist is the whole market, so it sells more only by charging less, and that one fact puts marginal revenue below price and the chosen output below the competitive one. By the end you will be able to define monopoly and name the five barriers to entry. To classify a barrier and test a market for natural monopoly. To explain why the monopolist's demand curve is the market's. To build a marginal revenue column and read elasticity from its sign. And to find a monopolist's quantity, price and profit.

Six entries on barriers to entry: what a monopoly is, and the five things that keep rivals out.

The single seller.

MIC 0701 Monopoly and Market Power

A monopoly is a single seller of a good with no close substitutes. It is a price setter, choosing its price by choosing its output, and that is what market power means; the town's only water company and the holder of a drug patent are the cases. Monopoly and perfect competition are the two poles, and every real market sits somewhere between them.

What keeps rivals out.

MIC 0702 Barriers to Entry

A barrier to entry is anything that blocks new firms from a profitable market. With barriers, profit does not attract entry, so the competitive zero-profit result never arrives; a rival cannot enter a market it needs a license, a mine or a network to serve. The barrier is the source of the power: remove it and the monopoly erodes, whatever its size.

The barrier made of cost.

MIC 0703 Natural Monopoly

A natural monopoly exists when economies of scale run over the whole market: demand crosses the long-run average cost curve where it is still falling, so one firm serves the market cheaper than two could. Water mains, electric lines, a small town's only bridge. The word natural means the barrier is cost, not law, and unit ten asks what to do about it.

Barriers of ownership and law.

MIC 0704 Control of a Resource; Legal Monopoly

Owning the only source of a key input keeps rivals out, as does a government grant of an exclusive right: a franchise, a license, a rule that only one firm may serve. A single mine, the one licensed taxi company, first-class mail. Legal monopolies are usually regulated in return, and licensing also limits supply in labor markets, as unit three noted.

The barrier that rewards invention.

MIC 0705 Intellectual Property

A patent, copyright, trademark or trade secret gives its holder an exclusive right for a time: a limited monopoly to reward invention, followed by open competition. A drug patent runs twenty years from filing; a copyright, the author's life plus seventy. The monopoly is the point, not a side effect, and unit twelve weighs it as a remedy for underinvestment in ideas.

Barriers a firm builds itself.

MIC 0706 Predatory Pricing and Other Intimidation

Predatory pricing is a sharp temporary price cut meant to drive out an entrant, after which the price rises again. Heavy advertising and sunk entry costs deter rivals the same way: an entrant that must spend heavily to be noticed loses it all on failure. Predatory pricing is illegal and hard to prove, since a low price can also be ordinary competition.

Two procedures: naming a barrier from a description, and testing a market for natural monopoly.

Naming the barrier.

MIC 0707 Classifying a Barrier

Given a description of how a firm keeps rivals out, name the barrier. Average cost falling over the whole market is a natural monopoly; owning an input nobody else can get is control of a resource; a government forbidding competitors is a legal monopoly; a patent, copyright, trademark or secret is intellectual property; threatened price cuts or costly entry is intimidation. Then say whether the barrier is likely to erode. A regional cement plant whose cost per ton falls out to the whole region's demand is a natural monopoly, eroded only by a technology with a smaller efficient scale; the only known deposit of a mineral is control of a resource, eroded by a new deposit or a substitute; a city's one cable franchise is legal, eroded by a change in the law or by streaming; a patented drug expires on a date; a firm that slashes prices whenever a startup appears is practicing intimidation. Barriers combine, so name the one that would still block entry if the other vanished, and none is permanent.

Testing for natural monopoly.

MIC 0708 Is It a Natural Monopoly?

Place market demand against the long-run average cost curve and find the output where they meet. If average cost is still falling there, one firm serves the market cheaper than two splitting it, and the market is a natural monopoly; if average cost has bottomed out and turned up before that output, the market can hold several efficient firms. Check by costing the split. A town's water demand at a cost-covering price is twenty million gallons a day, and a plant's average cost falls from ten cents a gallon at five million to six cents at twenty million, still falling at thirty; one plant serves the town at six cents, two at ten million each cost eight apiece, so it is a natural monopoly. A bakery market of twenty thousand loaves a day, where average cost bottoms at two thousand, holds ten efficient bakeries. The test is about market size against the cost curve, not about how many firms happen to exist, and the curve is the long-run one.

Two entries on the monopolist's demand: why it is the market's, and where the market's edges are.

The demand curve the monopolist sees.

MIC 0709 The Monopolist's Demand Curve Is the Market's

A competitive firm sees a flat demand curve. A monopolist is the market, so its demand curve is the market's, sloping down: it sells more only by charging less, and to move a thousand more doses it must cut the price for every dose. Even a monopolist is bound by demand, to any point on the curve, not any point it likes.

Where the market's edges are.

MIC 0710 What Defines the Market

A firm is a monopoly in a market where its product has no close substitutes. How close is close decides the market, so most monopoly arguments are arguments about substitutes; one maker of cellophane may face many makers of flexible packaging. Define the market narrowly and every brand is a monopoly, broadly and none is; unit four's cross-price elasticity is the test.

Five entries on marginal revenue: revenue that rises then falls, marginal revenue below price, the column, the straight-line shortcut, and elasticity.

Revenue along that curve.

MIC 0711 Total Revenue Rises Then Falls

Because a monopolist cuts the price on every unit to sell more, total revenue rises at first, peaks, and then falls as output grows, and the peak is where demand is unit elastic. The medicine's revenue climbs to thirty-six thousand at six thousand doses and falls after. A price taker's revenue rises without limit; a price setter's does not.

What one more unit adds.

MIC 0712 Marginal Revenue Below Price

One more unit brings in its price but loses revenue on every earlier unit now sold for less, so a monopolist's marginal revenue is below price and can turn negative. A third unit at seven instead of two at eight adds seven and gives back two: five. Marginal revenue below price is the mark of every price setter, not only a monopolist.

Building the column.

MIC 0713 Building a Marginal Revenue Column

From a demand schedule, compute total revenue at each quantity, price times quantity, and take marginal revenue between two rows as the change in total revenue. Read the column: it starts at the highest price, falls faster than price, reaches zero where total revenue peaks, and goes negative beyond, and no firm with any cost produces past that zero. The medicine sells one thousand doses at eleven dollars, two at ten, down to eight at four. Total revenue in thousands runs eleven, twenty, twenty-seven, thirty-two, thirty-five, thirty-six, thirty-five, thirty-two; marginal revenue per dose for each added thousand runs eleven, nine, seven, five, three, one, minus one, minus three, passing zero at six thousand. The error is to take the new price as marginal revenue: the third thousand sells at nine but adds only seven, because the first two thousand lost a dollar each.

The shortcut for a straight line.

MIC 0714 The Twice-as-Steep Rule

When demand is a straight line, marginal revenue is a straight line with the same intercept and twice the slope, hitting zero at half the quantity demand does. Demand from twelve dollars to twelve thousand doses gives marginal revenue from twelve dollars to six thousand. The rule holds for straight-line demand only; for a curved demand the column must be computed.

What the sign of marginal revenue says.

MIC 0715 Marginal Revenue and Elasticity

Positive marginal revenue means elastic demand; zero, unit elastic; negative, inelastic. A profit maximizer with any marginal cost never produces where marginal revenue is negative, so it stays on the elastic part: there, raising the price would raise revenue and cut cost. Revenue peaks where marginal revenue is zero, and profit at a smaller quantity, unless marginal cost is zero.

Two entries on the monopolist's choice: the rule, and the full computation.

The rule.

MIC 0716 Profit Maximization: MR = MC, Then Price from Demand

A monopolist produces where marginal revenue equals marginal cost, like every firm, then reads the price off demand at that quantity: above marginal revenue, so above marginal cost. Find the quantity on marginal revenue, then go up to demand. The price is not at the crossing but above it, and reading it at the crossing is the standard error.

The full computation.

MIC 0717 Finding the Monopolist's Quantity, Price and Profit

Three steps. Compare marginal revenue with marginal cost row by row and take every unit whose marginal revenue is at least its marginal cost; the last such row is the quantity. Read the price at that quantity from the demand schedule, not from the marginal revenue column. Compute average total cost there and take price minus average cost, times quantity, for profit; and check that marginal revenue at the chosen row is positive. The medicine's marginal revenue per dose runs eleven, nine, seven, five, three, one against marginal cost of two, two, three, four, five, six. The fourth thousand pays, five against four, and the fifth does not, three against five: four thousand doses. Demand at four thousand says eight dollars. Total cost is the ten-thousand fixed cost plus eleven thousand of variable cost, so average cost is five twenty-five, and profit is two seventy-five times four thousand, eleven thousand dollars a week. Two errors: pricing at the crossing, five dollars, when demand says eight; and treating profit as guaranteed, since a fixed cost of fifty thousand would give the same quantity and a loss, and the shutdown test would apply.

Look at what you can now do. You can define a monopoly as a single seller with no close substitutes, say that its power comes from a barrier, and name the five kinds: cost, a resource, the law, intellectual property, and intimidation. You can classify a barrier from a description by asking which would still block entry, and test a market for natural monopoly by placing demand against long-run average cost and costing the split. You can say that the monopolist's demand curve is the market's, and that where the market ends is an argument about substitutes. You can build a marginal revenue column as the change in total revenue, use the twice-as-steep rule on a straight line, and read elastic, unit elastic or inelastic from marginal revenue's sign. And you can find the monopolist's quantity where marginal revenue meets marginal cost, read its price from demand above the crossing, and compute its profit. Part two asks what that choice costs everyone else.