6.2 — Monopoly

Market Power and Profit Maximization

A monopoly exists when a single firm supplies an entire market and no close substitutes are available. Because there is no competition, monopolies have significant control over price and output. This market structure is the least competitive and often raises concerns about consumer welfare.

Monopolies typically exist due to extremely high barriers to entry that prevent new firms from entering the market.

Key Characteristics of a Monopoly

Monopolies share several defining features:

  • One seller dominates the market

  • No close substitutes for the product

  • Very high barriers to entry

  • The firm is a price maker

These characteristics give monopolies a high degree of market power compared to firms in other market structures.

Demand and Revenue for a Monopolist

A monopolist faces the entire market demand curve, which slopes downward. This means that in order to sell more output, the monopolist must lower the price.

Because of this relationship:

  • Average revenue equals the demand curve

  • Marginal revenue lies below the demand curve

  • Selling additional units reduces the price received on earlier units

This makes the monopolist’s revenue structure more complex than that of a perfectly competitive firm.

How a Monopolist Maximizes Profit

A monopolist maximizes profit by producing the level of output where marginal revenue equals marginal cost.

Once this quantity is chosen:

  • The monopolist uses the demand curve to determine the highest price consumers are willing to pay

  • Price is greater than marginal cost

  • Output is lower than in perfect competition

This results in higher prices and restricted output from the consumer’s perspective.

Efficiency and Market Outcomes

Monopolies do not achieve the efficiency outcomes seen in perfect competition.

In a monopoly:

  • Price is greater than marginal cost

  • Price does not equal minimum average cost

  • Allocative efficiency is not achieved

These inefficiencies lead to a loss of consumer surplus and reduced overall welfare.

Government Regulation of Monopolies

Because monopolies can harm consumers, governments often regulate them.

Common regulatory approaches include:

  • Average-cost pricing to allow normal profit

  • Price ceilings to limit excessive prices

  • Public ownership in essential industries

Regulation aims to balance fair prices for consumers with the firm’s ability to cover costs.

Real-World Examples of Monopolies

Monopolies often exist in industries where duplication would be inefficient.

Examples include:

  • Electricity distribution

  • Water services

  • Public transit systems

These are often referred to as natural monopolies and are typically heavily regulated.

Why Monopoly Matters

Monopolies help explain why governments intervene in markets and why competition is encouraged whenever possible.

Understanding monopolies allows economists to:

  • Evaluate market fairness

  • Assess the need for regulation

  • Analyze the impact of market power on consumers

This section completes the study of how different market structures affect demand, pricing, and economic outcomes.