Monopoly is a market where there is an exclusive seller of a product for which there are no good substitutes, and there are high entry barriers for that product.
A monopoly faces a downward sloping demand curve and this firm may choose to produce at any point on the market demand curve.
To maximize profits, a monopolist will choose to produce the output level for which marginal revenue is equal to marginal cost (MR = MC). For the monopoly firm, the price is higher than the marginal revenue due to the downward sloping demand curve. Since MR = MC at the profit-maximizing output and P > MR for a monopolist, the monopolist will set a price greater than marginal cost.
Monopoly profits will be positive as long as the market price exceeds average cost. Profit represents the difference between price and ATC times the number of units of output sold. If the ATC curve of a monopolist is above its demand curve (i.e., demand for the product is not high enough), economic losses will result. Therefore, the profitability of a monopolist is limited by the demand for its product. The monopolist, however, has considerable pricing power and can charge a higher price for its unique product. Monopoly profits can continue into the long run because entry is not possible some economists refer to the profits that monopolies earn in the long run as monopoly rents the return to the factor that forms the basis of the monopoly.
A monopoly is inefficient. It restricts output and sells for a price higher than the equilibrium price, creating a deadweight loss. Consumer surplus decreases because consumers must pay more for the goods and because they are getting less of the good than demanded. Producers gain from higher prices, but lose because they are producing less than the equilibrium quantity. Monopolies produce less at a higher cost and increase price at a level greater than the increased cost of production. Monopolies also redistribute surpluses. Some of the lost consumer surplus goes to the monopoly producer. When there is perfect competition, the firm has no pricing ability and must accept the market price.
Another cost of a monopoly is rent seeking, working to take part of a consumer or producer surplus or economic profit. For example, a part of a monopoly’s economic profit comes from taking part of the consumer surplus for itself. Rent seekers may either buy or create a monopoly to obtain excess profits. An example of rent seeking behavior is expending resources to get Congress to pass protections like quotas and tariffs that will benefit a limited group of producers. Rent seeking behavior can reach equilibrium, so only a normal profit and not a monopoly profit is made. For example, suppose there are a limited number of seats on the New York Stock Exchange (whose members can make profits because of their greater knowledge about trading in their securities). In equilibrium, the price of a seat on the exchange will be bid up to the point where only normal profits, not monopolistic profits, can be made.
Price discrimination is when a seller charges different prices for the same product or service.
In order to gain from price discrimination, price-searchers must be able to:
- Recognize and separate at least two groups with varying elasticities of demand
- Ensure that those who buy at low prices do not resell to customers who are charged higher prices
Under price discrimination, groups with the most inelastic demand are charged high prices and groups with more elastic demand are charged low prices. Therefore, under price discrimination, inelastic consumers are worse off while elastic consumers are better off. Allocative efficiency is enhanced under price discrimination because more output is produced overall. If the firm can divide its customers into groups with differing demand elasticities, and it can control reselling, the firm may be able to gain from price discrimination by charging higher prices to inelastic demand groups and lower prices to elastic demand customers. It can also increase total gains from trade and allow production where otherwise there would be no production. Generally, producer surplus is increased, while total consumer surplus is decreased.
Perfect price discrimination occurs when a producer can sell its output for the highest prices that anyone will pay. In this case, the monopolist captures all of the consumer surplus. Here, the market demand curve and marginal revenue curves are the same. It is to the producers’ advantage to lower the price, say through advertised specials, and sell additional units (still keeping the higher price for those willing to pay it). The producer will sell until MR = MC. This is efficient, but instead of consumers and producers sharing the surplus, the producer captures all of it.
A natural monopoly is a situation in which one firm can produce the total output of the market at lower cost than several firms could.Believing that they are natural monopolies, governments frequently grant monopoly rights to public utilities to provide essential goods or services such as water, gas, electric power, or mail delivery.