Monopoly

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.