Economics 1021A Chapter 13 20131125
A monopoly is a market:
That produces a good or service for which no close substitute exists
In which there isone supplier that is protected from competition by a barrier preventing the entry of new
A monopoly is a price setter, not a price taker like a firm in perfect competition.
The reason is that the demand for the monopoly’s output is the market demand.
To sell a larger output, a monopoly must set a lower price.
A monopoly has two key features:
No close substitutes
If a good has a close substitute, even if it is produced by only one firm, that firm effectively faces
competition from the producers of the substitute.
A monopoly sells a good that has no close substitutes.
Barriers to entry
A constraint that protects a firm from potential competitors are called a barrier to entry. Three types of
barriers to entry are:
A natural monopoly is a market in which economies of scale enable one firm to supply the entire
market at the lowest possible cost.
In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the
entire market demand is met.
An ownership barrier to entry occurs if one firm owns a significant portion of a key resource.
A legal monopoly is a market in which competition and entry are restricted by the granting of a:
Public franchise (like Canada Post, a public franchise to deliver firstclass mail)
Government license (like a license to practice law or medicine)
Patent or copyright
There are two types of monopoly pricesetting strategies: A singleprice monopoly is a firm that must sell each unit of its output for the same price to all its
For a singleprice monopoly, marginal revenue is less than price at each level of output.
A singleprice monopoly’s marginal revenue is related to the elasticity of demand for its good:
If demand is elastic, a fall in price brings an increase in total revenue.
The monopoly selects the profitmaximizing quantity in the same manner as a competitive firm, wheMR
= MC .
The monopoly might make an economic profit, even in the long run, because the barriers to entry protect
the firm from market entry by competitor firms.
A singleprice monopoly never produces an output at which demand is inelastic.
If it did produce such an output, the firm could increase total revenue, decrease total cost, and increase
economic profit by decreasing output.
Compared to perfect competition, monopoly produces a smaller output and charges a higher price.
Because price exceeds marginal social cost, marginal social benefit exceeds marginal social c st, and a
deadweight loss arises.
Some of the lost consumer surplus goes to the monopoly as producer surplus.
Price discrimination is the practice of selling different units of a good or service for different prices.
Many firms price discriminate, but not all of them are monopoly firms.
To be able to price discriminate, a monopoly must:
Identify and separate different buyer types.
Sell a product that cannot be resold.
Price differences that arise from cost differences are not price discriminat