Market Power: Monopoly and Monopsony – Study Notes

Market Power: Monopoly and Monopsony

Characteristics of Monopoly

A monopoly is a market structure in which a single firm is the sole producer of a good or service with no close substitutes. This gives the firm significant market power to influence prices and output.

• Nature of Good: The goods sold by a monopoly have no close substitutes.

• Selling Price: The seller is the only firm in the market.

• Market Power: The ability of one person or group to have substantial influence on market price.

• Entry and Exit: Entry to the market is restricted by barriers to entry.

Barriers to entry ensure that a monopoly remains the only producer in a market:

• Ownership of Key Resources: Control over essential resources (e.g., diamonds).

• Government Regulation: Patents grant the sole right to produce a good for a period (usually 20 years).

• Economies of Scale: Large economies of scale make it cheaper for one producer to supply the good (natural monopoly).

Example: Electricity supply is often a natural monopoly due to high fixed costs and economies of scale.

Monopoly vs. Perfect Competition: Demand Curves

The demand curve facing a monopoly firm is the market demand curve for the entire industry, unlike in perfect competition where each firm faces a horizontal demand curve.

• Monopoly Firm: The demand curve is downward sloping; increasing output lowers price.

• Perfect Competition: The demand curve is horizontal; firms are price takers.

	Monopoly Firm	Perfect Competition Firm
Demand Curve	Downward sloping	Horizontal
Increase Output →	P ↓	P = AR = MR

Monopoly Revenue

A monopoly faces a downward-sloping demand curve. A price change has two effects:

• Price Effect: The firm earns less revenue per unit sold because of the price decrease.

• Output Effect: The firm earns more revenue because it sells more quantity at the lower price.

The monopoly's marginal revenue is always less than the price of the good.

Subscribers (Q)	Price (P)	Total Revenue (TR = P × Q)	Average Revenue (AR = TR/Q)	Marginal Revenue (MR = ΔTR/ΔQ)
1	$9	$9	$9	-
2	$8	$16	$8	$7
3	$7	$21	$7	$5
4	$6	$24	$6	$3
5	$5	$25	$5	$1

Formula:

• Total Revenue: $TR = P \times Q$

• Average Revenue: $AR = \frac{TR}{Q}$

• Marginal Revenue: $MR = \frac{\Delta TR}{\Delta Q}$

Profit Maximization in Monopoly

The profit-maximizing quantity for a monopoly occurs where marginal revenue equals marginal cost ($MR = MC$). The corresponding price is found on the demand curve at that quantity.

• Profit or Loss Formula: $\text{Profit} = (\text{Price} - \text{ATC}) \times \text{Quantity}$

• Step 1: Find profit-maximizing quantity where $MR = MC$

• Step 2: Find price on demand curve and ATC at that quantity

Example: Graphs show $MR$, $MC$, $ATC$, and demand curves to illustrate profit maximization.

Economic Profit and Surplus

The economic profit can be found by multiplying the difference between price and average total cost by quantity:

• $\text{Economic Profit} = (P - ATC) \times Q$

At the monopoly's profit-maximizing output:

• Price equals marginal revenue

• Price exceeds marginal cost

• Profit per unit is maximized

Efficiency and Deadweight Loss

A monopoly produces less than the efficient quantity to increase its profit, resulting in deadweight loss and reduced economic efficiency.

	Perfect Competition	Monopoly	Change
Consumer Surplus	High	Lower	Decrease
Producer Surplus	Lower	Higher	Increase
Total Surplus	Maximum	Lower	Decrease

• Productive Efficiency: Monopoly causes a deadweight loss, which represents a loss of productive efficiency.

• Allocative Efficiency: Monopoly produces less than the efficient quantity, reducing allocative efficiency.

Monopsony

A monopsony is a market with a single buyer. In the case of a labor market, there is only one employer. Monopsonies set wages by hiring the quantity of workers where marginal cost of labor equals marginal revenue product.

• In a competitive labor market: Wage = MCL = MRPL

• In a monopsony: Must offer a higher wage to increase employment

Example: A small town with only one major employer (e.g., Walmart).

In a monopsony, a minimum wage law will cause the equilibrium wage and quantity to increase.

Bilateral Monopoly

A bilateral monopoly contains a single buyer and a single seller. This market structure often leads to wage and employment outcomes determined through negotiation.

• Example: A union negotiating with a single employer alliance.

• Wage and employment are set through bargaining.

• Results depend on relative bargaining power.

Antitrust Laws and Government Regulation of Monopolies

Antitrust laws limit the market power that monopolies can gain. Key U.S. statutes include:

• Sherman Act of 1890: Prohibited collusion and price fixing.

• Clayton Act of 1914: Prohibited discriminatory pricing and tying arrangements.

• Federal Trade Commission Act of 1914: Created the FTC to help enforce antitrust laws.

• Robinson-Patman Act of 1936: Prohibited price discrimination that reduced competition.

• Cellar-Kefauver Act of 1950: Prohibited mergers that would reduce competition.

The government can also regulate the prices monopolies can charge, using:

• Socially Optimal Price: Maximizes efficiency and total surplus; may result in losses for the monopoly.

• Fair Return Price: Allows monopoly to earn economic profit; less deadweight loss than unregulated monopoly.

Key Formulas and Concepts

• Profit Maximization: $MR = MC$

• Profit: $\text{Profit} = (P - ATC) \times Q$

• Marginal Revenue: $MR = \frac{\Delta TR}{\Delta Q}$

• Total Revenue: $TR = P \times Q$

Summary Table: Monopoly vs. Perfect Competition

Feature	Monopoly	Perfect Competition
Number of Firms	One	Many
Market Power	High	None
Barriers to Entry	High	Low
Demand Curve	Downward sloping	Horizontal
Price vs. Marginal Cost	$P > MC$	$P = MC$
Efficiency	Lower	Higher

Additional info: These notes expand on brief points from the original study prep, providing full academic context, definitions, and examples for Microeconomics students.