Monopoly: Output and Price Decisions in Microeconomics

Monopoly

Monopoly and How It Arises

A monopoly is a market structure in which a single firm is the sole producer of a good or service with no close substitutes. Monopolies arise due to barriers that prevent entry by other firms.

• Barriers to Entry: Factors that prevent other firms from entering the market, such as:

  • Ownership of a vital resource

  • Government regulation (e.g., patents, licenses)

  • Natural monopoly (when a single firm can supply the entire market at a lower cost than multiple firms)

• Examples: Canada Post, London Hydro

Single-Price Monopoly’s Output and Price Decision

Price, Marginal Revenue, and Marginal Cost

A single-price monopoly charges the same price to all customers. The firm faces the market demand curve and must lower its price to sell more units.

• Total Revenue (TR): The price (P) multiplied by the quantity sold (Q).

• Marginal Revenue (MR): The change in total revenue from selling one more unit.

For a single-price monopoly, marginal revenue is less than price at each level of output:

$MR < P$

Calculating Marginal Revenue

• Suppose the monopoly sets a price of $16 and sells 2 units:

• $TR = 16 \times 2 = 32$

• If the price drops to $14 to sell 3 units:

• $TR = 14 \times 3 = 42$

• Marginal revenue for the third unit:

• $MR = 42 - 32 = 10$

• Thus, $MR < P$ for each price level.

Profit Maximization

• The monopoly maximizes profit by producing the quantity where marginal revenue equals marginal cost:

• $MR = MC$

• The monopoly sets the highest price at which it can sell the profit-maximizing quantity (found on the demand curve).

Economic Profit

• Economic profit is the difference between total revenue and total cost.

• Monopolies can earn economic profit in the long run because barriers to entry protect them from competition.

Single-Price Monopoly and Competition Compared

Perfect Competition

• Equilibrium occurs where quantity demanded equals quantity supplied at price $P_c$ and quantity $Q_c$.

• Firms are price takers; $P = MR = MC$.

• Total surplus (consumer + producer surplus) is maximized, and the outcome is efficient.

Monopoly

• Equilibrium output $Q_m$ occurs where $MR = MC$.

• Equilibrium price $P_m$ is found on the demand curve at $Q_m$.

• Compared to perfect competition, a monopoly produces a smaller output and charges a higher price.

• Monopoly results in a deadweight loss because price exceeds marginal cost, reducing total surplus and causing inefficiency.

Summary Table: Monopoly vs. Perfect Competition

Market Structure	Output	Price	Efficiency	Profit in Long Run
Perfect Competition	Higher ($Q_c$)	Lower ($P_c$)	Efficient (maximized total surplus)	Zero (entry eliminates profit)
Monopoly	Lower ($Q_m$)	Higher ($P_m$)	Inefficient (deadweight loss)	Possible (barriers to entry)

Key Formulas

• Total Revenue: $TR = P \times Q$

• Marginal Revenue: $MR = \Delta TR / \Delta Q$

• Profit Maximization: $MR = MC$

Summary

• Monopolies arise due to barriers to entry and can earn long-run economic profit.

• A single-price monopoly sets output where $MR = MC$ and charges the highest price consumers are willing to pay for that quantity.

• Compared to perfect competition, monopolies produce less, charge more, and create deadweight loss (inefficiency).

Additional info: Diagrams referenced in the slides typically show the demand, marginal revenue, marginal cost, and average total cost curves, with profit-maximizing output and price marked. Deadweight loss is illustrated as the area between the demand and marginal cost curves for the units not produced by the monopoly.