PCM - Monopoly Lesson
Monopoly Lesson
A monopoly is the opposite of perfect competition. For a monopoly to exist, there can only be one seller of goods for which there are no close substitutes. While there are certain instances when monopoly power is justified, generally monopolies are viewed negatively due to the inefficiencies they produce in the market.
Monopoly Video
View the video below to learn more about a monopoly. To make the video full screen, click the double arrows at the bottom right corner of the object.
Characteristics of Monopolies
- Only one seller of a good
- Good produced has no close substitutes
- The market demand curve is the demand curve for the monopolist
- The monopolist is a price maker; to sell more, price must be lowered
- Barriers to entry: entry is effectively barred
- Positive long run profits are possible
- D = Price = Average Revenue
- Price > Marginal Revenue
Why is P > MR for a Monopoly?
Perfect competition is a unique market structure in that it is the only structure in which price is synonymous with marginal revenue. In all other structures (monopoly, monopolistic competition, and oligopoly), price (which will always be found on the demand curve) is greater than marginal revenue. This is because firms operating in these market structures all have some degree of price-making ability. Therefore, if they want to sell more of a good or service, the price must decrease. However, the price decrease is applied to all previous units of the good and not just the next unit a firm wants to sell.
|
Price |
Quantity |
Total Revenue PxQ |
Average Revenue TR/Q |
Marginal Revenue ΔTR/ΔQ |
|---|---|---|---|---|
|
$5.00 |
1 |
$5.00 |
$5.00 |
$5.00 |
|
$4.00 |
2 |
$8.00 |
$4.00 |
$3.00 |
|
$3.00 |
3 |
$9.00 |
$3.00 |
$1.00 |
|
$2.00 |
4 |
$8.00 |
$2.00 |
-$1.00 |
If the monopoly wants to sell more of its good, it must lower the price. As you can see, total revenue first increases and then begins to decrease. This is related back to the elasticity ranges of a linear demand curve. Demand, which is plotted using P and Q, will lie above the MR curve, which is plotted using MR and Q. A monopoly will never produce in the inelastic portion of its demand curve. In this case, the inelastic portion of the demand curve includes prices below $3.00. We know this is the inelastic range because of the total revenue test (when price and total revenue move in the same direction, demand is inelastic). By producing quantities beyond the 3rd unit, the firm's total revenue will decrease while its costs of production increase. This has a detrimental impact on profit.
As you can see, price is greater than marginal revenue as the quantity sold increases. Graphically, this results in the demand curve (which is created using price and quantity) lying above the marginal revenue curve (which is created using marginal revenue and quantity).
Pure Monopoly
View the video below to learn more about profit maximization, revenue maximization, and the price elasticity of demand (PED) for a monopolist. To make the video full screen, click the double arrows at the bottom right corner of the object.
Graphing the Monopoly Activity
Like perfectly competitive firms, monopolies can earn a positive profit, breakeven, or earn a loss. However, monopolies can sustain positive profit in the long run because entry is barred. If the monopoly is earning a loss, it must evaluate if it should operate through the loss or shutdown. Move through the activity below to learn more about the different profit graphs for a monopoly.
Special Monopoly Scenario: The Natural Monopoly
A natural monopoly exists when it is more efficient for one firm to produce a good rather than multiple firms. More efficient "means the overall cost of production is lower when just one firm produces the good or service. An example of a natural monopoly might be a power company. It is more cost effective to allow a power company to supply power to given geographic areas. It would raise costs if competing power companies all tried to service a given neighborhood (each company would run its own poles and lines, etc). Natural monopolies are allowed to exist, but the government usually regulates the pricing policies of natural monopolies to protect the consumer. Steps the government takes to regulate natural monopolies will be discussed in a future module.
Government Regulation of a Monopoly Video
View the video below to learn more about the impact of government regulations. To make the video full screen, click the double arrows at the bottom right corner of the object.
IMAGES CREATED BY GAVS