Types of Markets
Type # firms Product Entry Perfect Competition Large number Homogeneous or standardized Easy Monopolistic Competition Many Differentiated Easy Oligoply Few Either Moderate to high barriers Monopoly One Unique High barriers

Monopoly
Only one seller in the market No competiton from other firms selling the same or closely-related product. Some competition from firms in other markets to the extent that the products might be substitutes in some uses. Example: The electric power company has a monopoly is its geographic area but it faces competition from other energy sources such as natural gas and even wood (for heat).

Causes: Natural Monopoly

Natural monopoly occurs when there are significant economies of scale due to indivisible capital. One firm, operating at minimum efficient scale (output at which all economies of scale have been exploited) can supply the whole market. Entrance of another firm would drive price below average costs. The market is not large enough to support two efficient-sized firms in the long run. Electric power distribution (indivisibilities in the grid of power lines)

Causes: Patent Monopoly
A patent gives the holder the legal right to be the sole producers of a product or user of a new process for 20 years. The US government grants inventors a patent to encourage innovation. Example: new drugs. Other firms can not produce the product without being sued for infringing on the patent. The patent holder therefore has a 20 year monopoly.

Other Causes

Other monopolies are created when government (any level) gives some firm a franchise as the sole supplier of services in a market in return for that firm agreeing to certain conditions. Example: local garbage service, state-licensed liquor stores. Other monopolies come about through the actions of the firm, such as buying out competitors or known sources of a necessary raw material. Most of these actions are illegal but sometimes still occur.

Decision-making in Monopoly
A monopolist will also seek to maximize profits (TR-TC). The monopolist establishes both price and quantity: it is a price setter, not a price taker. In choosing the price and quantity, the monopolist will follow the marginal principle.

Monopolist's demand curve

The monopolist's demand curve is the same as the market demand curve. It can choose whichever point on the demand curve (price, quantity combinations) maximizes profits. The firm can set a high price and sell a small quantity. In order to sell a larger quantity, it would have to set a lower price. If the product is easily resold, the firm must lower the price on all units, not just the additional ones.

Monopolist's Marginal Rvenue

Total revenue (receipts) equals price times quantity To sell a greater quantity, the firm must lower the price on all units. Total revenue increases because additional units are sold but total revenue decreases because the price is lower. Marginal revenue is the change in total revenue as a result of producing an additional unit. MR = change in total revenue / change in output. MR = price (revenue) on the additional unit plus the change in revenue on the intitial units due to a changed price(change in price X initial quantity). Because the firm must cut the price to sell more, the second term is negative. Therefore MR < p.

Short-run Profit-Maximization
Like a competitive firm, the monopolist maximizes profits by increasing output as long as MR > MC so long as total revenues cover total variable costs. If TR < TVC, it shuts down. The difference is that MR < p for a monopolist while MR=p for a competitive firm. One the monopolist determines what output to produce, it charges the highest price which is consistent with selling all these units.

Finding the monopolist's price and output
Find MR. MR = change in TR/change in output. Find MC. MC = change in TC / change in output. Find the largest output at which MR > or = MC. Produce that output unless TR < TVC (p < AVC). If TR < TVC, then shutdown (Q = 0). Find the highest price at which you can sell the quantity determined in the previous steps.

Example

Output 0 1 2 3 4 5 6 7 Price 11 10 9 8 7 6 5 4 TR 0 10 18 24 28 30 30 28 MR - 10 8 6 4 2 0 -2 The firm gets $10 revenue if it sells only one unit. If it increases output by one, it must sell both for $9. It gets $9 on the second unit but it gets $1 less revenue than before from selling the first unit. The net gain is $8. Once the firm moves into the inelastic portion of the demand curve, increasing output causes total revenue to fall.

Example
Output 0 1 2 3 4 5 6 7 Price 11 10 9 8 7 6 5 4 TR 0 10 18 24 28 30 30 28 TVC 0 2 5 9 14 20 27 35 MR - 10 8 6 4 2 0 -2 MC - 2 3 4 5 6 7 8 The firm will increase output as long as MR > MC. The profit-maximizing output is 3 units. The firm can sell at 3 units if it charges $8 but not if it charges more. TR (24) > TVC (9) so the firm will produce, not shutdown.

Monopolist's Short-Run Profits
The monopolist produces that output such that MR = MC and sets price equal to consumers' willingness to pay for that quantity (demand). If total revenue is less than total variable costs, the monopolist should shut down in the short run. Depending on the level of consumer demand and the monopolist's costs of production, short-run profits may be positive, zero, or negative.

Exit from Monopoly
If the monopolist is operating at a loss in the short-run, then in the long run it will either adjust the size of its plant (capital) to lower cost and increase profits or it will exit from the industry. If the firm exits, the product is no longer offered on the market.

Response to short-run profits

Other firms would like to enter the market but barriers to entry make it difficult and unprofitable for them to do so. Overcoming the legal restrictions imposed by patents or government licenses is costly and uncertain. If the established firm controls all the known raw materials and is unwilling to sell any. The entrant would have to explore for new sources, which is costly and time-consuming. Entry is delayed and less likely due to higher costs. Entering on a small scale puts the firm at a cost disadvantage; entering on a large scale is costly, difficult to finance, and drives the price below AC.

Effect of entry barriers
Without entry, there is no market mechanism to drive down the price and eliminate economic profits. Monopolists will earn economic profits (TR > TC) even in the long run.

Comparison to Perfect Competition

A monopolist will produce less and charge a higher price than you'd find in a perfectly competitive market with similar costs. The competitive market produces and sells where p = MC; a monopoly operates such that p > MR=MC Because the marginal revenue curve lies below the demand curve, it will intersect MC at a smaller output. Producing the smaller output allows the monopolist to charge a higher price. The higher price than would be established in a competitive market.

Social Consequences

Some consumer surplus goes instead to the firm (due to higher prices); some is lost as output decreases. Total surplus decreases. The market is NOT efficient. Some beneficial transactions do not occur. The monopolist produces too little. Additional units have a value to consuemrs (the price they're willing to pay) greater than the marginal cost of producing them. It is not in the monopolist's self-interest to produce the additional units because the firm would gain less in revenues (MR) than the marginal cost of producing the units.