MONOPOLY

Monopoly and market power

• Perfect competition: Price takers and the horizontal demand curve
• Imperfect competition: Price setters and the downward sloping demand curve
• Market power: The ability of price-setting firms to raise prices without losing
all sales
• Measures of market power
• Elasticity of demand: Market power is inversely related to elasticity of demand
𝑃−𝑀𝐶
• Lerner index (= 𝑃
): Market power is directly related to the Lerner index

• Cross-price elasticity of demand: Market power is inversely related to the cross-price

elasticity of demand
Monopoly and market power
• Pure monopoly: Market structure characterized by the existence of a
single firm who is the sole producer of a product for which there are no
close substitutes.
• Characteristics of monopoly market:
• Single seller of a product. Firm and industry are synonymous.
• No close substitutes for the products sold by a monopolist.
• Price setter: Pure monopolist has considerable control over the price of the
product
• Barriers to entry restrict competitors from entering the market ensuring super-
normal profits in the long-run.
Why do monopolies arise?
• Economies of scale: A single firm operating at a large scale can produce
the product at a much lower cost than many small firms.
Why do monopolies arise?
• Barriers created by the government: Licenses and patents create barriers
for the entry of new firms.
• Control of an essential input can also lead to a monopoly. E.g. De Beers
company and diamond market monopoly; Alcoa company and the
aluminum market monopoly
Demand and marginal revenue under monopoly
The short-run output decision: Maximising profits
1 2 2 3 4 5 6 7

Quantity Price Total Total Profit Marginal Marginal Change in

(𝑸) (𝑷 = 𝑨𝑹) Revenue Cost (𝐓𝐑 − 𝐓𝐂) Revenue Cost profit
(𝐓𝐑) (𝐓𝐂) 𝐌𝐑 =
∆𝐓𝐑
𝐌𝐂 =
∆𝐓𝐂 𝐌𝐑 − 𝐌𝐂
∆𝐐 ∆𝐐

0 12 0 3 -3 — — —
1 11 11 5 4 11 2 9
2 10 20 8 12 9 3 6
3 9 27 12 15 7 4 3
4 8 32 17 15 5 5 0
5 7 35 23 12 3 6 -3
6 6 36 30 6 1 7 -6
7 5 35 38 -3 -1 8 -7
8 4 32 47 -15 -3 9 -12
The short-run output decision: Maximising profits
The short-run output decision: Minimising loss
1 2 2 3 4 5 6 7 8

Quantity Price Total Total Profit Marginal Marginal Total Average

(𝐐) (𝐏 = 𝐀𝐑) Revenue Cost (𝐓𝐑 − Revenue Cost Variable Variable
(𝐓𝐑) (𝐓𝐂) 𝐓𝐂) 𝐌𝐑 =
∆𝐓𝐑
𝐌𝐂 =
∆𝐓𝐂 Cost Cost
∆𝐐 ∆𝐐 𝐓𝐕𝐂 𝐀𝐕𝐂
0 12 0 23 -23 — — 0 —
1 11 11 25 -14 11 2 2 2
2 10 20 28 -8 9 3 5 2.50
3 9 27 32 -5 7 4 9 3
4 8 32 37 -5 5 5 14 3.25
5 7 35 43 -8 3 6 20 4
6 6 36 50 -14 1 7 27 4.50
7 5 35 58 -23 -1 8 35 5
8 4 32 67 -25 -3 9 44 5.5
The short-run output decision: Minimising loss
The long-run output decision
1 2 2 3 4 5 6 7

Quantity Price Total Total Profit Marginal Marginal Change in

(𝑸) (𝑷 = 𝑨𝑹) Revenue Cost (𝐓𝐑 − 𝐓𝐂) Revenue Cost profit
(𝐓𝐑) (𝐓𝐂) 𝐌𝐑 =
∆𝐓𝐑
𝐌𝐂 =
∆𝐓𝐂 𝐌𝐑 − 𝐌𝐂
∆𝐐 ∆𝐐

0 12 0 3 -3 — — —
1 11 11 5 4 11 2 9
2 10 20 8 12 9 3 6
3 9 27 12 15 7 4 3
4 8 32 17 15 5 5 0
5 7 35 23 12 3 6 -3
6 6 36 30 6 1 7 -6
7 5 35 38 -3 -1 8 -7
8 4 32 47 -15 -3 9 -12
The long-run output decision
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