A monopoly is a market with a single firm that produces a good or service for which no close

substitute exists and that is protected by a barrier that prevents other firms from selling that good
or service.

Main characteristics of pure monopoly:

• Single seller A pure, or absolute, monopoly is an industry in which a single firm is the sole
producer of a specific good or the sole supplier of a service; the firm and the industry are
synonymous. In the real world, a monopolistic industry may consist of one firm that dominates
the market with a very large market share. For example, DeBeers Company of South Africa
controls over 80% of diamond sales, and is considered to be a monopoly.

• No close substitutes A pure monopoly’s product is unique in that there are no close substitutes.
The consumer who chooses not to buy the monopolised product must do without it.

• Price maker The pure monopolist controls the total quantity supplied and thus has
considerable control over price; it is a price maker (unlike a pure competitor, which has no such
control and therefore is a price taker). The pure monopolist confronts the usual downward-
sloping product demand curve. It can change its product price by changing the quantity of the
product it produces. The monopolist will use this power whenever it is advantageous to do so.

• Barriers to entry A constraint that protects a firm from potential competitors is called a barrier
to entry. The three types of barrier to entry are ■ Natura(public utilitieslikewater
supply,electricity)l ■ Ownership (firm owns a significant portion of a key resource) ■ Legal
(patent)A monopolist has no immediate competitors because certain barriers keep potential
competitors from entering the industry. Those barriers may be economic, technological, legal, or
of some other type. But entry is totally blocked in pure monopoly.

• Nonprice competition The product produced by a pure monopolist may be either standardized
(as with natural gas and electricity) or differentiated (as with Windows or Frisbees). Monopolists
that have standardized products engage mainly in public relations advertising, whereas those
with differentiated products sometimes advertise their products’ attributes.
Monopoly Price-Setting Strategies

A major difference between monopoly and competition is that a monopoly sets its own price. In
doing so, the monopoly faces a market constraint: To sell a larger quantity, the monopoly must
set a lower price. There are two monopoly situations that create two pricing strategies:

■ Single price ■ Price discrimination

Single Price A single-price monopoly is a firm that must sell each unit of its output for the same
price to all its customers. De Beers sells diamonds (of a given size and quality) for the same
price to all its customers. If it tried to sell at a low price to some customers and at a higher price
to others, only the low-price customers would buy from De Beers. Others would buy from De
Beers’ low-price customers. De Beers is a single-price monopoly.

Price Discrimination When a firm practices price discrimination, it sells different units of a
good or service for different prices. Many firms price discriminate. Microsoft sells its Windows
and Office software at different prices to different buyers. Computer manufacturers who install
the software on new machines, students and teachers, governments, and businesses all pay
different prices. Pizza producers offer a second pizza for a lower price than the first one. These
are examples of price discrimination. When a firm price discriminates, it looks as though it is
doing its customers a favor. In fact, it is charging the highest possible price for each unit sold and
making the largest possible profit.
Demand and revenue curves under monopoly

Since the pure monopolist is the entire industry, the demand curve it faces is the industry or
market demand curve, which is downward-sloping. The monopolist is a pricemaker with a
significant degree of market power

The monopolist’s revenue curves

In perfect competition where the firm is a price-taker, the market-determined price is constant for
all output, leading to the perfectly elastic (horizontal) demand curve. But when a firm faces a
downward-sloping demand curve, price is no longer constant for all output: more output can only
be sold at a lower price. Table provides the data for a monopolist’s total, marginal and average
revenues, and the diagrams in Figure plot these data.
• As price (P) falls, output (Q) increases because of the downward-sloping demand curve). Total
revenue (TR), obtained by Q×P, at first increases, reaches a maximum at six and seven units of
output, and then begins to fall.

• Marginal revenue, showing the change in total revenue resulting from a change in output, falls
continuously; MR is equal to zero when total revenue is at its maximum (at seven units of
output), and becomes negative when total revenue falls.2

• Average revenue (column 5) is equal to price (see column 2). At any level of sales, price
equals average revenue, so the demand curve is also the monopolist’s average revenue
curve. All along the demand curve, price equals average revenue. Therefore, the demand curve
is also the monopolist’s average revenue curve

• The MR curve lies below the demand curve. The reason is that, unlike in perfect competition,
where MR = P, here the firm must lower its price in order to sell more output. The lower price is
charged not only for the last unit of output but all the previous units of output sold

The monopolist’s output and price elasticity of demand

In the range of output where total revenue is increasing and marginal revenue is positive,
the demand curve facing the firm is price elastic (PED > 1);. In the range of output where total
revenue is falling and marginal revenue is therefore negative, the demand curve is price inelastic
(PED < 1). Total revenue is maximum, and MR = 0 where PED = 1. These observations have
important implications for the level of output produced by the monopolist.

The implication is that a monopolist will never choose a price-quantity combination

where price reductions cause total revenue to decrease (marginal revenue to be negative). The
profit-maximizing monopolist will always want to avoid the inelastic segment of its demand
curve in favor of some price-quantity combination in the elastic region. Here’s why: To get into
the inelastic region, the monopolist must lower price and increase output. In the inelastic region a
lower price means less total revenue. And increased output always means increased total cost.
Less total revenue and higher total cost yield lower profit.
 .When demand is elastic, a decrease in price increases total revenue. Therefore, where
demand is elastic, marginal revenue is positive, and total revenue increases as the price falls. On
the other hand, where demand is inelastic a decrease in price reduces total revenue.

A profit-maximizing monopolist would never willingly expand output to where demand

is inelastic because doing so would reduce total revenue.
 Price and Output Decision (Firm’s profit maximising output level)

The monopolist determines the profit-maximising (or loss-minimising) level output using
the MC = MR rule. A monopoly sets its price and output at the levels that maximize economic
profit. To determine this price and output level, we need to study the behavior of both cost and
revenue as output varies..

We know the firm is a monopoly from the demand data in the first two columns. These
columns show that price must be lowered to sell more output, indicating that the firm’s demand
curve slopes downward. Multiplying price times quantity for each output yields total revenue, as
shown in column (3). Column (4) identifies the long-run total cost (TC) of producing each
output. Since profit () is the difference between total revenue and total cost, the firm selects the
output where total revenue exceeds total cost by the largest possible amount. This occurs at an
output of 7 and a price of $8.80. At that output, profit is $12.21 and MR=MC.

To see that profit is maximized where MR=MC, note that marginal revenue exceeds
marginal cost at output levels less than 7 units, indicating that the firm can increase profit by
expanding output, but to do so, it must lower price. At output levels greater than 7 units,
marginal cost exceeds marginal revenue, and the firm can increase profit by reducing output and
raising its price.
Short-Run Losses and the Shutdown Decision

Although a monopolist is the sole supplier of a good with no close substitutes, the
demand for that good may not generate economic profit in either the short run or the long run. In
the short run, the loss-minimizing monopolist, like the loss-minimizing perfect competitor, must
decide whether to produce or to shut down. If the price covers average variable cost, the firm
will produce. If not, the firm will shut down, at least in the short run.

Loss minimization occurs in figure at point e, where the marginal revenue curve
intersects the marginal cost [Link] the equilibrium rate of output, Q, price p is found on the
demand curve at point [Link] price exceeds average variable cost, at point c, but is below
average total cost, at point a. Because price covers average variable cost and makes some
contribution to average fixed cost, this monopolist loses less by producing Q than by shutting
down. The average loss per unit, measured by ab, is average total cost minus average revenue, or
price. The loss, identified by the shaded rectangle, is the average loss per unit, ab, times the
quantity sold, Q. The firm will shut down in the short run if the average variable cost curve is
above the demand curve, or average revenue curve, at all output rates. But the monopolist will
continue to produce rather than shut down in the short run because price exceeds average
variable cost (at point c).

The intersection of a monopolist’s marginal revenue and marginal cost curves identifies
the profit-maximizing (or loss-minimizing) quantity, but the price is found up on the demand
curve. Because the equilibrium quantity can be found along a monopolist’s marginal cost curve,
but the equilibrium price appears on the demand curve, no single curve shows both price and
quantity supplied. Because no curve reflects combinations of price and quantity supplied, there is
no monopolist supply curve.

Long-Run Profit Maximization

For perfectly competitive firms, the distinction between the short run and the long run is
important because entry and exit of firms can occur in the long run, erasing any economic profit
or loss. For the monopolist, the distinction between the short run and long run is less important.
If a monopoly is insulated from competition by high barriers that block new entry, economic
profit can persist in the long run. Under monopoly, high barriers to entry prevent potential
competitor firms from entering a profit making industry, and the monopolist can therefore
continue making economic (supernormal) profits indefinitely in the long run. Yet short-run profit
is no guarantee of long-run profit.
For example, suppose the monopoly relies on a patent. Patents last only so long and even
while its product is under patent, the monopolist often must defend it in court (patent litigation
has increased more than half in the last decade). On the other hand, a monopolist may be able to
erase a loss (most start-up firms lose money initially) or increase profit in the long run by
adjusting the scale of the firm or by advertising to increase demand. A monopolist unable to
erase a loss will leave the market.
Monopoly market outcomes and efficiency

Higher price and lower output by the monopolist compared to the industry in perfect
competition

A comparison of monopoly with perfect competition at the level of the industry reveals
that price is higher and quantity of output produced lower in monopoly. Figure shows the long-
run equilibrium positions of a perfectly competitive industry, composed of many small firms,
and of a monopoly, which is the entire industry.

Part (a) for the perfectly competitive industry shows equilibrium price and quantity to be
Ppc and Qpc, Point a, where the industry demand and supply curves intersect, appears also in
part (b), showing what would happen to price and quantity if the perfectly competitive industry
were organised as a monopoly. The MC curve of part (a), or the competitive industry’s supply
curve becomes the monopolist’s marginal cost curve.4 The demand curve remains unchanged,
but the monopolist’s marginal revenue (MRm) curve lies below D. When the profit-maximising
monopolist applies the MR = MC, the result is output Qm and price Pm.

Allocative inefficiency: loss of consumer and producer surplus

Whereas the perfectly competitive industry achieves allocative efficiency shown by MB

= MC and maximum social surplus, monopoly does not.. In part (a), area A represents consumer
surplus, while area B is producer surplus, with A + B showing maximum social surplus. Part (b)
shows the inefficiencies that result in monopoly.

• Area C, consumer surplus in monopoly, is smaller than area A in perfect competition.

Part of A was converted into producer surplus because of the higher monopoly price (Pm rather
than Ppc), and another part of A was lost as triangle E because of the lower monopoly quantity
(Qm rather than Qpc). Area E represents a welfare (deadweight) loss.

• Area D, producer surplus in monopoly, shows that producer surplus has increased by
taking away a portion of consumer surplus (due to the monopolist’s higher price), and it has also
decreased by losing area F (due to the monopolist’s lower quantity). Area F is also a welfare
(deadweight) loss.

• E + F represents loss of social benefits (consumer and producer surplus) due to

monopoly’s higher price and lower quantity.

Allocative inefficiency: P > MC

Figure shows the long-run equilibrium position of the firm in perfect competition and monopoly.
 The condition for allocative efficiency is given by P = MC at the profit-maximising level
of output. In Figure, the profit-maximising level of output Qm, the monopolist’s price, Pe, is
higher than marginal cost. This is hardly surprising, since P > MC is the same as MB > MC
(since P = MB), Therefore, we conclude once again that the monopolist does not achieve
allocative efficiency.

Productive inefficiency: production at higher than minimum ATC The condition for
productive efficiency is that production takes place at minimum ATC

The output produced by the monopolist, Qm, is not at the point of minimum ATC. At Qm, the
monopolist’s average total costs (ATC) are higher than minimum ATC; therefore, there is
productive inefficiency.

Lack of competition in monopoly may lead to higher costs (X-inefficiency)

Whereas in perfect competition firms are under constant pressure to produce with the lowest
possible costs to survive, in monopoly the lack of competition can make the monopolist less
concerned about keeping costs low. Higher costs could arise due to poor management, a poorly
motivated workforce, lack of innovation and use of new technologies. This is known as X-ineffi
ciency, defined as producing at a higher than necessary ATC. This is a separate issue from the
lack of productive efficiency noted above. Lack of productive efficiency means that while the
firm does not produce at the point of minimum ATC, it does produce at some point on the ATC
curve. X-inefficiency indicates that the firms’ costs are higher than ATC, shown in Figure.
Price Discrimination
The monopolist need not charge single price to all buyers. Under certain conditions the
monopolist can increase its profit by charging different prices to different buyers. In so doing,
the monopolist is engaging in price discrimination, the practice of selling a specific product at
more than one price when the price differences are not justified by cost differences. Price
discrimination can take three forms:

• Charging each customer in a single market the maximum price she or he is willing to pay.
• Charging each customer one price for the first set of units purchased and a lower price for
subsequent units purchased.
• Charging some customers one price and other customers another price.

Conditions
The opportunity to engage in price discrimination is not readily available to all sellers. Price
discrimination is possible when the following conditions are met:

• Monopoly power The seller must be a monopolist or, at least, must possess some degree of
monopoly power, that is, some ability to control output and price.

• Market segregation At relatively low cost to itself, the seller must be able to segregate buyers
into distinct classes, each of which has a different willingness or ability to pay for the product.
This separation of buyers is usually based on different price elasticities of demand, as the
examples below will make clear.

No resale The original purchaser cannot resell the product or service. If buyers in the low-price
segment of the market could easily resell in the high-price segment, the monopolist’s price
discrimination strategy would create competition in the high-price segment. This competition
would reduce the price in the high-price segment and undermine the monopolist’s price-
discrimination policy. This condition suggests that service industries such as the transportation
industry or legal and medical services, where resale is impossible, are good candidates for price
discrimination.
Three types of price discrimination
In auction, consumer bids price up to their reservation price.
Other forms of price discrimination

3. Two-part tariff

Bundling
You must have come across campaigns of the following kind. “Buy one, get the second at half-
price”. A camera is sold in a box with a free film; a hotel room often comes with accompanying
breakfast. These are examples of Bundling. Bundling is the practice of selling two or more
separate products together for a single price i.e. bundling takes place when goods or services
which could be sold
separately are sold as a package. A codification of bundling practices and
definitions of selling strategies

Dumping can be categorized into three types: persistent, predatory, and sporadic. Persistent
dumping occurs when a domestic monopolist consistently seeks to maximize overall profits by
charging a higher price in the domestic market while offering a lower price internationally to
compete with foreign producers, a practice known as international price discrimination.
Predatory dumping involves temporarily selling a product at a price lower than its cost or below
market rates in foreign markets to eliminate competition. Once rival producers are driven out, the
company raises prices to capitalize on its newfound monopoly. Sporadic dumping happens
occasionally when a company sells excess stock at a lower price internationally than
domestically to clear an unexpected surplus without reducing domestic prices.

Trade restrictions are implemented to counteract predatory dumping and protect domestic
industries from unfair foreign competition. These measures, often in the form of antidumping
duties, aim to neutralize price disparities. However, identifying the exact nature of dumping can
be challenging, and domestic producers frequently advocate for protection against all forms of
dumping. While persistent and sporadic dumping can adversely affect domestic producers, it
benefits consumers by providing access to lower-priced goods, and these consumer gains may
outweigh potential producer losses.

Bilateral Monopoly
MONOPSONY