Monopoly

Monopolists are single suppliers to a market, with no competitors.

Monopolists can emerge in a market for several reasons, including:

  1. The firm has exclusive ownership of a scarce resource, such as owning the rail track in a country.
  2. The firm is the first one in a market - in market economies this is likely to be short lived as new firms enter the market. However, new entrants can receive protection by way of time-limited patents, copyright laws or trade marks.
  3. Similarly, monopolists can emerge as a result of the impact of barriers to entry in a market, including high set-up costs, the unavailability of economies of scale which have already been exploited by the first firm in the market, and deliberate barriers.
  4. Barriers that are deliberately designed to limit entry include 'limit pricing' - where price is reduced to the level that limits new entrants, merging with or taking over a potential rival, and controlling the supply chain through exclusive contracts and other restrictive practices.
  5. The firm is granted monopoly status by the country's government.

Profits

When one or more of these conditions are met, the monopolist can derive super-normal profits - that is, profits above normal profits. Normal profits are those which just cover the entrepreneur's opportunity cost.

If the firm can maintain its position as a monopoly supplier it can make supernormal profits into the long run.

Assuming the firm is a profit maximiser it will produce up to the output where the marginal cost of producing and supplying one more unit of output exactly equals the marginal revenue gained by the firm from selling that one unit of output - hence the profit maximising rule: MC=MR.

Supernormal profits are shown in the graph as area P A B C.

General diagram for a monopolist

Losses

Monopolist can also make losses, when average costs exceed average revenue. In this case, with an average cost curve of ATC1, losses are the area: N V A P.

Here we can see the area representing losses:

Monopolist making losses

Monopoly power

Some firms that are not pure monopolies can derive a level of 'monopoly power' as a result of having limited competition in the market. Markets with only a few firms are referred to as oligopolies.

As well as maximising profits, features of monopoly include:

  1. Different pricing strategies - monopolists can charge different prices to achieve different objectives, given that they are price makers. Depending on market conditions, they can set various prices. At point ‘A’ (price P) in the first diagram, maximum profits are made as marginal cost equals marginal revenue. Point ‘K’ (price M) is the price required to maximise revenue - here, marginal revenue is zero so any further output creates a negative marginal revenue, which reduced total revenue below its maximum. At point ‘L’ (price R) sales volume is maximised - maximising sales volume occurs when the firm sells as much as it can without making a loss.
  2. They can retain their dominance - monopolists can retain their power by erecting deliberate barriers to entry, including spending on advertising, limit pricing and predatory acquisition of potential rivals.
  3. Monopolists can restrict output - as well as set prices, monopolists can restrict output, although they cannot set a price and restrict output at the same time. Setting high prices or restricting output are regarded as anti-competitive practices.

Video on monopoly and monopoly power

Example

Consider the following example of costs and revenue for a hypothetical firm.

Quantity P=AR TR MR FC VC TC AC MC Profit
0 45 0   10 0 10     -10
1 40 40 40 10 8 18 8 8 22
2 35 70 30 10 10 20 5 2 50
3 30 90 20 10 12 22 4 2 68
4 25 100 10 10 22 32 5.5 10 68
5 20 100 0 10 42 52 8.4 20 48
6 15 90 -10 10 75 85 12.5 33 5
7 10 70 -20 10 119 129 17 44 -59
8 5 40 -30 10 172 182 21.5 53 -142

Monopolist example

From the example we can observe the following:

  1. Profit maximisation occurs at output 4, which is where MC = MR.
  2. Profits are 68, shown in the table and also highlighted in the graph.
  3. Revenue maximisation occurs at output 5, which is where MR = 0.
  4. Sales maximisation is at output 6. (The highest volume of sales without making a loss).
  5. The general observation that, if demand (the AR curve) slopes downwards, then profit, revenue and sales maximisation all occur at different prices and outputs.

Monopsonies

In addition to monopolies as single sellers, some firms may be single buyers, called monopsonists.

Monopsonists may be able to exert considerable market power over suppliers, by:

  1. Dictating the price they are prepared to pay from suppliers, who may be much smaller, and cannot exert power in negotiations. This might include demand discounts from suppliers.
  2. Dictating terms and conditions of business.
  3. Delaying payments - a particular problem for small suppliers.
  4. This means that they can reduce their costs, and if this is not passed on to consumers, it will mean increasing their profits.

 

Monopoly and welfare loss

Natural monopolies

Oligopolies

Exercise

Look at the partly completed table below and answer the questions:

  1. Complete the table
  2. Draw a graph to show average revenue, marginal revenue, average cost and marginal cost.
  3. Identify profit, revenue and sales maximisation points,
  4. Show the area for super-normal profits on your graph.

Quantity P=AR TR MR FC VC TC AC MC Profit
0 110     20 80        
1 105     20 100        
2 100     20 112        
3 95     20 122        
4 90     20 142        
5 85     20 170        
6 80     20 220        
7 75     20 288        
8 70     20 380        
9 65     20 490        
10 60     20 640        
11 55     20 840        
12 50     20 1080        
13 45     20 1380        

go to answer


Check your knowledge

Monopoly

Try a quiz on monopoly.

Go to monopoly quiz


Perfect competition

More on perfect competition.

Perfect competition
Oligopoly

What are the disadvantages of oligopoly?

Oligopoly
Game theory

How does game theory explain oligopoly?

Game theory

facebook link logo twitter link logo email link logo whatsapp link logo gmail link logo google classroom link logo