196 Putting It Together: Monopoly

Summary

The goal of this module was analyze a firm’s profit maximizing strategies under conditions of monopoly.  You learned how to:

• Define the characteristics of a monopoly. A monopoly occurs when a single firm supplies the whole market for some product. Because they face no direct competition, monopolies can charge any price they want and earn economic profits, even in the long run.
• Define and explain the sources of barriers to entry. Barriers to entry are economic or legal prohibitions on other firms entering an industry to capture some of the monopoly’s profits.
• Calculate and graph a monopoly’s fixed, variable, average, marginal and total costs. Costs are computed and cost curves graphed the same way as in perfect competition. This is one of the similarities across market structures.
• Explain why a monopoly is inefficient using deadweight loss. Allocative inefficiency occurs when firms produce less than the optimal supply, which monopolies do to allow them to charge a higher price. Deadweight loss is the loss in total surplus (producer + consumer surplus) that occurs at output less than the optimal one.
• Analyze different strategies to control monopolies, including natural monopolies. Governments use laws and regulation to reduce the inefficiency of monopolies. Regulated monopolies supply more than they otherwise would in return for a guaranteed profit.

Examples

Why are monopolies bad? It’s not primarily because they charge too high a price. Rather, it’s because they are allocatively inefficient, in other words, they produce too little of the product, and because (often) they are productively inefficient, that is, they don’t produce as cheaply as possible. That last point is a bit subtle, so we’ll learn more about it in a later module.

Nearly all monopolies in the U.S. are regulated monopolies, meaning the prices they charge have to be reviewed and approved (or not) by a regulatory branch of the government. A good example of this is the U.S. Postal Service, whose rates must be accepted by the Postal Rate Commission. Thus, regulated monopolies don’t behave exactly the way pure monopolies do, as explained in this module. Why do we study them then? Because nearly all firms in the real world have some market power, that is the ability to influence the market price. Monopoly power, the ability to set the market price, is the ultimate in market power. Understanding how monopolies exploit their power helps us understand how real world, but not-quite-monopoly firms, operate.