49.Monopoly and How It Arises
A monopoly is a firm that produces a good or service for which no close substitute exists and which is protected by a barrier that prevents other firms from selling that good or service. A monopoly has two key features:
No Close Substitutes: There are no close substitutes for the good or service.
Barriers
to Entry:
A constraint that protects a firm from potential competition is
called a barrier
to entry.
Monopolies are protected by barriers to entry.
Natural barriers to entry create a natural monopoly, which is an industry in which economies of scale enable one firm to supply the entire market at the lowest possible cost.
An ownership barrier to entry occurs if one firm owns a significant portion of a key resource.
Legal barriers to entry create a legal monopoly, which is a market in which competition and entry are restricted by the granting of a public franchise (an exclusive right is granted to a firm to supply a good or service—the U.S. Postal Service has a public franchise to deliver first-class mail), a government license (when the government controls entry into particular occupations, professions and industries—a license is required to practice law), a patent (an exclusive right granted to the inventor of a product or service) or a copyright (exclusive right granted to the author or composer of a literary, musical, dramatic, or artistic work).
50.A Single-Price Monopoly’s Output and Price Decisions
Price and Marginal Revenue
The demand curve facing a monopoly firm is the market demand curve. Total revenue (TR) is the price (P) multiplied by the quantity sold (Q). Marginal revenue (MR) is the change in total revenue resulting from a one-unit increase in the quantity sold.
Marginal Revenue and Elasticity
If demand is elastic, the MR is positive. A decrease in the price will result in a proportionately greater increase in quantity, generating an increase in revenue.
If demand is unit elastic (as it is at the midpoint of a linear demand curve), the MR equals zero. A change in the price will result in a proportionate change in quantity, generating no change in revenue. If further increase in revenue is not possible from changing price, this is also the point where revenue is maximized.
If demand is inelastic, MR is negative. A decrease in price will result in a proportionately smaller increase in quantity, generating a decrease in revenue.
A single-price monopoly never produces in the inelastic part of its demand because if it did, the firm could increase its total profit by decreasing its output, which would raise its total revenue and decrease its total cost.
Price and Output Decision
To maximize its profit, a monopoly produces the level of output where MR = MC. The monopoly then uses its demand curve to set the price at the highest price for which it will be able to sell the quantity it produces. In the figure, which uses the demand and MR schedules from the table above, the firm produces 20 units of output and sets a price of $3 per unit.
The firm earns an economic profit if P > ATC, which is the case for the firm in the figure. The monopoly can earn the economic profit even in the long run because the barriers to entry protect the firm from competition. However, a monopoly firm is not guaranteed an economic profit. In the short run and/or long run, it might earn a normal profit, (P = ATC) or in the short run, it might incur an economic loss (P < ATC).