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Calculating the best allocation with calculus
Chapter 10 Monopoly: Decision-Making Without Rivals
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In This Chapter
▶ Identifying the source of monopoly power ▶ Separating demand and marginal revenue ▶ Determining the profit-maximizing quantity and price ▶ Minimizing cost with multiple factories
Parker Brothers’ popular board game Monopoly has it all wrong. The board game doesn’t describe monopoly at all. The board game has 22 properties — not counting railroads and utility companies — that you can buy, sell, and rent. That’s way too much competition. In the market structure of monopoly, there’s only one firm, and because a single firm produces the good, monopoly has a very low degree of competition. In fact, monopolists have no direct rivals.
This situation may give the misimpression that a monopolist has unlimited power. That isn’t the case. The monopolist is constrained by whether or not consumers are willing to buy the monopolist’s product at a given price. Also, a monopolist can face indirect competition from other firms that produce something that addresses the same needs. For example, the firm providing natural gas and the firm providing electricity are monopolies. As a consumer, you can choose either natural gas or electricity to operate your home’s oven and stove.
In this chapter, I start by examining monopoly characteristics and their impact on decision-making, especially price setting. These characteristics give the monopolist the ability to set price. After identifying the source of monopoly power, I summarize how a monopolist determines the shortrun profit-maximizing quantity, price, and amount of profit by using two approaches — the first based on total revenue and total cost, and the second based on marginal revenue and marginal cost. After considering the shortrun situation, I explain how things evolve in the long run. Finally, I conclude
the chapter by examining how monopolies profitably produce the same good in two or more factories. And after you understand these concepts, you’ll feel like you own both Park Place and Boardwalk. Now, that’s a really profitable monopoly.
If you possess monopoly power, you’re able to set your good’s price. Thus, as manager, you must now determine both the profit-maximizing quantity of output and the good’s price. You really have to mind your p’s and q’s in monopoly.
Monopolies have the following characteristics:
✓ A single firm: Your firm is the only one that produces the good.
Therefore, the entire quantity of the good sold in the market is produced by your firm. ✓ No close substitutes: In addition to being the only firm producing the good, there are no close substitutes for the good you produce. No other firm provides a similar or directly substitutable good. As a consequence, no direct competition between firms exists. ✓ Barriers to entry: Barriers to entry ensure the continued existence of the monopoly. Barriers to entry also enable the monopolist to maintain positive economic profit, or returns in excess of the normal rate of return, in the long run. Barriers to entry can take many forms, including economies of scale, government regulation, patents, and control of specific natural resources.
Because a single firm produces the good’s entire market output, the firm is a price setter — the monopolist determines the price it charges for the good. The demand for the monopolist’s product is the same as the market demand because only one firm is producing the good. However, this situation has its pros and cons. On the pro side, you get to set price, and you have no direct rivals. On the con side, if you want to sell more of the good, you have to lower price. In perfect competition (see Chapter 9), you could sell as much as you wanted without having to change price. This isn’t the case in monopoly.
The reason you have to lower price to sell more of the good is a monopolist’s ability to set price is constrained by consumer demand — consumers will buy more of the product only if you lower its price.
