Chapter 11: Oligopoly: I Need You

Chapter 10: Monopoly: Decision-Making Without Rivals

Also, the absence of close substitutes for the monopolist’s product ensures the monopolist’s ability to set price without direct competition. However, to the extent imperfect substitute goods exist, they influence consumer demand and the monopolist’s ability to set price. Therefore, the monopolist doesn’t take into account rival firm behavior when it determines its short-run profitmaximizing quantity and price. But over an extended period of time, or in the long run, the monopolist’s profits are affected by indirect competition.

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Unable to Charge as Much as You Want: Relating Demand, Price, and Revenue

There is little doubt that monopoly has a bad reputation. At the word monopoly, consumers typically picture a large firm that charges any price it wants. It’s a firm with virtually unlimited power. But consumers are wrong!

The ultimate source of power in a market is the consumer. As a consumer, you get to decide whether you’re willing and able to purchase a good at a given price. In theory, the monopolist can charge any price it wants, but practically, the monopolist can’t charge too high of a price or you won’t buy the good. The monopolist is constrained by your willingness to pay the price it charges.

For example, economists consider De Beers a resource monopoly because it effectively controls the world’s supply of diamonds. And although diamonds are very popular, if De Beers keeps raising its price, consumers will start substituting other precious gems, such as rubies and emeralds, for diamonds. Thus, as diamond prices increase, the quantity of diamonds consumers purchase will decrease.

The monopolist’s pricing decision is subject to the constraint imposed by consumer demand. If the monopolist charges too high of a price, nobody wants to buy its product. So, if the monopolist wants to sell more product, it must lower price as indicated by the market demand curve.

The inverse relationship between price and quantity demanded is the critical element in monopoly price setting. Because a single firm provides the entire quantity of the commodity in the market, the demand for the monopolist’s product, represented by a lower-case d in Figure 10-1, is the same as the market demand, represented by a capital D in Figure 10-1. The market demand possesses the usual characteristics; an inverse relationship between price and quantity demanded and changing price elasticity of demand along the demand curve. In order to sell more of its product, the monopolist must lower its price, not only for the additional unit but for every other unit as well.