Micro CHAPTER 4.2:

CHAPTER SUMMARY

Monopolies are industries that are dominated by a single business due to high barriers to entry. Sometimes there is literally only one business, and other times there is one business that has an extremely high (~90%) market share. A monopolist - a company with a monopoly - sets the market price for the whole industry, so they are a price-maker, unless the government sets a price ceiling.

Monopolies are generally considered by economists to be bad for the economy, because they reduce competition, causing consumers to pay higher prices. However, some firms operate as natural monopolies - these are industries where it makes sense to have just one firm operating because having multiple firms competing with each other would be wasteful. One example of these is trains. It doesn't really make sense to have two competing train tracks running between Hanoi and Ho Chi Minh City. The most efficient outcome would be to have one train line that runs between the cities, so governments will either run the trains themselves or allow one private company to do it, but set a price ceiling on what the company can charge.

Graphing a monopoly is different from graphing a firm in perfect competition, but still follows many of the same rules. The biggest change is that we say goodbye to the horizontal MR curve, as we learned last chapter. This results in a graph that looks like this:

The firm will produce at the quantity where MR = MC. However, it will set the price at the demand curve (not the point where MR = MC) in order to maximize profit.

On the chart below, we have added the ATC curve to the monopoly graph. We calculate the profit or loss by looking at the quantity * the space between the price and the average total cost. If the ATC curve is below the demand curve at the profit maximizing quantity, the monopolist makes a profit (Chart 1 below). If the ATC curve is above the demand curve at the profit maximizing quantity, the monopolist makes a loss (Chart 2).

One problem with an unregulated (no rules) monopoly is that it produces a deadweight loss, as can be seen in Chart 3 above, because the socially optimal quantity - the quantity that would produce the most CS + PS - is at the point where MC = D, but the profit maximization point is at the point where MC = MR.

Governments will sometimes regulate (create & enforce rules for) monopolies, requiring them to charge a certain price or produce a certain quantity, aiming to reach the socially optimal quantity and price. They might set a price ceiling at the fair-return level, which is where demand = ATC, giving the monopoly a normal profit.

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