Unlike a perfectly competitive firm, a monopolist faces the entire market demand curve, which slopes downward. This has crucial implications for pricing and revenue.
To sell more units, the monopolist must lower the price on ALL units, not just the additional one. This creates two effects:
Note: For a linear demand curve P = a - bQ, the MR curve is MR = a - 2bQ
Like all firms, monopolists maximize profit where MR = MC. But unlike competitive firms, they charge a price above marginal cost.
Find profit-maximizing quantity
Set MR = MC and solve for Qm
Find monopoly price
Go up to the demand curve at Qm to find Pm
Calculate profit
Profit = (Pm - ATC) × Qm
In perfect competition, P = MC. In monopoly, P > MC. This means consumers pay more than the marginal cost of production, creating deadweight loss and inefficiency.
Comparing market outcomes reveals why monopoly creates inefficiency and harms consumers.
| Outcome | Perfect Competition | Monopoly | Effect |
|---|---|---|---|
| Price | P = MC | P > MC | Higher prices |
| Output | Higher quantity | Lower quantity | Less output |
| Consumer Surplus | Maximized | Reduced | Consumers worse off |
| Producer Surplus | Normal profit | Economic profit | Producers better off |
| Total Surplus | Maximized | Deadweight loss | Society worse off |
| Allocative Efficiency | Yes (P = MC) | No (P > MC) | Inefficient |
Monopoly creates deadweight loss – the loss of total surplus that occurs because the monopolist produces less than the socially optimal quantity. This represents transactions that would benefit both buyers and sellers but don't occur because of monopoly pricing.
The deadweight loss triangle is the area between the demand curve and MC curve, from the monopoly quantity to the competitive quantity.
Not all monopolies are created equal. Understanding different types helps explain their origins and policy implications.
A natural monopoly occurs when a single firm can supply the entire market at a lower cost than multiple firms due to very large economies of scale.
Examples: Electricity distribution, water/sewage systems, natural gas pipelines, local telephone lines
Policy Implication: Natural monopolies are often regulated or publicly owned because competition would be inefficient.
A legal monopoly exists when the government grants exclusive rights to produce a good or service, creating barriers through law rather than economics.
Examples: Patented pharmaceuticals, Canada Post (letter mail monopoly), licensed professions (doctors, lawyers)
Rationale: Patents and copyrights incentivize innovation and creativity by allowing inventors/creators to recoup R&D costs.
A resource monopoly exists when a firm controls nearly all of an essential input needed for production of a good or service.
Examples: De Beers and diamonds (historically), OPEC and oil, rare earth mineral deposits
Governments can regulate monopolies to reduce inefficiency and protect consumers. A key approach is average-cost pricing.
Under average-cost pricing, the government forces the monopolist to set price equal to average total cost: P = ATC
P = ATC
Regulated price equals average total cost
Setting P = MC (allocatively efficient) would often result in losses for natural monopolies because MC < ATC. The firm would need government subsidies to survive, creating other problems.
Note: Pr > Punregulated but Qr > Qunregulated
Break up monopolies or prevent mergers that reduce competition
Set maximum prices for essential goods and services
Government operates the monopoly (e.g., crown corporations)