💸 Unit 1: Basic Economic Concepts
1.0Unit 1: Basic Economic Concepts
1.1Basic Economic Concepts: Scarcity
1.2Resource Allocation and Economic Systems
1.3Production Possibilities Curve (PPC)
📈 Unit 2: Supply and Demand
2.4Price Elasticity of Supply
2.6Market Equilibrium and Consumer and Producer Surplus
2.7Market Disequilibrium and Changes in Equilibrium
2.8The Effects of Government Intervention in Markets
⚙️ Unit 3: Production, Cost, and the Perfect Competition Model
3.6Firms' Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market
📊 Unit 4: Imperfect Competition
4.1Introduction to Imperfectly Competitive Markets
💰 Unit 5: Factor Markets
5.2Changes in Factor Demand and Factor Supply
5.3Profit-Maximizing Behavior in Perfectly Competitive Factor Markets
🏛 Unit 6: Market Failure and Role of Government
6.1Socially Efficient and Inefficient Market Outcomes
6.3Public and Private Goods
6.4The Effects of Government Intervention in Different Market Structures
⏱️ 5 min read
November 15, 2020
A monopoly is a market structure in which an individual firm has sufficient control of an industry or market. They determine the terms of access to other firms.
A natural monopoly occurs when an individual firm comes to dominate an industry by producing goods and services at the lowest possible production cost. Since other firms cannot compete with these low costs, it drives them out of the business and allows the dominant firm to monopolize the industry. Natural monopolies are actually beneficial to society because they charge low prices and promote productive efficiency.
In a monopoly graph, the demand curve is located above the marginal revenue cost curve. This is because they have to lower their price in order to sell each additional unit. Their profit-maximizing profit output is where MR=MC. The price is determined by going from where MR=MC, up to the demand curve.
The graph above shows a standard monopoly graph with demand greater than MR. It also shows the profit-maximizing output where MR = MC at Q1. You then determine the price by going up from Q1 to the demand curve and labeling the profit-maximizing price at P1.
Many times, when drawing a monopoly graph, we are asked to show either a profit or a loss. We use the cost curve, ATC, to show it. When we are showing a profit, the ATC will be located below the price on the monopoly graph. We shade the area that represents the profit.
Monopoly Graph Showing a Profit
When we are showing a loss, the ATC will be located above the price on the monopoly graph. We shade the area that represents the loss.
Monopoly Graph Showing a Loss
Calculating a Monopoly's Profit
In this particular graph, the firm is earning a total revenue of $1200, which is calculated by multiplying the price they are receiving for each unit by the profit-maximizing output. The total cost is the value of the ATC multiplied by the profit-maximizing output ($2 x 200 = $400). The profit is calculated by subtracting total cost from total revenue ($1200 - $400 = $800).
Calculating a Monopoly's Loss
In this particular graph, the firm is earning a total revenue of $500, which is calculated by multiplying the price they are receiving for each unit by the profit-maximizing output. The total cost is the value of the ATC multiplied by the profit-maximizing output ($9 x 100 = $900). The loss is calculated by subtracting total cost from total revenue ($500-$900 = -$400).
In a perfectly competitive market, firms are both allocatively and productively efficient. One of the ways this is shown is when perfectly competitive firms maximize consumer and producer surplus. Monopolies, on the other hand, are not allocatively and productively efficient because they overcharge and underproduce. Below is a graph that shows consumer and producer surplus on a monopoly graph as well as deadweight loss, the loss of consumer and producer surplus due to inefficiency.
There are many key points that we should be familiar with on a monopoly graph (please see the graph below to identify all these key points).
Fair-return price and output: This is where P = ATC. This should not be confused with the productively efficient point of P = minimum ATC. This is the point on a monopoly graph where total revenue (TR) = total cost (TC), meaning that the monopoly makes a normal profit. This is usually accomplished via a price ceiling. (On the graph below it is Q4 and P1.)
The demand curve on a monopoly graph have both elastic, inelastic, and unit elastic sections. We use the quantity where MR=0 to determine the difference. We first draw a line from the quantity where MR=0 up to the demand curve. The point where it hits the demand curve is the unit elastic point. The section above this point is the elastic region of the demand curve, and the section below this point is the inelastic region of the demand curve.
In the elastic region, a monopoly can lower the price and still increase their total revenue (TR). However, in the inelastic region, if they lower their price, they decrease their total revenue (remember the Total Revenue Test!). A monopoly will never willingly produce in the inelastic region because it would lower their profits (marginal revenue is negative, while marginal costs continue to increase. In order for them to produce in the inelastic region, the government has to regulate them with a price ceiling or provide support through a subsidy. (See the graph of both a monopoly and a corresponding TR curve below).
2550 north lake drive
milwaukee, wi 53211
92% of Fiveable students earned a 3 or higher on their 2020 AP Exams.
*ap® and advanced placement® are registered trademarks of the college board, which was not involved in the production of, and does not endorse, this product.
© fiveable 2020 | all rights reserved.