This creates a monopoly. Monopoly power comes from markets that have high barriers to entry. This can be caused by a variety of factors:.
Monopoly and perfect competition mark the two extremes of market structures, but there are some similarities between firms in a perfectly competitive market and monopoly firms. Both face the same cost and production functions, and both seek to maximize profit.
The shutdown decisions are the same, and both are assumed to have perfectly competitive factors markets. However, there are several key distinctions. In a perfectly competitive market, price equals marginal cost and firms earn an economic profit of zero. In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit.
Perfect competition produces an equilibrium in which the price and quantity of a good is economically efficient. Monopolies produce an equilibrium at which the price of a good is higher, and the quantity lower, than is economically efficient.
For this reason, governments often seek to regulate monopolies and encourage increased competition. For monopolies, marginal cost curves are upward sloping and marginal revenues are downward sloping. In traditional economics, the goal of a firm is to maximize their profits. This means they want to maximize the difference between their earnings, i. To find the profit maximizing point, firms look at marginal revenue MR — the total additional revenue from selling one additional unit of output — and the marginal cost MC — the total additional cost of producing one additional unit of output.
When the marginal revenue of selling a good is greater than the marginal cost of producing it, firms are making a profit on that product.
This leads directly into the marginal decision rule, which dictates that a given good should continue to be produced if the marginal revenue of one unit is greater than its marginal cost. Therefore, the maximizing solution involves setting marginal revenue equal to marginal cost. This is relatively straightforward for firms in perfectly competitive markets, in which marginal revenue is the same as price. Monopoly production, however, is complicated by the fact that monopolies have demand curves and MR curves that are distinct, causing price to differ from marginal revenue.
Monopoly : In a monopoly market, the marginal revenue curve and the demand curve are distinct and downward-sloping. Production occurs where marginal cost and marginal revenue intersect. Perfect Competition : In a perfectly competitive market, the marginal revenue curve is horizontal and equal to demand, or price. The marginal cost curves faced by monopolies are similar to those faced by perfectly competitive firms.
Most will have low marginal costs at low levels of production, reflecting the fact that firms can take advantage of efficiency opportunities as they begin to grow. Marginal costs get higher as output increases. For example, a pizza restaurant can easily double production from one pizza per hour to two without hiring additional employees or buying more sophisticated equipment.
So our total revenue curve, it looks like-- and if you've taken algebra you would recognize this as a downward facing parabola-- our total revenue looks like this. It's easier for me to draw a curve with a dotted line. Our total revenue looks something like that. And you can even solve it algebraically to show that it is this downward facing parabola.
The formula right over here of the demand curve, its y-intercept is 6. So if I wanted to write price as a function of quantity we have price is equal to 6 minus quantity. Or if you wanted to write in the traditional slope intercept form, or mx plus b form-- and if that doesn't make any sense you might want to review some of our algebra playlist-- you could write it as p is equal to negative q plus 6. Obviously these are the same exact thing.
You have a y-intercept of six and you have a negative 1 slope. If you increase quantity by 1, you decrease price by 1. Or another way to think about it, if you decrease price by 1 you increase quantity by 1. So that's why you have a negative 1 slope. So this is price is a function of quantity. What is total revenue? Well, total revenue is equal to price times quantity.
But we can write price as a function of quantity. We did it just now. This is what it is. So we can rewrite it, or we could even write it like this, we can rewrite the price part as-- so this is going to be equal to negative q plus 6 times quantity. And this is equal to total revenue. Thus, consumers will suffer from a monopoly because a lower quantity will be sold in the market, at a higher price, than would have been the case in a perfectly competitive market.
The problem of inefficiency for monopolies often runs even deeper than these issues, and also involves incentives for efficiency over longer periods of time. There are counterbalancing incentives here. On one side, firms may strive for new inventions and new intellectual property because they want to become monopolies and earn high profits—at least for a few years until the competition catches up. In this way, monopolies may come to exist because of competitive pressures on firms.
However, once a barrier to entry is in place, a monopoly that does not need to fear competition can just produce the same old products in the same old way—while still ringing up a healthy rate of profit. He meant that monopolies may bank their profits and slack off on trying to please their customers. The old joke was that you could have any color phone you wanted, as long as it was black. An explosion of innovation followed. Services like call waiting, caller ID, three-way calling, voice mail though the phone company, mobile phones, and wireless connections to the Internet all became available.
A wide range of payment plans was offered, as well. It was no longer true that all phones were black; instead, phones came in a wide variety of shapes and colors. The end of the telephone monopoly brought lower prices, a greater quantity of services, and also a wave of innovation aimed at attracting and pleasing customers. In the opening case, the East India Company and the Confederate States were presented as a monopoly or near monopoly provider of a good.
Regarding the cotton industry, we also know Great Britain remained neutral during the Civil War, taking neither side during the conflict. Did the monopoly nature of these business have unintended and historical consequences? Might the American Revolution have been deterred, if the East India Company had sailed the tea-bearing ships back to England?
Of course, it is not possible to definitively answer these questions; after all we cannot roll back the clock and try a different scenario. We can, however, consider the monopoly nature of these businesses and the roles they played and hypothesize about what might have occurred under different circumstances.
Perhaps if there had been legal free tea trade, the colonists would have seen things differently; there was smuggled Dutch tea in the colonial market. If the colonists had been able to freely purchase Dutch tea, they would have paid lower prices and avoided the tax. What about the cotton monopoly? With one in five jobs in Great Britain depending on Southern cotton and the Confederate States nearly the sole provider of that cotton, why did Great Britain remain neutral during the Civil War?
At the beginning of the war, Britain simply drew down massive stores of cotton. These stockpiles lasted until near the end of Why did Britain not recognize the Confederacy at that point? Two reasons: The Emancipation Proclamation and new sources of cotton.
Having outlawed slavery throughout the United Kingdom in , it was politically impossible for Great Britain, empty cotton warehouses or not, to recognize, diplomatically, the Confederate States. In addition, during the two years it took to draw down the stockpiles, Britain expanded cotton imports from India, Egypt, and Brazil. Monopoly sellers often see no threats to their superior marketplace position. In these examples did the power of the monopoly blind the decision makers to other possibilities?
But, as they say, the rest is history. A monopolist is not a price taker, because when it decides what quantity to produce, it also determines the market price. For a monopolist, total revenue is relatively low at low quantities of output, because not much is being sold. Total revenue is also relatively low at very high quantities of output, because a very high quantity will sell only at a low price.
Thus, total revenue for a monopolist will start low, rise, and then decline. The marginal revenue for a monopolist from selling additional units will decline. Each additional unit sold by a monopolist will push down the overall market price, and as more units are sold, this lower price applies to more and more units. If that price is above average cost, the monopolist earns positive profits.
Monopolists are not productively efficient, because they do not produce at the minimum of the average cost curve. As a result, monopolists produce less, at a higher average cost, and charge a higher price than would a combination of firms in a perfectly competitive industry. Monopolists also may lack incentives for innovation, because they need not fear entry. Aboukhadijeh, Feross.
Accessed July 7, British Parliament. Dattel, E. Accessed July Grogan, David. Accessed March 12, Massachusetts Historical Society. Pelegrin, William. Skip to content Chapter 9. Because the drug manufacturer has a patent for the drug, it has a monopoly. It also has a well-defined market of a specific size. Thus, it can maximize its own profits by charging the highest price that the victims and their insurance companies are willing or able to pay, knowing that the cancer victims will do whatever they can to pay the price.
This is why several drug manufacturers greatly increased their prices recently, to take advantage of inelastic demand for their products. Because as long as marginal revenue exceeds marginal cost, then producing an additional unit will increase profits. When marginal revenue equals marginal cost, then the monopolist looks to the demand curve to see what price that corresponds to. At that point, profit is maximized. Note that a monopoly does not have a supply curve because it sets the supply according to the demand.
In most markets, the market price is determined by the intersection of the demand curve and supply curve. However, for a monopoly, the market price is not set by the intersection of the demand and supply curves, for the monopolist decides what the supply will be — the monopolist sets the price at which its profits are maximized, which will then determine what the supply will be.
The monopolist's economic profit is then equal to the average revenue minus the ATC ATC multiplied by the number of units sold:.
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