AP, IB, and College Microeconomic and Macroeconomic Principles 

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Keys to Understanding Monopoly – AP/IB/College

Keys to Understanding the Monopoly Graph

Updated 8/15/2017 Jacob Reed
Like All Profit Maximizing Firms:

  • Produce the quantity where MR=MC
  • Price at Demand
  • Temporarily shut down when price falls below Average Variable Cost (AVC) at the profit maximizing quantity
  • Profit/loss is determined by the gap between the ATC and the firm’s demand curve at the profit maximizing quantity (MR=MC)
Market structures spectrum

Monopoly:

Number of Sellers: One. There are no close substitutes and no competitors.

Product Difference: The product is unique.

Barriers to Entry: High barriers which prevent any competitors from entering. Monopolies may engage in rent seeking behavior (working to pass voter initiatives, lobbying politicians, etc), to maintain a monopoly. These actions will increase the firm’s ATC and erode some economic profits.

Long-run Profit: Due to the high barriers to entry, economic profit is possible in the long run.

Efficiency: No, Monopolies price above marginal cost and do not produce at the lowest average cost so they are not allocatively or productively efficient.

Graph: Since there is only one firm, the market is the firm. As a result, the firms demand curve is downward sloping. The average revenue, and price will also be the demand curve (DARP). If the firm is not a perfect price discriminator, the marginal revenue curve is below demand. That is because the firm must lower the price on all units produced when it produces higher quantities and not just the last unit produced. The firm produces the quantity where MR=MC but prices at the demand curve above.

Note: The cost curves for a monopoly are the same as a perfectly competitive firm and monopolistically competitive firm.  The AVC and AFC are rarely needed in this graph. 

Regulation: Governments will sometimes regulate Monopolies by imposing price ceilings which are more efficient. A fair return price is one which enforces a price where economic profits are zero (P=ATC). The socially optimal price is allocatively efficient; where price equals marginal cost.

Compared to perfectly competitive markets: Unlike perfectly competitive firms, monopolies produce less, and price higher. Monopolies can also earn an economic profit in the long run. 

Price Discrimination: Price discrimination occurs when a firm is able to charge different customers different prices for the same product. Like letting kids eat free or giving senior citizens discounts at restaurants. Firms charge lower prices to people with a lower willingness to pay and higher prices to people with a higher willingness to pay. If the firm is able to figure the maximum price each customer is willing to pay and charge them that price, the firm would be a perfect price discriminator. That would cause the MR curve to be the same curve as the Demand, Average Revenue, and Price (MRDARP). Perfect price discriminators are allocatively efficient. The last unit produced will be priced at the marginal cost. ​

Other recommended resourcesACDC Leadership (Monopoly)