IB Economics 2.11.6 Monopoly Notes

A Monopoly Faces the Whole Market's Demand

1. A monopoly is a single seller behind high barriers to entry, the most powerful form of imperfect competition.
2. Because it is the whole market, it faces the market's downward-sloping demand curve, so to sell one more unit it must lower the price on every unit.
3. That makes its marginal revenue lie below the demand curve, since the gain on the extra unit is partly cancelled by the lower price charged on all the rest.
   1. Marginal revenue therefore falls twice as steeply as demand.

Marginal Revenue and Elasticity Move Together

1. How steeply marginal revenue falls is tied to elasticity, which changes as you move down a straight-line demand curve.
2. Near the top, price is high and quantity low, so demand is elastic and a price cut raises total revenue, keeping marginal revenue positive.
3. At the midpoint, demand is unit elastic, total revenue peaks, and marginal revenue is zero, $MR = 0$.
4. Below the midpoint, demand is inelastic, a price cut lowers total revenue, and marginal revenue turns negative.

The Monopoly Maximises Profit Where MR = MC

1. A monopoly maximises profit at the output where marginal revenue equals marginal cost, $MR = MC$, not where revenue is largest.
2. That crossing fixes the profit-maximising quantity, $Q_M$.
3. To find the price, read up from that quantity to the demand curve, the highest price buyers will pay for that output.
   1. So the monopoly's price sits above its marginal cost, $P_M > MC$.
4. Profit per unit is the gap between price and average total cost at that output, and total profit is that gap times quantity, $(P_M - C_M) \times Q_M$.
   1. When price is above $ATC$, the shaded rectangle is abnormal profit.
5. Because barriers to entry keep rivals out, that abnormal profit can persist into the long run, unlike in perfect competition.
   1. A monopoly is not guaranteed a profit, though: if costs are high or demand weak, $ATC$ can sit above the price and the firm makes a loss.

Revenue Maximisation: A Bigger Output at MR = 0

1. Some firms aim to maximise revenue rather than profit, for example to grow their market share.
2. Revenue is largest not where $MR = MC$ but where marginal revenue is zero, at the unit-elastic midpoint of demand.
3. That output is larger than the profit-maximising one and is sold at a lower price.
   1. Producing past $MR = MC$ adds units that cost more than they earn, so profit is smaller than at the profit-maximising output.

Natural Monopoly: When One Firm Is the Cheapest Supplier

1. A natural monopoly is a special case where one firm can supply the whole market at a lower average cost than several firms could.
2. It arises when economies of scale are so large that average cost keeps falling across the entire range of demand.
3. The clearest examples are network industries like water pipes, the electricity grid, and rail track.
   1. Laying a second network beside the first would double the fixed cost while splitting the customers, pushing each firm's average cost up.
4. The diagram behaves like any monopoly, with output at $MR = MC$ and price read up to demand, except that average cost falls right across the market.

Why a Monopoly Is Inefficient

1. A market is allocatively efficient when price equals marginal cost, so the value of the last unit to buyers matches what it costs to make.
2. A monopoly never reaches that point, because setting output at $MR = MC$ and reading price up to demand leaves price above marginal cost.
3. Output stops short of the quantity where price would equal marginal cost, so units buyers value above their cost are never made.
   1. That lost welfare is the deadweight loss, the shaded triangle between the monopoly output $Q_M$ and the efficient output $Q^*$.
4. A monopoly also misses productive efficiency, since it does not produce at the lowest point of average total cost.
   1. Weak competitive pressure can let costs drift up further, a slack known as X-inefficiency.
5. Barriers to entry mean this never corrects itself, so the same restricted output and deadweight loss carry from the short run into the long run.

Evaluating Monopoly: The Central Trade-off

A monopoly is judged by weighing what its scale and profits can deliver against the welfare it destroys by restricting output.

1. Advantages
   1. Economies of scale: high output can push average costs below what many small firms could reach.
   2. Innovation: abnormal profit can fund research and development and the scale to compete globally.
2. Disadvantages
   1. Allocative inefficiency: price is held above marginal cost, so output is below the social optimum and welfare is lost.
   2. Higher prices and less choice: with no rivals, consumers pay more and firms face little pressure to improve.
   3. X-inefficiency: weak competition lets costs and organisational slack drift upward.
3. A monopoly is most harmful when strong barriers shield a firm that raises prices and lets costs drift, and least harmful when large economies of scale and genuine innovation reach consumers as lower prices or better products.