Market Power, Pricing Strategies, and Effects on Consumers
Unlike perfectly competitive firms, a monopolist IS the market. The firm's demand curve is the entire market demand curve, which slopes downward. This fundamental difference gives monopolists pricing power but also creates trade-offs.
To sell more units, the monopolist must lower the price. Higher prices mean fewer sales.
The monopolist chooses the price-quantity combination, not just accepts market price.
Consumers can't easily switch to alternative products, giving the firm market power.
Can charge high prices OR sell high quantities, but not both simultaneously.
For a monopolist, Marginal Revenue (MR) < Price. The MR curve lies below the demand curve. This is one of the most important distinctions between monopoly and perfect competition.
Suppose a monopolist currently sells 10 units at $100 each (total revenue = $1,000)
Scenario: Sell One More Unit
To sell the 11th unit, the monopolist must lower the price to $95 for ALL units
New Revenue: 11 units × $95 = $1,045
Old Revenue: 10 units × $100 = $1,000
Marginal Revenue = $1,045 - $1,000 = $45
Why MR ($45) < Price ($95):
Lowering price to sell more has a revenue-reducing effect on existing sales!
Key Takeaway: A monopolist's marginal revenue from an additional unit equals the price of that unit minus the revenue lost from lowering the price on all previous units. This is why the MR curve lies below the demand curve.
Like all firms, monopolists maximize profit by producing where MR = MC. However, unlike competitive firms, the monopolist then charges a price above marginal cost based on the demand curve.
Find MR = MC: Determine the profit-maximizing quantity where marginal revenue equals marginal cost
Go up to demand: From that quantity, look up to the demand curve to find the price consumers will pay
Calculate profit: Profit = (P - ATC) × Quantity, shown as a shaded rectangle on the graph
Perfect Competition:
P = MR = MC
Firms charge price equal to marginal cost
Monopoly:
MR = MC, but P > MR
Price is above marginal cost
This price markup above MC represents the monopolist's market power
Compared to perfect competition, monopolies produce negative outcomes for society:
Monopolists charge P > MC, extracting more from consumers than competitive firms
Monopolists restrict output below the socially optimal level to keep prices high
Society loses potential gains from trade—allocative inefficiency harms welfare
Less Consumer Surplus: Higher prices transfer wealth from consumers to the monopolist
Reduced Choice: Lower output means fewer products available in the market
Less Innovation (potentially): Without competitive pressure, monopolists may have less incentive to innovate, though patent-based monopolies can drive R&D
A typical monopoly graph would display:
The graph visually demonstrates how monopolists produce less and charge more than competitive firms, creating economic inefficiency.
You've completed the core economic theory. Now see how these concepts apply to real markets and current events.
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