Monopoly
Monopoly power comes from markets that have high barriers to entry: control of natural resources, increasing returns to scale over a large range of production, network externalities, and legal or regulatory obstacles. However, there are still similarities with perfect competition. We still assume the same cost and profit functions, the same shutdown conditions (SR: MR > AVC and LR: MR > ATC), and their factor markets are assumed perfectly competitive.
The distinction is that price will be set above marginal cost, as the monopoly has separate marginal revenue and demand curves. This causes an economic profit (though a socially inefficient quantity produced).
Profit Maximizing
- First, marginal revenue lies below the demand curve. This occurs because marginal revenue is the demand, p(q), plus a negative number.
- Second, the monopoly quantity equates marginal revenue and marginal cost, but the monopoly price is higher than the marginal cost.
- Third, there is a deadweight loss, for the same reason that taxes create a deadweight loss: The higher price of the monopoly prevents some units from being traded that are valued more highly than they cost.
- Fourth, the monopoly profits from the increase in price, and the monopoly profit is illustrated.
- Fifth, since—under competitive conditions—supply equals marginal cost, the intersection of marginal cost and demand corresponds to the competitive outcome.