Overview
This lecture explains how monopolies use market power to set prices above marginal cost, outlines how to find profit-maximizing output and price, and introduces the role of barriers to entry in sustaining monopoly power.
Monopoly and Market Power
- A monopoly exists when one firm exclusively controls a market, often due to patents or other barriers to entry.
- Market power is the ability to raise prices above marginal cost without competition entering the market.
- Example: GlaxoSmithKline's patent on an AIDS drug allows US prices far above those in competitive markets like India.
Sources of Market Power
- Patents and government regulations (e.g., exclusive licenses) create legal barriers to entry.
- Economies of scale mean large firms can produce at lower costs, deterring small entrants.
- Exclusive access to key resources (like diamond mines) can create monopoly power.
- Temporary technological advantages can give firms short-term market power.
Profit Maximization for Monopolists
- Monopolists maximize profit by producing the quantity where marginal revenue (MR) equals marginal cost (MC).
- Unlike competitive firms, a monopolist’s MR is less than the price because increasing sales requires lowering the price for all units.
- The MR curve for a linear demand curve starts at the same vertical intercept as demand but has twice the slope.
Marginal Revenue Calculation
- MR from selling one more unit = Revenue from the extra unit minus revenue lost from lowering the price on prior units.
- For a linear demand curve: If demand is P = A - BQ, then MR = A - 2BQ.
- The MR curve always hits the quantity axis at half the value of the demand curve's intercept with that axis.
Finding the Profit-Maximizing Price and Quantity
- Find where MR = MC to determine the profit-maximizing output (Q).
- Move up to the demand curve at Q to find the profit-maximizing price (P).
- Profit per unit is P minus average cost; total profit is profit per unit times Q.
Key Terms & Definitions
- Monopoly — A market with only one seller controlling the entire supply.
- Market Power — The ability to set price above marginal cost due to lack of competition.
- Marginal Cost (MC) — The cost of producing one additional unit.
- Marginal Revenue (MR) — The extra revenue from selling one additional unit.
- Economies of Scale — Cost advantages from large-scale production.
- Barriers to Entry — Factors preventing new competitors from entering a market.
Action Items / Next Steps
- Prepare for next lecture on how the monopoly mark-up depends on demand elasticity.
- Optionally practice with provided questions or proceed to the next video.