Four Market Model Summary: Monopoly - Online Tutor, Practice Problems & Exam Prep

A monopoly is characterized by a single supplier dominating the market, often seen in utilities and patented prescription drugs. High barriers to entry prevent competition, allowing for long-run profits as firms maximize profit where marginal revenue equals marginal cost. In monopolies, price exceeds marginal revenue due to the downward-sloping demand curve, leading to economic profits. Understanding these dynamics is crucial for grasping market structures and their implications on consumer surplus and market power.

Four Market Model Summary: Monopoly

Hey guys, alright we've done it. We've reached the end of the monopoly unit, so let's go back to that market model summary page that has all 4 models listed on it and let's go on and fill in the column for the monopoly. Alright, so here I've got just the monopoly column. Let's go ahead and fill it in one by one. So, we saw a monopoly has one supplier, right? There's only one for the number of firms. That is the monopoly. They are the one producer of this product. So what were some examples that we talked about? We talked about utilities, something like an electricity company, right? Electricity companies, you don't usually see tons of electrical companies in the same market, right? You don’t go shopping for who's going to provide your electricity, there’s generally just one firm providing for your area, right? And that’s because of the natural monopoly that exists in those types of industries. Right? So, if you want more, remember that natural monopoly, right, those big economies of scale. If you don’t really remember, I’d suggest going back to that video because that was a good topic here. Another example would be something like prescription drugs. Okay. Prescription drugs is something that the government might provide a patent for, right? When you create this new drug, the company creates a drug, they file a patent with the government, and they’re protected for 20 years; they are the only one that can produce this drug, right? So it limits competition and gives them monopoly power over that drug, right? And those patents, that is the incentive to research these drugs, right? If there was no patent, if they were to just research it, they find out this formula, and then everybody starts producing it, they’re not going to get any value out of it, right? What was the point of all that research if they're not going to get any of the value from the research? So the patent protects the company and it gives them the incentive to do research and find new drugs to cure diseases and stuff. Okay?

So let’s go down. Barriers to entry, right? Barriers to entry, we saw in perfect competition, there were none, right? If you wanted to be a wheat farmer, you buy a farm and you start farming wheat. Well, in a monopoly, we see that there were high barriers to entry, right? It’s not easy to join a market where there’s a monopoly. There was something either own a key resource, they’re protected by the government, or they have some sort of natural monopoly that’s keeping them as the only producer in that industry. How about the profit-maximizing quantity? Well here again, we saw that they maximize profit by producing where marginal revenue equals marginal cost, right? And that was the same in perfect competition and we’re going to see that in other market models as well. We see that marginal revenue equals marginal cost is that profit-maximizing point. Cool? How about long-run profitability? Well, in a monopoly, there is the possibility for long-run profits. I’ll put LR profits. Okay? And that’s because they have that market power. They’re able to limit the quantity on the market and sustain those profits and since there’s nobody who can enter the market because of these barriers to entry, they can sustain those profits in the long run as well. Okay, how about the next one? Relationship of price and marginal revenue, right? So in every industry we see that or in every market structure we see that price equals average revenue and in perfect competition, we saw that it also equaled marginal revenue as well, but in monopolies and in every other case, it’s not the same, right? The marginal revenue curve because of the downward sloping demand that the firm faces, the marginal revenue curve is separate and it’s lower than the price, right? So we’re going to see that the price is greater than marginal revenue, right? That’s what we’ve seen all throughout the chapter. That demand curve is always above that marginal revenue curve. And how about last, relationship of price and marginal cost? Well, we saw this as well that price is going to be above marginal cost as well, right, and that’s where the profits are coming from to the firm. Cool, so remember this isn’t a catch-all. We talked about other things in this chapter as well, so this is just a summary of those high-level concepts that can help you compare and contrast between the different market structures. Okay? But there is obviously much more detail that we went over throughout the lessons. Cool? Alright. Let’s go on to our next unit and I'll see you there.

Here’s what students ask on this topic:

What are the characteristics of a monopoly market structure?

A monopoly market structure is characterized by a single supplier dominating the market. This firm is the sole producer of a particular product or service, often seen in utilities like electricity or patented prescription drugs. High barriers to entry prevent other firms from entering the market, which can include ownership of key resources, government protection, or natural monopolies due to economies of scale. Monopolies maximize profit where marginal revenue (MR) equals marginal cost (MC). In this structure, the price (P) is greater than both marginal revenue and marginal cost, leading to long-run economic profits. Understanding these dynamics is crucial for grasping market structures and their implications on consumer surplus and market power.

How do monopolies maximize their profits?

Monopolies maximize their profits by producing at the quantity where marginal revenue (MR) equals marginal cost (MC). This is the profit-maximizing condition for any firm. In mathematical terms, this can be expressed as:

$\mathrm{MR}=\mathrm{MC}$

At this point, the additional revenue gained from selling one more unit equals the additional cost of producing that unit. Because monopolies face a downward-sloping demand curve, their marginal revenue is less than the price they charge. This allows them to set a higher price, leading to economic profits. High barriers to entry prevent other firms from entering the market, allowing the monopoly to sustain these profits in the long run.

What are the barriers to entry in a monopoly?

Barriers to entry in a monopoly are factors that prevent other firms from entering the market and competing with the monopolist. These barriers can be high and include:

• Ownership of Key Resources: The monopolist may own a crucial resource needed for production.
• Government Protection: Patents, licenses, and regulations can protect the monopolist from competition.
• Natural Monopolies: Economies of scale can make it inefficient for multiple firms to operate in the market, as seen in utilities like electricity.

These barriers ensure that the monopoly remains the sole supplier, allowing it to maintain long-run economic profits.

Why is the price greater than marginal revenue in a monopoly?

In a monopoly, the price is greater than marginal revenue (MR) because the monopolist faces a downward-sloping demand curve. This means that to sell additional units, the monopolist must lower the price, not just for the additional unit but for all previous units sold. As a result, the additional revenue gained from selling one more unit (MR) is less than the price at which that unit is sold. Mathematically, this can be expressed as:

$P>\mathrm{MR}$

This pricing strategy allows the monopolist to maximize profits by setting a higher price, leading to economic profits.

Can monopolies earn long-run profits? If so, how?

Yes, monopolies can earn long-run profits. This is primarily due to the high barriers to entry that prevent other firms from entering the market and competing away the profits. These barriers can include ownership of key resources, government protection through patents and licenses, and natural monopolies due to economies of scale. Because the monopolist is the sole supplier, it can set prices above marginal cost, leading to economic profits. Additionally, the monopolist maximizes profit by producing where marginal revenue (MR) equals marginal cost (MC), ensuring sustained profitability over the long run.