SUMMARY

1. There are four main types of market structure based on the number of firms in the industry and product differentiation: perfect competition, monopoly, oligopoly, and monopolistic competition.

2. A monopolist is a producer who is the sole supplier of a good without close substitutes. An industry controlled by a monopolist is a monopoly.

3. The key difference between a monopoly and a perfectly competitive industry is that a single perfectly competitive firm faces a horizontal demand curve but a monopolist faces a downward-sloping demand curve. This gives the monopolist market power, the ability to raise the market price by reducing output compared to a perfectly competitive firm.

4. To persist, a monopoly must be protected by a barrier to entry. This can take the form of control of a natural resource or input, increasing returns to scale that give rise to natural monopoly, technological superiority, a network externality, or government rules that prevent entry by other firms, such as patents or copyrights.

5. The marginal revenue of a monopolist is composed of a quantity effect (the price received from the additional unit) and a price effect (the reduction in the price at which all units are sold). Because of the price effect, a monopolist’s marginal revenue is always less than the market price, and the marginal revenue curve lies below the demand curve.

6. At the monopolist’s profit-maximizing output level, marginal cost equals marginal revenue, which is less than market price. At the perfectly competitive firm’s profit-maximizing output level, marginal cost equals the market price. So in comparison to perfectly competitive industries, monopolies produce less, charge higher prices, and earn profits in both the short run and the long run.

7. A monopoly creates deadweight losses by charging a price above marginal cost: the loss in consumer surplus exceeds the monopolist’s profit. Thus monopolies are a source of market failure and should be prevented or broken up, except in the case of natural monopolies. Monopsony, an industry in which there is only one buyer of a good, is more rare than cases of monopoly. The monopsonist can affect the price of the good it buys: it captures surplus from sellers by reducing how much it purchases and thereby lowers the price. It creates deadweight loss by reducing the level of the good transacted to inefficiently low levels.

8. Natural monopolies can still cause deadweight losses. To limit these losses, governments sometimes impose public ownership and at other times impose price regulation. A price ceiling on a monopolist, as opposed to a perfectly competitive industry, need not cause shortages and can increase total surplus.

9. Not all monopolists are single-price monopolists. Monopolists, as well as oligopolists and monopolistic competitors, often engage in price discrimination to make higher profits, using various techniques to differentiate consumers based on their sensitivity to price and charging those with less elastic demand higher prices. A monopolist that achieves perfect price discrimination charges each consumer a price equal to his or her willingness to pay and captures the total surplus in the market. Although perfect price discrimination creates no inefficiency, it is practically impossible to implement.