Chapter Introduction





“Got stones?”

What You Will Learn in This Chapter

  • The significance of monopoly, where a single monopolist is the only producer of a good

  • How a monopolist determines its profit-maximizing output and price

  • The difference between monopoly and perfect competition, and the effects of that difference on society’s welfare

  • How policy makers address the problems posed by monopoly

  • What price discrimination is, and why it is so prevalent when producers have market power

image | interactive activity

A FEW YEARS AGO DE BEERS, the world’s main supplier of diamonds, ran an ad urging men to buy their wives diamond jewelry. “She married you for richer, for poorer,” read the ad. “Let her know how it’s going.”

Crass? Yes. Effective? No question. For generations diamonds have been a symbol of luxury, valued not only for their appearance but also for their rarity. Diamonds were famously idolized in song by Marilyn Monroe in the film “Gentlemen Prefer Blondes,” where we learn that diamonds are “a girl’s best friend.”

But geologists will tell you that diamonds aren’t all that rare. In fact, according to the Dow Jones-Irwin Guide to Fine Gems and Jewelry, diamonds are “more common than any other gem-quality colored stone. They only seem rarer …”

Why do diamonds seem rarer than other gems? Part of the answer is a brilliant marketing campaign. But mainly diamonds seem rare because De Beers makes them rare: the company controls most of the world’s diamond mines and limits the quantity of diamonds supplied to the market.

Up to now we have concentrated exclusively on perfectly competitive markets—markets in which the producers are perfect competitors. But De Beers isn’t like the producers we’ve studied so far: it is a monopolist, the sole (or almost sole) producer of a good. Monopolists behave differently from producers in perfectly competitive industries: whereas perfect competitors take the price at which they can sell their output as given, monopolists know that their actions affect market prices and take that effect into account when deciding how much to produce.

Monopoly is one type of market structure in which firms have the ability to raise prices. Oligopoly and monopolistic competition are two other types of market structures—both covered in the next chapter—in which firms can also take actions that affect market prices. We begin this chapter with a brief overview of the types of market structures and a system of classifying markets and industries into two main dimensions. This will help us understand on a deeper level why producers in these markets behave quite differently.