Principles of Economics II 
(Microeconomics)

A. A monopoly is an industry in which there is only one supplier of a product with no close substitutes and in which barriers to entry prevent the entry of other firms.

1. If there are close substitutes for the product, the firm is not a monopoly because it faces competition from producers of the substitutes.

B. Barriers to entry are hurdles that prevent new firms from entering an industry. For instance, a firm may acquire control of all of a vital input. Barriers to entry may be legal or natural barriers.

1. Legal barriers to entry create legal monopolies. Examples of legal barriers include:

a) Public franchise. Granting a legal right that allows only one firm the liberty to produce the product. For example, the U.S. Postal Service has a public franchise to deliver first-class mail.

b) Government license. Requiring a license or certificate to work in an occupation. For instance, a license is required to practice law. Licensing does not necessarily create a monopoly but it does restrict competition.

c) Patent and copyright. Granting an exclusive right to the inventor of a product or service or to the creator of a literary, musical, dramatic, or artistic work.

2. Natural barriers to entry create natural monopolies. Natural monopolies can occur when economies of scale allow one firm to supply the entire market at a lower cost than would be possible if two or more companies were in the industry. Public utilities often are deemed to be natural monopolies.

A. A monopoly controls the price it charges.

B. A monopoly may price discriminate or may charge a single price.

1. Price discrimination is the practice of selling different units of a good or service for different prices.

2. A single-price monopoly sells each unit of its product for the same price.

A. The demand curve facing a monopoly is the same as the industry demand curve.

B. Marginal revenue, MR, is the change in total revenue from producing and selling an additional unit of output. The key feature of a single-price monopoly is that marginal revenue is less than the price; that is, MR < P.

1. Marginal revenue is less than the price because the monopoly must lower its price to sell an additional unit of output. The increased sale raises the firm’s revenue by the amount of the price, but this increase is offset by the (now) lower price, which reduces the amount collected on the sale of the initial units produced.

2. If demand is elastic, total revenue increases when the monopoly lowers its price to sell an additional unit of output. Hence the MR is positive.

3. If demand is unit elastic, total revenue does not change when the monopoly lowers its price to sell an additional unit of output, and MR = 0.

4. If demand is inelastic, total revenue decreases when the monopoly lowers its price to sell an additional unit of output. As a result, the MR is negative.

a) A single-price monopoly never produces a level of output for which demand is inelastic. If it did, the firm could boost its profit by curbing its production, thereby simultaneously raising its revenue and lowering its costs.

C. The technology and cost constraints for a monopoly firm are similar to those for perfectly competitive firms. However, the monopoly faces a different market constraint because its actions affect the price it receives for its product.

D. The monopoly maximizes its profit by producing the level of output at which its marginal revenue equals its marginal cost (MR = MC ). The monopoly determines its price from the demand curve as the highest price possible to charge and still sell the amount it produces. This situation is illustrated in Figure 13.1, where the monopoly produces Q and sets a price equal to P.

E. The monopoly may earn an economic profit even in the long run because the barriers to entry protect the firm from competitors.