Monopoly

Definition

A monopoly is a market structure characterized by a single supplier of a good or service that has no close substitutes. Monopolies arise due to barriers to entry that prevent other firms from competing in the market, allowing the monopolist to set prices and output levels to maximize profits.

5 Must Know Facts For Your Next Test

1. Monopolies can arise due to factors such as economies of scale, control of essential resources, or government-granted exclusive rights.
2. A profit-maximizing monopolist will produce a lower quantity and charge a higher price than would be seen in a competitive market.
3. Monopolists can engage in various anticompetitive practices, such as predatory pricing, to deter potential competitors from entering the market.
4. Governments may regulate monopolies through policies such as price controls, antitrust laws, or the promotion of competition to protect consumer welfare.
5. The inefficiency of monopolies, in terms of higher prices and lower output, is known as the deadweight loss of monopoly.

Review Questions

• Explain how barriers to entry contribute to the formation of a monopoly.
  • Barriers to entry are factors that make it difficult for new firms to enter a market and compete with an existing monopoly. These barriers can include economies of scale, control of essential resources, or government-granted exclusive rights. When barriers to entry are high, it becomes challenging for potential competitors to enter the market, allowing the monopolist to maintain its dominant position and set prices without the threat of competition.
• Describe how a profit-maximizing monopolist determines the optimal level of output and price.
  • A profit-maximizing monopolist will choose the level of output and price that generates the highest possible profits. Unlike a firm in a competitive market, a monopolist faces a downward-sloping demand curve, meaning that it can only sell a higher quantity by lowering the price. The monopolist will choose the output level where the marginal revenue (the additional revenue from selling one more unit) equals the marginal cost (the additional cost of producing one more unit). This output level will be lower, and the price will be higher, than what would be observed in a competitive market.
• Evaluate the role of government regulation in addressing the potential harms of monopolies.
  • Governments may intervene to regulate monopolies in order to protect consumer welfare and promote competition. Policies such as antitrust laws, price controls, and the promotion of competition can help mitigate the negative effects of monopolies, which include higher prices, lower output, and a lack of incentive for innovation. By regulating monopolies, governments can aim to restore the efficiency and consumer benefits that would be present in a competitive market. However, the effectiveness of these regulations depends on the specific market conditions and the government's ability to enforce them.

Related terms

Barriers to Entry: Factors that make it difficult for new firms to enter a market and compete with an existing monopoly, such as economies of scale, control of essential resources, or government regulations.

Profit Maximization: The process by which a monopolist determines the optimal level of output and price to charge in order to generate the highest possible profits.

Anticompetitive Behavior: Actions taken by a monopolist to maintain its market dominance and prevent the entry of potential competitors, often through unethical or illegal means.