ECON101 Lecture Notes - Lecture 13: Natural Monopoly, De Beers, Demand Curve
31 Oct 2018
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Monopoly
A monopoly is a market:
a. That produces a good or service for which no close substitutes exist.
b. In which there is one supplier that is protected from competition by a barrier preventing the
entry of new firms.
A monopoly has two key features:
a. No close substitutes
b. Barriers to entry
No Close Substitute
If a good has a close substitute, even if it is produced by only one firm, that firm effectively faces
competition from the producers of the substitute. Therefore a monopoly sells a good that has no
close substitutes.
Barriers to Entry
A constraint that protects a firm from potential competitors is called a barrier to entry.
Three types of barriers to entry are:
1. Natural
Natural barriers to entry create natural monopoly. A natural monopoly (pure monopoly) is an
industry in which economies of scale enable one firm to supply the entire market at the lowest
possible cost
In a natural monopoly, economies of scale are so powerful that they are still being achieved even
when the entire market demand is met. The LRAC curve is still sloping downward when it meets the
demand curve.
2. Ownership
An ownership barrier to entry occurs if one firm owns a significant portion of a key resource. For
example, during the last century, De Beers owned 90 percent of the world’s diamonds.
3. Legal
Legal barriers to entry create a legal monopoly. A legal monopoly is a market in which competition
and entry are restricted by the granting of a:
➢ Public franchise
➢ Government license
➢ Patent (an exclusive right granted to the inventor of a product or service) or a copyright (an
exclusive right grated to authors or a composer of a literary, musical, dramatic, or artistic
work.
Monopoly:
A monopoly sets its own price.
As the sole producer of a product, a monopolist is in a unique position. If the monopolist decides to
raise price of the product, it need not worry about competitors, who, by charging lower prices,
would capture a larger market share of the market at the monopolist’s expense.
The monopolist is the market and completely controls the amount of output offered for sale.
There are two types of monopoly price-setting strategy:
1. A single-price monopoly is a firm that must sell each unit of its output for the same price to
all its customers
2. Price discrimination is the practice of selling different units of a good or service for different
prices.
Price and Marginal Revenue
A monopoly is a price setter. The objective is to maximize profit.
In a monopoly market, there is only one firm so the demand curve a monopoly faces is the demand
for the market demand.
The monopolist’s average revenue (AR) is the market demand curve.
Marginal revenue, MR, is the change in total revenue that results from a one-unit increase in the
quantity sold. For a single-price monopoly, marginal revenue is less than price at each level of
output. That is, MR < P.
Check Slide 20 for further explanation
Demand and Marginal Revenue
To sell a larger output, a monopoly must set a lower price.
When price is lowered to sell additional unit, two opposing forces affect TR:
➢ The lower price results in revenue loss.
➢ The increased quantity sold results in revenue gain.
Check Slide 25 for further explanation
Marginal Revenue and Elasticity
A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good. If
demand is elastic, a fall in price brings an increase in total revenue.
The revenue gain from the increase in quantity sold outweighs the revenue loss from the lower price
per unit, and MR is positive. As the price falls, total revenue increases and MR is positive.
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Document Summary
A monopoly is a market: that produces a good or service for which no close substitutes exist. In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. A monopoly has two key features: no close substitutes, barriers to entry. If a good has a close substitute, even if it is produced by only one firm, that firm effectively faces competition from the producers of the substitute. Therefore a monopoly sells a good that has no close substitutes. A constraint that protects a firm from potential competitors is called a barrier to entry. Three types of barriers to entry are: natural. A natural monopoly (pure monopoly) is an industry in which economies of scale enable one firm to supply the entire market at the lowest possible cost. In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the entire market demand is met.
