Monopoly

A monopoly is the complete opposite of perfect competition, where the market structure consists of a single seller of a product with no close substitutes, and who serves an entire market. A very good example would be professional sports leagues, and the American Medical Association.

Sources of Monopoly include:

• exclusive control over inputs
• economies of scale (when production cost decreases with an increase in quantity produced), which causes natural monopolies. Natural monopolies have a decreasing Average Cost curve, so they need the entire market to reach the lowest average cost, and to make the most profit. Natural monopolies are usually utilities like water, gas, landlines and cable)
• Patents: exclusive right to an idea for 20 years
• Government licenses or franchises

The Monopolist has a downward sloping demand curve, and P > MR, as the producer must lower prices to sell more. To derive MR from the demand curve, you use the half-way rule. Draw perpendicular lines from the demand curve to the y-axis, and the MR curve will be the connection of all half way marks of those perpendicular lines. In other words, if P = a – bQ, MR = a – 2bQ. MR = P – (P/∈).

Requirements for the short run equilibrium for a monopolist include:

• MR = MC
• P ≥ AVC

Requirements for the long run equilibrium for a monopolist include:

• MR = LRMC
• P ≥ LRAC
• In the long run, there is no threat for a monopolist for other firms to enter the market, so long-term profit is sustainable

Monopoly myths:

• Monopoly will never lose money: can lose money in the short run because the Price must only cover AVC costs, not necessarily all costs. 
• Monopoly can charge whatever price they want: they can, but they should choose a price where MR = MC, as that maxes their profit.

Monopolies will never produce on the inelastic portion of the demand curve (the section that is to the right of the x-intercept of MR), as with every product you make after that point, revenue will be negative, which means MC has to be negative. This is not possible, so production past MR = 0 is not possible.

The Lerner Index is the measure of how much monopoly power a firm has.

L = (P – MC)/P

This measure projects power with a measurement between 0 and 1. If P = MC, L = 0, which means perfect competition. If MC = 0, L = 1, which means a pure monopoly.

A high L ≠ high profit. Profit depends on average cost vs. price.

Price Discrimination comes in varying degrees.

• First degree price discrimination: based on willingness to pay. A car dealership is a very good example. As your willingness to pay increases, the price increases. D = MR. 
• Second degree price discrimination: based on declining block rate structures. usually used by utility companies. Based on how much you purchased.