Notes07 - Notes 07 Introductory Microeconomics ECON 1110...

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Notes 07– Introductory Microeconomics ECON 1110 Monopoly Introduction We have considered the behavior of firms in a perfectly competitive market – the case of price takers (firms that have no effect on market prices and so take prices as given). We now consider the case of price searchers (firms that can affect market prices, and so search for the price that maximizes producer surplus). At the extreme case price searchers can be monopolists (the only producer of a good in a market). We will examine how the monopolist behaves and how that behavior differs from the case of perfect competition. Note: I will often use the terms price searcher and monopolist interchangeably. When does a monopoly exist? 1) A monopoly can be the outcome of patent policy. A patent grants the inventor sole rights to an invention for a certain time period. 2) It can be the outcome of trade secrets. 3) It can result from non-rivalry (i.e., a natural monopoly). One firm can produce all of the market output more cheaply than two firms. 4) It can also result from brand loyalty. Demand for the Monopolist Since the monopolist supplies the entire market, the demand function that the monopolist faces is the market demand for the good. The market demand curve is typically downward sloping. This is different from the firm demand curve encountered by a price-taker. Since a price-taker can’t affect prices, the price-taker assumes that they can sell as much as they would like at the market price. As a result, to a price-taker, the firm demand curve appears to be perfectly elastic (i.e. the firm demand curve appears to be horizontal). A monopolist can be viewed as freely selecting either price or quantity , but not both: the monopolist will be constrained by the market demand. Indeed, when selecting price the market demand represents a restriction to how much the monopolist can sell at any given price; and when selecting quantity the demand curve will indicate the maximum price per unit that can be charged for any given level of output. Unlike the perfectly competitive firm, the monopolist recognizes that its choice of quantity affects the market price. Or, equivalently, the monopolist recognizes that its choice of price affects the quantity purchased in the market; this is why monopolists are referred to as price- searchers. 1
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