MARKET POWER: MONOPOLY AND MONOPSONY
1. a monopolist is producing at a point at which marginal cost exceeds marginal revenue. How should it adjust its output
to increase profit?
When marginal cost is greater than marginal revenue, the incremental cost of the last unit produced is greater than
incremental revenue. The firm would increase its profit by not producing the last unit. It should continue to reduce
production, thereby decreasing marginal cost and increasing marginal revenue, until marginal cost is equal to marginal
2. We write the percentage markup of prices over marginal cost as (P - MC)/P. For a profit-maximizing monopolist, how
does this markup depend on the elasticity of demand? Why can this markup be viewed as a measure of monopoly power?
We can show that this measure of market power is equal to the negative inverse of the price elasticity of demand.
The equation implies that, as the elasticity increases (demand becomes more elastic), the inverse of elasticity decreases
and the measure of market power decreases. Therefore, as elasticity increases (decreases), the firm has less (more) power
to increase price above marginal cost.
3. Why is there no market supply curve under conditions of monopoly?
The monopolist’s output decision depends not only on marginal cost, but also on the demand curve. Shifts in demand do
not trace out a series of prices and quantities that we can identify as the supply curve for the firm. Instead, shifts in
demand lead to changes in price, output, or both. Thus, there is no one-to-one correspondence between the price and the
seller’s quantity; therefore, a monopolized market lacks a supply curve.
4. Why might a firm have monopoly power even if it is not the only producer in the market?
The degree of monopoly power or market power enjoyed by a firm depends on the elasticity of the demand curve that it
faces. As the elasticity of demand increases, i.e., as the demand curve becomes flatter, the inverse of the elasticity
approaches zero and the monopoly power of the firm decreases. Thus, if the firm’s demand curve has any elasticity less
than infinity, the firm has some monopoly power.
5. What are some of the sources of monopoly power? Give an example of each.
The firm’s exploitation of its monopoly power depends on how easy it is for other firms to enter the industry. There are
several barriers to entry, including exclusive rights (e.g., patents, copyrights, and licenses) and economies of scale. These
two barriers to entry are the most common. Exclusive rights are legally granted property rights to produce or distribute
a good or service. Positive economies of scale lead to "natural monopolies" because the largest producer can charge a
lower price, driving competition from the market. For example, in the production of aluminum, there is evidence to
suggest that there are scale economies in the conversion of bauxite to alumina. (See
U.S. v. Aluminum Company of