Microeconomics Foundations (ECON 101) · Module 7 of 9
Market Power: Monopoly & Imperfect Competition
What happens to price, output, and efficiency when firms aren't simple price-takers.
Monopoly & Market Power
- A monopoly is a single seller with no close substitutes and significant barriers to entry, giving it market power — the ability to influence the price it charges.
- Because a monopolist faces the entire downward-sloping market demand curve, its marginal revenue is less than price at every quantity beyond the first unit.
Why is a monopolist's marginal revenue always less than the price it charges, beyond the first unit?
Solution. To sell an additional unit, a monopolist must lower the price on ALL units sold, since it faces the whole downward-sloping demand curve, not just the additional one, so the extra revenue gained is less than the new, lower price.
Monopoly Profit Maximization & Deadweight Loss
- Like any firm, a monopolist maximizes profit where MR = MC, but then charges the price on the demand curve corresponding to that quantity, which is higher than in a competitive market.
- A monopoly produces less and charges more than a competitive market would, creating a deadweight loss — a loss of total economic surplus compared to the competitive outcome.
Why does monopoly typically result in a deadweight loss compared to perfect competition?
Solution. A monopolist restricts output below the competitive (efficient) level to charge a higher price, so some mutually beneficial trades between the monopolist and consumers who would value the good above its cost don't happen, resulting in a loss of total surplus.
Monopolistic Competition
- Monopolistic competition features many firms selling differentiated, not identical, products, with some market power due to that differentiation but easy entry and exit.
- In the long run, monopolistically competitive firms also earn zero economic profit, as new firms with similar (differentiated) products enter and erode any positive profits.
How does monopolistic competition differ from both perfect competition and monopoly?
Solution. Like perfect competition, it has many firms and easy entry/exit leading to zero long-run economic profit; unlike perfect competition, firms sell differentiated products, giving each firm some limited market power over its own specific product, similar to, but weaker than, a monopoly.
Oligopoly & Strategic Interaction
- An oligopoly features a small number of firms whose decisions significantly affect each other, requiring firms to consider rivals' likely responses — a situation studied using game theory.
- Oligopolists often face an incentive to collude, like a cartel, to raise joint profits, but also a strong incentive to cheat on such agreements, making collusion difficult to sustain.
Why might oligopoly firms in a cartel have a strong incentive to secretly cheat on their collusive agreement, even though the agreement benefits all firms collectively?
Solution. While the group as a whole benefits from restricting output and keeping prices high, each individual firm can often earn more profit by secretly producing and selling more than its agreed share at the high cartel price — at least until other firms notice and retaliate.
Check yourself
2 of this module's 5 quiz questions. Pick your answers, then check them in the app, with an explanation for every question.
1. What makes a monopolist's marginal revenue less than the price it charges?
2. What is deadweight loss in the context of monopoly?