Demand and Marginal Revenue

In this chapter, we will assume that the monopolist charges all customers the same price. The monopolist faces the whole demand of the market. We can compare with a perfectly competitive market by looking again at Figure. The individual firm in a competitive market only faces a small part of the market. Therefore, it can be represented as in the right-hand side of the figure. A monopolist is the whole market. Therefore, it looks like the left-hand side of the figure. In order to sell more goods, the monopolist has do reduce the price, and the demand curve it faces will therefore slope downwards.

Now. note that the demand curve is decided by the consumers and not by the firm. It answers the question: if we would offer a certain price, how many units would we then be able to sell? In the perfectly competitive market, marginal revenue was equal to the price. That is not the case for a monopolist. For the monopolist to be able to sell an additional unit of the good, she must lower the price of all units. The total effect of selling one more unit then consists of both what she is paid for the last unit and of the reduction of revenue from all the other units that she now has to sell at the lower price. Consequently, the marginal revenue will be lower than the price.
Let us see what this means for a good with linear demand. If the demand curve is a straight lme. the MR curve will also be a straight line with the same intercept on the Y-axis as the demand curve. However, it will have a slope with twice the magnitude. (To show that, we need to use the derivative, but this, again, is outside the scope of this book.)

We will use the demand curve Od = 30 - p. or if we solve for p: p = 30 - Od . If the MR curve is to start in the same point and have a slope that is twice as large, its functional form must be MR = 30 - 2*Od. (The constant is the same, 30. and the slope is changed from -1 to -2). In Figure the curves are drawn as D and MR. We have also drawn a marginal cost curve, MC (= 2*0), an average cost curve. ATC. and an average variable cost curve, A VC (= Q). and. in the lower part of the figure, total revenue. TR. and profit, n.

Monopoly

Monopoly can be viewed as the opposite of perfect competition. Instead of many firms, there is only one: the monopolist. This has important conse­quences for both price setting and the quantity produced.

Barriers to Entry

Why do monopolies arise? There are many different reasons, but all of them have to do with barriers to entry in the market. The reasons for these barriers could be

• Structural.
There are properties of the market that automatically shut competitors out:

• Economies of scale.
If there are economies of scale, large-scale advantages, the size of the firm is crucial for average cost. A situation can then arise in which only one firm can recover its costs. This is called a natural monopoly and an example of this is rail­roads.

• Cost advantages.
If the monopolist has access to a cheaper way of producing the good, for instance if she has a patent on a cheap­er technology, she can push competitors out of the market.

•  Strategic limitations. The monopolist can create barriers to entry. An example is limit pricing, where the monopolist sets the price so low that it becomes unattractive for competitors to enter.

•  Political. The government may decide to grant a firm a monopoly in a certain market. A common example is for pharmaceutical goods.

•  Patents and exclusive rights. If a firm has a patent on a certain good, other firms are shut out during the life span of the patent. It is also possible to have exclusive right to extracting, for instance, oil or met­als.