Microeconomics guide, Unit 4, step 16 of 28Previous step Next step

Step 16: Monopoly

By the EconTutorials team. 10-minute read with 6 practice questions.

SyllabusAP Micro 4.1–4.2 · Cambridge 7.6 · IB 2.11 (HL)

In 30 seconds

A monopoly is a single seller of a good with no close substitutes, protected by barriers to entry. It is a price maker.
Its demand curve is the market demand curve, so to sell more it must cut its price on every unit. That makes marginal revenue less than price.
It produces where $ MC = MR $, then charges the price read from the demand curve. Profit is $ (P_m – ATC) \times Q_m $, and barriers let it last into the long run.
Compared with perfect competition, monopoly means a higher price, lower output, $ P > MC $ and a deadweight loss.

Video lesson coming soonA short animated lesson for this step will appear here.

What a monopoly is

Think of the only café inside an exam hall during a long day of papers. There is no other place to buy a drink, and you cannot leave to find one. The café does not have to accept anyone else’s price: it chooses its own. It knows that if it charges too much it will sell fewer drinks, but it has no rival waiting to steal its customers. That is the position of a monopolist.

In Step 11, a perfectly competitive firm was a tiny price taker. A monopolist is the opposite: because it is the only seller, it is the market. Its decision about how much to produce sets the market price.

Key termMonopoly: a market structure with a single seller, no close substitutes and high barriers to entry.

Key termPrice maker: a firm that can influence the market price by choosing how much to produce.

Key termBarriers to entry: factors that stop new firms entering a market, which let a monopolist keep its position and its profit in the long run.

Where monopoly power comes from

The book groups barriers to entry into four types. Exams often ask you to match an example to the right type.

Barrier	How it works	Examples from the book
Legal barriers	Patents, copyrights, licences and franchises ban rivals by law	Drug patents; Royal Mail’s former legal monopoly on UK letters
Natural monopoly	Very high fixed costs mean one firm can supply the whole market more cheaply than two or more	Water supply, electricity distribution, railway networks
Control of essential resources	One firm owns a key input that rivals need	De Beers and diamonds, historically
Network effects and brand loyalty	The product becomes more valuable as more people use it, so the leader is hard to displace	Search engines, desktop operating systems

Why marginal revenue is below price

Here is the key difference from perfect competition. A monopolist faces the whole downward-sloping market demand curve. To sell one more unit, it must lower its price, and the lower price applies to every unit, not just the extra one.

Say the exam-hall café sells 8 drinks at $10 each (revenue $80). To sell a 9th drink it must drop the price to $9 for everyone. Revenue becomes $ 9 \times 9 = \$81 $. The extra drink brought in $9, but the café lost $1 on each of the first 8 drinks. So marginal revenue is only $ 81 – 80 = \$1 $, far below the $9 price.

Key termMarginal revenue in monopoly: the extra revenue from selling one more unit, which is always less than price because the price cut also reduces revenue on all the units already being sold.

For a straight-line demand curve, there is a handy shortcut. The MR curve starts at the same point on the price axis but falls twice as steeply:

\[ \text{If } P = a – bQ, \text{ then } MR = a – 2bQ \]

Finding the monopoly price and profit

A monopolist follows the same rule as every firm: produce where $ MC = MR $. Then it does one more thing. It goes up to the demand curve to find the highest price buyers will pay for that quantity. Three steps:

Find $ Q_m $ where MC = MR.
Go up to the demand curve to read $ P_m $.
Find ATC at $ Q_m $ and calculate profit.

\[ \text{Profit} = (P_m – ATC) \times Q_m \]

Worked example

A monopolist faces demand $ P = 80 – 2Q $ and has a constant $ MC = 20 $. At its profit-maximising output, ATC = $30. Find its output, price and profit, and compare with the competitive outcome.

Step 1$ MR = 80 – 4Q $. Set $ MR = MC $: $ 80 – 4Q = 20 \Rightarrow Q_m = 15 $

Step 2$ P_m = 80 – 2(15) = \$50 $

Step 3$ \text{Profit} = (50 – 30) \times 15 = \$300 $

Step 4Competition sets $ P = MC $: $ 80 – 2Q = 20 \Rightarrow Q_c = 30,\; P_c = \$20 $

The monopolist makes half the competitive output (15 instead of 30) and charges $50 instead of $20. Barriers to entry stop new firms coming in to compete the $300 profit away.

Common mistakeReading the monopoly price off the point where MC crosses MR. That point only tells you the quantity. The price comes from going straight up to the demand curve, because that is what buyers are willing to pay for $ Q_m $. Charging the lower MC = MR price would leave money on the table.

Monopoly versus perfect competition

	Perfect competition	Monopoly
Price	Lower ($ P_c $)	Higher ($ P_m > P_c $)
Quantity	Higher ($ Q_c $)	Lower ($ Q_m < Q_c $)
Long-run profit	Zero (free entry)	Positive (barriers to entry)
Allocative efficiency	Yes, P = MC	No, P > MC
Productive efficiency	Yes, minimum ATC	No, not at minimum ATC
Deadweight loss	None	Yes

Monopoly shrinks consumer surplus in two ways. Part of it is transferred to the monopolist as profit: buyers who still purchase now pay more. The rest is destroyed as deadweight loss: some buyers valued the good above its marginal cost but are priced out, so those trades never happen.

With a constant MC, these areas are easy to measure. The transfer is the rectangle $ (P_m – P_c) \times Q_m $, and the deadweight loss is the triangle $ \tfrac{1}{2} \times (Q_c – Q_m) \times (P_m – P_c) $. In the worked example above: transfer $ = 30 \times 15 = \$450 $, and DWL $ = \tfrac{1}{2} \times 15 \times 30 = \$225 $.

Can monopoly ever be a good thing?

Monopoly is generally harmful, but the book sets out four defences:

Natural monopoly. Building two sets of water pipes would be wasteful. A single regulated firm can be better, for example if a regulator sets price equal to ATC (fair-return pricing) so consumers are protected and the firm stays viable.
Innovation. Joseph Schumpeter (1942) argued that the chance of monopoly profit drives risky research. Drug patents are the classic example.
Economies of scale. One large firm may produce at lower average cost than several small ones. If those savings reach consumers, welfare can be higher.
Cross-subsidisation. Profits from one service can fund another that is valuable but unprofitable, such as Royal Mail using urban profits to support rural deliveries.

Governments respond to monopoly with regulation, antitrust (competition) law and, in some cases, nationalisation. The book’s case study is the 2024 US court ruling that Google had illegally maintained a monopoly in search, partly through paying to be the default search engine on other companies’ devices.

Exam tipThe monopoly diagram is the most important diagram in this unit. Draw D and MR (MR below D, starting at the same point, twice as steep), plus MC and ATC. Mark $ Q_m $ where MC = MR, go up to D for $ P_m $, shade profit between $ P_m $ and ATC, and shade the DWL triangle between $ Q_m $ and $ Q_c $, between D and MC. Label everything: unlabelled curves lose marks.

Practise: 6 questions

Try each one on paper first, then check the worked answer.

EasyQ1. A monopolist has MC = MR at Q = 200. At that output, the demand curve gives P = $30 and ATC = $22. Calculate economic profit. Show worked answer

$ \text{Profit} = (30 – 22) \times 200 = 8 \times 200 = \$1{,}600 $

EasyQ2. Name the type of barrier to entry in each case: (a) a 20-year patent on a new medicine; (b) a single company supplying a city’s water through one network of pipes. Show worked answer

(a) Legal barrier: the patent bans rivals by law.
(b) Natural monopoly: the fixed cost of the network is so high that one firm can supply the whole market more cheaply than two.

MediumQ3. A monopolist faces demand $ P = 60 – 2Q $. Write the MR equation and find MR when Q = 12. Compare it with the price at Q = 12. Show worked answer

Using $ MR = a – 2bQ $: $ MR = 60 – 4Q $.
At $ Q = 12 $: $ MR = 60 – 48 = \$12 $.
Price at $ Q = 12 $: $ P = 60 – 24 = \$36 $.
MR ($12) is well below P ($36) because selling the 12th unit requires a lower price on all the earlier units too.

MediumQ4. Under monopoly, P = $60 and Q = 40. Under perfect competition, P = $30 and Q = 80, with MC constant at $30. Calculate (a) the transfer of surplus from consumers to the monopolist and (b) the deadweight loss. Show worked answer

(a) Transfer $ = (P_m – P_c) \times Q_m = (60 – 30) \times 40 = \$1{,}200 $. This becomes monopoly profit; it is not lost to society.
(b) $ DWL = \tfrac{1}{2} \times (80 – 40) \times (60 – 30) = \tfrac{1}{2} \times 40 \times 30 = \$600 $. This surplus disappears completely.

MediumQ5. Explain why a monopolist can earn economic profit in the long run while a perfectly competitive firm cannot. Show worked answer

In perfect competition, profit attracts new firms. Supply rises, the price falls and profit is competed away to zero.
In monopoly, barriers to entry (patents, economies of scale, control of resources, network effects) stop new firms entering. With no entry there is no extra supply and no fall in price, so the profit persists.

ExamQ6. A monopolist faces demand $ P = 100 – Q $ and has $ MC = 10 + Q $. At its profit-maximising output, ATC = $45. (a) Derive MR. (b) Find the profit-maximising quantity and price. (c) Calculate economic profit. (d) Find the competitive quantity and price (where P = MC). (e) Calculate the deadweight loss. [8 marks] Show worked answer

(a) $ MR = 100 – 2Q $. [1 mark]
(b) $ 100 – 2Q = 10 + Q \Rightarrow 90 = 3Q \Rightarrow Q_m = 30 $. $ P_m = 100 – 30 = \$70 $. [2 marks]
(c) $ \text{Profit} = (70 – 45) \times 30 = \$750 $. [1 mark]
(d) $ 100 – Q = 10 + Q \Rightarrow 90 = 2Q \Rightarrow Q_c = 45 $. $ P_c = 100 – 45 = \$55 $. Competition produces more (45 vs 30) at a lower price ($55 vs $70). [2 marks]
(e) At $ Q_m = 30 $, MC $ = 10 + 30 = \$40 $. The DWL triangle has base $ 45 – 30 = 15 $ and height $ 70 – 40 = 30 $. $ DWL = \tfrac{1}{2} \times 15 \times 30 = \$225 $. These are trades where buyers valued the good above its marginal cost but which the monopolist chose not to make. [2 marks]

Check yourself

1. A monopolist’s MR curve lies below its demand curve because:

The gain on the extra unit is partly cancelled by lower revenue on earlier units.

2. Compared with perfect competition, a monopoly produces:

The monopolist restricts output to push the price up.

3. Which of these is NOT a barrier to entry?

A perfectly elastic demand curve describes a price taker in perfect competition.

Your score: 0 out of 3

The short version

A monopoly is one seller with no close substitutes, protected by legal, natural, resource or network barriers.
MR is below demand; for $ P = a – bQ $, $ MR = a – 2bQ $.
Produce where MC = MR, charge the price on the demand curve, and earn $ (P_m – ATC) \times Q_m $.
Monopoly means a higher price, lower output, P > MC, no productive efficiency and a deadweight loss; some consumer surplus becomes profit.
Defences include natural monopoly, innovation, economies of scale and cross-subsidisation; governments respond with regulation, antitrust law and nationalisation.

This guide covers the core of the chapter. For the full Chapter 12, with the complete monopoly diagram, the Google search case study and 15 exam-style questions with a complete answer key, see the book Economics Made Simple.