Monopoly Pricing

Where many buyers and sellers compete in a market, both buyer and seller are price takers — they have to accept the market price.

However, if only one firm supplies goods to a market, the market is a monopoly. Because there is no competition from other firms, the firm can set the price of the goods to whatever it chooses, making the firm a price maker.

In this Activity, you will see why certain types of goods and services are provided by monopolies, and how a monopoly, as a price maker, decides how to set its price.

Many power companies are monopolies because it is too expensive for more than one firm to build the network of transmission lines needed to move electricity from the generating stations to the customers.

Natural Monopoly

Governments of mixed economies usually discourage monopolies. However, a monopoly is the least expensive means of production when a market has a high barrier to entry and the marginal cost of adding a customer or unit of production is very small compared to the fixed costs of providing the product. Your town probably has one water company. A second firm would have to invest millions to provide water to even one customer; this is a barrier to entry. The existing water company incurs almost no marginal cost to add a new customer, but it has the high fixed cost of improving and maintaining the existing water supply system. Such a firm is a natural monopoly.

Governments also grant temporary monopolies on new goods. A patent or copyright protects the investment made to invent or create a new intellectual property, giving the holder of the patent or copyright complete control over who may produce the product for a period of time. A firm can also become a monopoly if it finds a way to reduce the cost of providing a good compared to their competitors, or wins a large enough share of the market to achieve large economies of scale.

However a firm becomes a monopoly, it is in the position of a price maker and must set its prices.

Demand Curve

Say a small town had only one movie theatre. The owner of the theatre has found that the demand for movie tickets has a linear relationship to the price of the tickets. As with any demand curve, lower prices increase the quantity demanded.

Move the slider to change the ticket price. Watch how the number of tickets sold changes with it.

Ticket Price

$15.00

Tickets Sold

0

Tickets Sold

Number of Tickets Sold

Price Making

One might think that the owner of the theatre would set the ticket price so that the number of tickets sold times the price is a maximum. That is, the owner would try to maximize the revenue. The graph shows the revenue as a function of the number of tickets sold.

Move the slider to set the number of tickets sold. Watch how the revenue changes with it.

Ticket Price P

$15.00

Tickets Sold Q

0

Revenue: Q x P

$0

Tickets Sold

Number of Tickets Sold

Price Making

However, the owner of the theatre has costs. If for each showing there is a fixed cost of $250, and a cost per customer of $4.00, the graph at right shows the profit for each showing as a function of the number of tickets sold.

Move the slider to set the number of tickets sold. Watch how the profit changes with it.

Ticket Price P

$15.00

Tickets Sold Q

0

Revenue R:
Q x P

$0

Profit:
R - $250 - ($4 x Q)

$0

Tickets Sold

Number of Tickets Sold

Price Making

The theatre owner sets his price to maximize the firm’s profit. Because of costs per customer, it is not the most efficient quantity, as the owner could serve many more customers. As the cost of adding additional customers increases, the price increases and the number of customers the monopolist is willing to serve decreases.

see answer
The theatre owner needs to reduce his per-customer costs in order to make a larger profit from more customers.

Maximum Profit

show

Maximum Revenue

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Did You Get It?

How could the theatre owner increase the
number of customers and the firm’s profit?

Tickets Sold

Number of Tickets Sold

Wrap Up

A monopoly is a market in which only one firm supplies a product that has no close substitutes.

For more information on monopoly pricing, read Chapter 8, Module 23 of Explorations in Economics and study the Module 23 Review and Assessment. You can also test yourself with the Module 23 online quiz here on the BCS.

Law of Supply — Monopoly Pricing

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