Editing Monopoly (section)

== Monopoly versus competitive markets ==
[[File:Modern Colossus of Rail Roads - Keppler 1879.jpg|thumb|right|235px|This 1879 anti-monopoly cartoon depicts powerful railroad barons controlling the entire rail system.]]
While monopoly and perfect competition represent the extremes of market structures<ref name=Png-268>Png (1999), p. 268.</ref> there is some similarity. The cost functions are the same.<ref>{{ cite book | last = Negbennebor | first = Anthony | title = Microeconomics, The Freedom to Choose | publisher = CAT Publishing | year = 2001}}</ref> Both monopolies and perfectly competitive (PC) companies minimize cost and maximize profit. The shutdown decisions are the same. Both are assumed to have perfectly competitive factors markets. There are distinctions; some of the most important are as follows:
* ''Marginal revenue and price'': In a perfectly competitive market, price equals marginal cost. In a monopolistic market, however, price is set above marginal cost. The price equal marginal revenue in this case.<ref>Mankiw (2007), p. 338.</ref>
* ''[[Product differentiation]]'': There is no product differentiation in a perfectly competitive market. Every product is perfectly homogeneous and a perfect substitute for any other. With a monopoly, there is great to absolute product differentiation in the sense that there is no available substitute for a monopolized good. The monopolist is the sole supplier of the good in question.<ref name="Hirschey, M p. 426">{{cite book | last = Hirschey | first = M | title = Managerial Economics | page = 426 | publisher = Dreyden | year = 2000}}</ref> A customer either buys from the monopolizing entity on its terms or does without.
* ''Number of competitors'': PC markets are populated by a large number of buyers and sellers. A monopoly involves a single seller.<ref name="Hirschey, M p. 426" />
* ''Barriers to entry'': Barriers to entry are factors and circumstances that prevent entry into market by would-be competitors and limit new companies from operating and expanding within the market. PC markets have free entry and exit. There are no barriers to entry, or exit competition. Monopolies have relatively high barriers to entry. The barriers must be strong enough to prevent or discourage any potential competitor from entering the market. 
* ''Elasticity of demand'': The price elasticity of demand is the percentage change of demand caused by a one percent change of relative price. A successful monopoly would have a relatively inelastic demand curve. A low coefficient of elasticity is indicative of effective barriers to entry. A PC company has a perfectly elastic demand curve. The coefficient of elasticity for a perfectly competitive demand curve is infinite.<ref>{{Cite book |last1=Hoag |first1=John H. |url=https://books.google.com/books?id=JZRIDQAAQBAJ |title=Introductory Economics |last2=Hoag |first2=Arleen J. |date=2002-06-06 |publisher=World Scientific Publishing Company |isbn=978-981-310-591-1 |pages=93 |language=en |edition=Third }}</ref>
* ''Excess profits'': Excess or positive profits are profit more than the normal expected return on investment. A PC company can make excess profits in the short term but excess profits attract competitors, which can enter the market freely and decrease prices, eventually reducing excess profits to zero.<ref>{{cite book | last1 = Pindyck | first1 = R | last2 = Rubinfeld | first2 = D | title = Microeconomics | url = https://archive.org/details/microeconomics5thpind | url-access = registration | edition = 5th | page = [https://archive.org/details/microeconomics5thpind/page/333 333] | publisher = Prentice-Hall | year = 2001| isbn = 978-0-13-016583-1 }}</ref> A monopoly can preserve excess profits because barriers to entry prevent competitors from entering the market.<ref>Melvin and Boyes (2002), p. 245.</ref>
* ''[[Profit maximization]]'': A PC company maximizes profits by producing such that price equals marginal costs. A monopoly maximises profits by producing where marginal revenue equals marginal costs.<ref>{{cite book | last = Varian | first = H | title = Microeconomic Analysis | url = https://archive.org/details/microeconomicana00vari_0 | url-access = registration | edition = 3rd | page = [https://archive.org/details/microeconomicana00vari_0/page/235 235] | publisher = Norton | year = 1992| isbn = 978-0-393-95735-8 }}</ref> The rules are not equivalent. The demand curve for a PC company is perfectly elastic – flat. The demand curve is identical to the average revenue curve and the price line. Since the average revenue curve is constant the marginal revenue curve is also constant and equals the demand curve, Average revenue is the same as price (<math>\text{AR} = \frac{\text{TR}}{Q} = P \cdot \frac{Q}{Q} = P</math>). Thus the price line is also identical to the demand curve. In sum, <math>\text{D} = \text{AR} = \text{MR} = P</math>.
* ''P-Max quantity, price and profit'': If a monopolist obtains control of a formerly perfectly competitive industry, the monopolist would increase prices, reduce production, incur deadweight loss, and realise positive economic profits.<ref>Pindyck and Rubinfeld (2001), p. 370.</ref>
* ''Supply curve'': in a perfectly competitive market there is a well defined supply function with a one-to-one relationship between price and quantity supplied.<ref>Frank (2008), p. 342.</ref> In a monopolistic market no such supply relationship exists. A monopolist cannot trace a short-term supply curve because for a given price there is not a unique quantity supplied. As Pindyck and Rubenfeld note, a change in demand "can lead to changes in prices with no change in output, changes in output with no change in price or both".<ref>Pindyck and Rubenfeld (2000), p. 325.</ref> Monopolies produce where marginal revenue equals marginal costs. For a specific demand curve the supply "curve" would be the price-quantity combination at the point where marginal revenue equals marginal cost. If the demand curve shifted the marginal revenue curve would shift as well and a new equilibrium and supply "point" would be established. The locus of these points would not be a supply curve in any conventional sense.<ref>Nicholson (1998), p. 551.</ref><ref>Perfectly competitive firms are price takers. Price is exogenous and it is possible to associate each price with unique profit maximizing quantity. Besanko, David, and Ronald Braeutigam, ''Microeconomics'' 2nd ed., Wiley (2005), p. 413.</ref>

The most significant distinction between a PC company and a monopoly is that the monopoly has a downward-sloping demand curve rather than the "perceived" perfectly elastic curve of the PC company.<ref name="Binger, B 1998">{{cite book | last1 = Binger | first1 = B. | last2 = Hoffman | first2 = E. | title = Microeconomics with Calculus | edition = 2nd | publisher = Addison-Wesley | year = 1998}}</ref> Practically all the variations mentioned above relate to this fact. If there is a downward-sloping demand curve then by necessity there is a distinct marginal revenue curve. The implications of this fact are best made manifest with a linear demand curve. Assume that the inverse demand curve is of the form <math>x = a - by</math>. Then the total revenue curve is <math>\text{TR} = ay - by^2</math> and the marginal revenue curve is thus <math>\text{MR} = a - 2by</math>. From this several things are evident. First, the marginal revenue curve has the same <math>x</math>-intercept as the inverse demand curve. Second, the slope of the marginal revenue curve is twice that of the inverse demand curve. What is not quite so evident is that the marginal revenue curve is below the inverse demand curve at all points (<math>y \ge 0</math>).<ref name="Binger, B 1998" /> Since all companies maximise profits by equating <math>\text{MR}</math> and <math>\text{MC}</math> it must be the case that at the profit-maximizing quantity MR and MC are less than price, which further implies that a monopoly produces less quantity at a higher price than if the market were perfectly competitive.

The fact that a monopoly has a downward-sloping demand curve means that the relationship between total revenue and output for a monopoly is much different from that of competitive companies.<ref name="Frank 2009 377">Frank (2009), p. 377.</ref> Total revenue equals price times quantity. A competitive company has a perfectly elastic demand curve meaning that total revenue is proportional to output.<ref name="Frank 2009 377" /> Thus the total revenue curve for a competitive company is a ray with a slope equal to the market price.<ref name="Frank 2009 377" /> A competitive company can sell all the output it desires at the market price. For a monopoly to increase sales it must reduce price. Thus the total revenue curve for a monopoly is a parabola that begins at the origin and reaches a maximum value then continuously decreases until total revenue is again zero.<ref>Frank (2009), p. 378.</ref> Total revenue has its maximum value when the slope of the total revenue function is zero. The slope of the total revenue function is marginal revenue. So the revenue maximizing quantity and price occur when <math>\text{MR} = 0</math>. For example, assume that the monopoly's demand function is <math>P = 50 - 2Q</math>. The total revenue function would be <math>\text{TR} = 50Q - 2Q^2</math> and marginal revenue would be <math>50 - 4Q</math>. Setting marginal revenue equal to zero we have
: <math> 50-4Q=0</math>
: <math>-4Q=-50</math>
: <math>Q = 12.5</math>

So the revenue maximizing quantity for the monopoly is 12.5 units and the revenue-maximizing price is 25.

A company with a monopoly does not experience price pressure from competitors, although it may experience pricing pressure from potential competition. If a company increases prices too much, then others may enter the market if they are able to provide the same good, or a substitute, at a lesser price.<ref>{{Cite book|last=Depken |first= Craig |title=Microeconomics Demystified |date= November 23, 2005 |publisher=McGraw Hill |isbn=0-07-145911-1 |page=170 |chapter=10}}</ref> The idea that monopolies in markets with easy entry need not be regulated against is known as the "revolution in monopoly theory".<ref>{{cite journal | title = The revolution in monopoly theory | first1 = Glyn | last1 = Davies | first2 = John | last2 = Davies | journal = Lloyds Bank Review | date = July 1984 | issue = 153 | pages = 38–52}}</ref>

A monopolist can extract only one premium,{{Clarify|date=April 2009}} and getting into complementary markets does not pay. That is, the total profits a monopolist could earn if it sought to leverage its monopoly in one market by monopolizing a complementary market are equal to the extra profits it could earn anyway by charging more for the monopoly product itself. However, the one monopoly profit theorem is not true if customers in the monopoly good are stranded or poorly informed, or if the tied good has high fixed costs.

A pure monopoly has the same economic rationality of perfectly competitive companies, i.e. to optimise a profit function given some constraints. By the assumptions of increasing marginal costs, exogenous inputs' prices, and control concentrated on a single agent or entrepreneur, the optimal decision is to equate the [[marginal cost]] and [[marginal revenue]] of production. Nonetheless, a pure monopoly can – unlike a competitive company – alter the market price for its own convenience: a decrease of production results in a higher price. In the economics' jargon, it is said that pure monopolies have "a downward-sloping demand". An important consequence of such behaviour is that typically a monopoly selects a higher price and lesser quantity of output than a price-taking company; again, less is available at a higher price.<ref name='R000000'>{{Cite book| last1 = Levine | first1 = David | author-link = David K. Levine | first2= Michele | last2 = Boldrin | title = Against intellectual monopoly | publisher = Cambridge University Press | date = 2008-09-07 | page = 312 | url = http://www.dklevine.com/general/intellectual/againstfinal.htm | isbn = 978-0-521-87928-6 }}</ref>