AP_Krugman_Textbook

614 section 11 Market Structures: Perfect Competition and Monopoly

Monopoly: The General Picture

Figure 61.3 involved specific numbers and assumed that marginal cost was constant,

there was no fixed cost, and therefore, that the average total cost curve was a horizontal

line. Figure 61.4 shows a more general picture of monopoly in action: Dis the market

demand curve; MR,the marginal revenue curve; MC,the marginal cost curve; and ATC,

the average total cost curve. Here we return to the usual assumption that the marginal

cost curve has a “swoosh” shape and the average total cost curve is U-shaped.

Monopoly Behavior and the Price Elasticity of Demand

A monopolist faces marginal revenue that is

lower than the market price. But how much

lower? The answer depends on the price elas-

ticity of demand.

Remember that the price elasticity of de-

mand determines how total revenue from sales

changes when the price changes. If the price

elasticity is greater than 1 (demand is elastic), a

fall in the price increases total revenue because

the rise in the quantity demanded outweighs the

lower price of each unit sold. If the price elastic-

ity is less than 1 (demand is inelastic), a lower

price reduces total revenue.

When a monopolist increases output by one

unit, it must reduce the market price in order to

sell that unit. If the price elasticity of demand is

less than 1, this will actually reduce revenue—

that is, marginal revenue will be negative. The mo-

nopolist can increase revenue by producing more

only if the price elasticity of demand is greater

than 1; the higher the elasticity, the closer the ad-

ditional revenue is to the initial market price.

What this tells us is that the difference be-

tween monopoly behavior and perfectly com-

petitive behavior depends on the price elasticity

of demand. A monopolist that faces highly elas-

tic demand will behave almost like a firm in a

perfectly competitive industry.

For example, Amtrak has a monopoly on in-

tercity passenger service in the Northeast Corri-

dor, but it has very little ability to raise prices:

potential train travelers will switch to cars and

fyi

planes. In contrast, a monopolist that faces

less elastic demand—like most cable TV

companies—will behave very differently from a

perfect competitor: it will charge much higher

prices and restrict output more.

KAREN BLEIER/AFP/Getty Images

figure 61.4

The Monopolist’s Profit

In this case, the marginal cost curve

has a “swoosh” shape and the average

total cost curve is U-shaped. The mo-

nopolist maximizes profit by producing

the level of output at which MR=MC,

given by point A,generating quantity

QM.It finds its monopoly price, PM,

from the point on the demand curve di-

rectly above point A,point Bhere. The

average total cost of QMis shown by

point C.Profit is given by the area of

the shaded rectangle.

QM Quantity

Price, cost,

marginal

revenue

PM

ATCM

C

D

MR

A

B

MC

Monopoly

profit

ATC