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Pure Monopoly 321

exceed the monopolist’s average cost. The lesson here is that pure monopoly

enables the firm to earn excess profit, but the actual size of this profit depends

on a comparison of demand and cost. For instance, if other goods or services

are close substitutes for the monopolist’s product, industry demand may be

relatively elastic and afford relatively little excess profit (curve D 2 ). If it is to

increase its profit substantially, the monopoly firm must find a way to lower its

average cost of production or to raise market demand. (However, there may be

no demand at all for the monopolist’s unique product. The U.S. Patent Office

overflows with inventions that have never earned a dime.)

Cost and Revenue per Unit

PM

AC

QM

MR

MC AC

AC

Industry demand

FIGURE 8.1

A Monopolist’s Optimal

Price and Output

The monopolist

maximizes its profit by

producing an output

such that MR equals

MC.

CHECK

STATION 1

A common measure of monopoly power is given by the Lerner index, defined as L 

(PMMC)/PM, where PMdenotes the monopolist’s price and MC is marginal cost. For

a profit-maximizing monopolist, how does the Lerner index depend on the elasticity of

industry demand? (Hint: Recall the price-markup rule of Chapter 3.) What do you see

as the advantages and disadvantages of using the Lerner index as a measure of monop-

oly power?

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