Monopoly and Monopolistic Competition

Introduction In the last chapter, we studied the behavior of competitive firms, that is, firms that take market prices as given and outside their control. Generally, such firms are small enough relative to their markets that their decisions have no effect on the market prices. Now we will study the polar opposite: the market in which only one firm supplies a particular good. This is called a monopoly market and the firm is a monopoly firm or monopolist . The word monopoly is from Greek, and means “one seller.” In the first part of this chapter, we analyze the classical solution to the monopoly problem. Then we consider various price discrimination techniques that monopolies can employ to increase their profits. At the end of the chapter, we look at a special market structure, called monopolistic competition , in which there are many firms producing goods that are very similar, but not identical, such as different brands of laundry detergent. There are various reasons that some markets are monopolies or near-monopolies. Sometimes there are technological reasons. For example, there may be very large startup costs. The classic example is the provision of a utility in an urban market via pipelines. If a firm is to sell water or natural gas in a city, it may need a network of underground pipes leading from source points to tens of thousands of residential and commercial customers. Having two or more firms installing such networks would be unnecessarily costly, and the first firm to get its pipes in the ground would have a tremendous advantage over later-arriving firms.