AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/4/4-2)
Unit 4 · Topic 4.2
4.2 Monopoly
A monopoly is the only seller of a product with no close substitutes. It picks the quantity where MR = MC and charges the highest price buyers will pay for that quantity. Compared with a competitive market, it makes less, charges more and creates deadweight loss.
Key terms
- monopoly
- barriers to entry
- natural monopoly
- economies of scale
- profit-maximizing rule (MR = MC)
- deadweight loss
What makes a monopoly
A monopoly is a single seller with no close substitutes, protected by high barriers to entry (4.1). Because it is the whole market, the market demand curve is its demand curve, and it slopes down.
A natural monopoly is a special case. The firm has economies of scale over the whole range of market demand: its long-run average total cost (ATC) keeps falling as output grows. One firm can then supply the market more cheaply than two or more firms could. Utilities like water and electricity distribution are classic examples, since building a second set of pipes or power lines would waste money. (How governments regulate a natural monopoly is in 6.4.)
Finding the monopolist's quantity, price and profit
Use the same profit-maximizing rule as every firm (3.5), in three steps.
- Quantity: find where MR = MC. That's the profit-maximizing quantity, Qm.
- Price: go straight up from Qm to the demand curve and read across to the price axis. That's Pm. Never read the price off the MR or MC curve.
- Profit: compare price with ATC at Qm. Profit = (Pm − ATC) × Qm. If ATC is above price, the firm takes a loss of (ATC − Pm) × Qm. It stays open in the short run only if price covers average variable cost (3.6).
Describing the monopoly graph in words
Label the vertical axis 'Price' and the horizontal axis 'Quantity'. Draw a downward-sloping demand curve (D = AR) and an MR curve that starts at the same price but lies below it. Draw a U-shaped ATC curve and an MC curve that crosses ATC at its lowest point.
Mark Qm where MR crosses MC. Pm is on demand directly above Qm. Profit is the rectangle with height (Pm − ATC at Qm) and width Qm. Consumer surplus is the triangle below demand, above Pm, from zero to Qm.
The allocatively efficient quantity is where demand crosses MC, to the right of Qm. Deadweight loss is the triangle between demand (on top) and MC (below), from Qm to that efficient quantity. Its point is at the efficient quantity.
Why monopoly is inefficient
At Qm, price is above marginal cost. Some buyers value an extra unit more than it costs to make, but the monopolist doesn't make it, because selling it would mean cutting the price on all its other units. So a monopoly is not allocatively efficient (P > MC), and the lost trades are the deadweight loss.
A monopoly is usually not productively efficient either: it rarely produces at the lowest point of ATC. And barriers to entry mean profit can last in the long run, unlike in perfect competition.
Compared with a perfectly competitive industry with the same costs, a monopoly produces a smaller quantity at a higher price. Some consumer surplus becomes profit, and some disappears as deadweight loss.
Monopolies have no supply curve
A supply curve shows how much a firm makes at each price it is given. A monopolist isn't given a price; it chooses one using demand and MR. So a monopoly has no supply curve. Its MC curve still matters for choosing the quantity, but don't label it as supply.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Profit-maximizing output from a table
A monopolist's demand and costs are: at 1 unit, price $20 and marginal cost $6; at 2 units, price $18 and MC $4; at 3 units, price $16 and MC $6; at 4 units, price $14 and MC $7; at 5 units, price $12 and MC $9; at 6 units, price $10 and MC $10; at 7 units, price $8 and MC $12. Fixed cost is $10. Find the profit-maximizing quantity, the price, and the profit. Then find the allocatively efficient quantity.
Show the solutionHide the solution
- Step 1: Total revenue = P × Q: $20, $36, $48, $56, $60, $60, $56. Marginal revenue: $20, $16, $12, $8, $4, $0, −$4.
- Step 2: Keep producing while MR ≥ MC. Unit 4: MR $8 > MC $7, so make it. Unit 5: MR $4 < MC $9, so don't. The profit-maximizing quantity is 4.
- Step 3: Price comes from demand at 4 units: $14 (not the MR of $8).
- Step 4: Total cost at 4 units = fixed cost + the sum of MC = 10 + 6 + 4 + 6 + 7 = $33. Profit = TR − TC = $56 − $33 = $23. (Check: ATC = 33 ÷ 4 = $8.25, and (14 − 8.25) × 4 = $23.)
- Step 5: Allocative efficiency is where P = MC: at 6 units, price $10 = MC $10. The monopolist produces 2 fewer units than that.
Answer: 4 units at $14 each, for a profit of $23. The allocatively efficient quantity is 6 units.
- Example 2Calculator allowed
Measuring profit, consumer surplus and deadweight loss on a graph
A monopolist's demand curve is a straight line from $100 on the price axis to 100 units on the quantity axis. Its MR curve runs from $100 down to 50 units. Marginal cost and ATC are both constant at $20 (a horizontal line). Find the monopoly quantity and price, profit, consumer surplus and deadweight loss.
Show the solutionHide the solution
- Step 1: Demand falls $1 for each unit, so MR falls $2 for each unit. MR = $20 where 100 − 2Q = 20, so Qm = 40.
- Step 2: Price from demand at 40 units: 100 − 40 = $60.
- Step 3: Profit = (P − ATC) × Q = (60 − 20) × 40 = $1,600. It's the rectangle from $20 up to $60, from 0 to 40 units.
- Step 4: Consumer surplus is the triangle under demand and above $60, from 0 to 40 units: ½ × 40 × (100 − 60) = $800.
- Step 5: The efficient quantity is where demand meets MC: 100 − Q = 20, so Q = 80. Deadweight loss is the triangle between demand and MC from 40 to 80 units: ½ × (80 − 40) × (60 − 20) = $800.
- Step 6: Check: in a competitive market, total surplus would be ½ × 80 × (100 − 20) = $3,200. Under monopoly, 800 + 1,600 + 800 = 3,200. Nothing goes missing; it's just split differently.
Answer: 40 units at $60. Profit $1,600, consumer surplus $800, deadweight loss $800.
Common mistakes
- Reading the price at the point where MR = MC. That point gives the quantity; the price is up on the demand curve.
- Setting price where MC crosses demand. That's the efficient (or competitive) outcome, not what a monopoly chooses.
- Assuming a monopoly always makes a profit. If ATC is above demand at Qm, it takes a loss, and it can still shut down in the short run if price is below AVC.
- Drawing deadweight loss as a triangle under MR. It sits between demand and MC, from Qm to the efficient quantity.
On the exam
- The long free-response question often starts with a firm in one market structure and asks you to describe a correctly labeled graph, identify the quantity and price, shade profit or deadweight loss, and then show what happens after a change in cost. Label every curve and every point you use.
- Be ready to compare monopoly with perfect competition: lower quantity, higher price, P > MC, deadweight loss, possible long-run profit.
Connected topics
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Check yourself
4 questions on 4.2 Monopoly. Pick an answer to see if you got it, and why.
The graph shows a monopolist's costs and revenue. The vertical axis measures price and cost in dollars, and the horizontal axis measures quantity.
The demand curve slopes downward, and the marginal revenue (MR) curve lies below it. The marginal cost (MC) curve slopes upward. The U-shaped average total cost (ATC) curve reaches its minimum of $33 at a quantity of 50, where MC crosses it.
MR and MC intersect at a quantity of 40, where both equal $30. At a quantity of 40, the demand curve is at a price of $50 and ATC is $35.
MC crosses the demand curve at a quantity of 60 and a price of $40.
Hypothetical graph described in words
What are the monopolist's profit-maximizing quantity and price?
What is the monopolist's economic profit?
What is the deadweight loss from this monopoly?
Which of the following correctly describes the monopolist's output of 40 units?
0 of 4 answered