Chapter 15 Summary

Chapter 15 talks about the behavior of firms that are monopolies, which refers to a situation in which 1 firm represents the entire market supply, and there are no close substitutes for that firm's product. Monopolies arise because of barriers to entry--that is, because there is something preventing other firms from entering the market. These can take the form of one firm controlling a key resource (as occurred with the DeBeers diamond monopoly), a monopoly created by the government (as occurs when the government issues patents), or a natural monopoly (when it is cheaper for 1 firm to supply the market than 2 or more) such as water distribution. While monopoly firms want to maximize profit, they face different production decisions because as they produce more they must lower the market price to sell the additional goods. Therefore, the monopolist's marginal revenue is always less than the price of the good. This leads to 2 effects on total revenue as quantity increases: the output effect (more quantity tends to mean more revenue) and the price effect (more quantity means less price). The monopoly will still set its production at the point where marginal revenue is equal to marginal cost, but here, marginal revenue is less than price, meaning that monopolists make a positive economic profit. Because of their profit-maximizing decisions, monopolies tend to increase the price of the good and reduce the quantity supplied.