In
economicsEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, a firm is said to reap
monopoly profits when a lack of viable market
competitionCompetition is a contest between individuals, groups, nations, animals, etc. for territory, a niche, or allocation of resources. It arises whenever two or more parties strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same...
allows it to set its
pricePrice in economics and business is the result of an exchange and from that trade we assign a numerical monetary value to a good, service or asset. If Alice trades Bob 4 apples for an orange, the price of an orange is 4 apples. Inversely, the price of an apple is 1/4 oranges.Price is only part of...
s above the
equilibriumIn economics, economic equilibrium is simply a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
price for a good or service without losing profits to competitors. Monopoly profit is a type of economic profit, that is, it is a profit greater than the normal profit that is typical in a perfectly competitive industry. The resulting price is known as the
monopoly price.
In a
perfectly competitiveIn neoclassical economics and microeconomics, perfect competition describes the perfect being a market in which there are many small firms, all producing homogeneous goods...
market, firms are said to be
price takers: since a customer can buy
widgetsA widget is a placeholder name for an object or, more specifically, a mechanical or other manufactured device. It is an abstract unit of production. The Oxford English Dictionary defines it as "An indefinite name for a gadget or mechanical contrivance, esp. a small manufactured item" and dates...
from one producer as easily as another, any widget producer on the market faces a
horizontal demand curveIn economics, the demand curve can be defined as the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...
at the equilibrium price: if the firm tries to sell widgets above the equilibrium price, customers will simply buy their widgets elsewhere and the firm will lose all of their business.
In
economicsEconomics is the social science that studies the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, a firm is said to reap
monopoly profits when a lack of viable market
competitionCompetition is a contest between individuals, groups, nations, animals, etc. for territory, a niche, or allocation of resources. It arises whenever two or more parties strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same...
allows it to set its
pricePrice in economics and business is the result of an exchange and from that trade we assign a numerical monetary value to a good, service or asset. If Alice trades Bob 4 apples for an orange, the price of an orange is 4 apples. Inversely, the price of an apple is 1/4 oranges.Price is only part of...
s above the
equilibriumIn economics, economic equilibrium is simply a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
price for a good or service without losing profits to competitors. Monopoly profit is a type of economic profit, that is, it is a profit greater than the normal profit that is typical in a perfectly competitive industry. The resulting price is known as the
monopoly price.
In a
perfectly competitiveIn neoclassical economics and microeconomics, perfect competition describes the perfect being a market in which there are many small firms, all producing homogeneous goods...
market, firms are said to be
price takers: since a customer can buy
widgetsA widget is a placeholder name for an object or, more specifically, a mechanical or other manufactured device. It is an abstract unit of production. The Oxford English Dictionary defines it as "An indefinite name for a gadget or mechanical contrivance, esp. a small manufactured item" and dates...
from one producer as easily as another, any widget producer on the market faces a
horizontal demand curveIn economics, the demand curve can be defined as the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...
at the equilibrium price: if the firm tries to sell widgets above the equilibrium price, customers will simply buy their widgets elsewhere and the firm will lose all of their business. (In actual markets, of course, there is never a situation where
exactly comparable goods are available
just as easily from one firm as from another — the theory of perfect competition is a useful idealized model rather than a naturalistic description.)
By contrast, lack of competition in a market creates a downward sloping demand curve for a monopolist or
oligopolistAn oligopoly is a market form in which a market or industry is dominated by a small number of sellers . The word is derived, by analogy with "monopoly", from the Greek oligoi 'few' and poleein 'to sell'. Because there are few sellers, each oligopolist is likely to be aware of the actions of the...
: although they will lose some business by raising prices, they will not lose it all, and it may be more profitable in most situations to sell at a higher price. This does not mean that monopolists are not price takers. It only says that they have the option of being either a "price taker" (at a level of output of their own choosing), or a "quantity taker" (at a price of their own choosing). They can set their own price and accept a level of output determined by the market, or they can set their output quantity and accept the price determined by the market. They cannot set both price and output.
A firm with
monopoly power setting prices will typically set price at the profit maximizing level. The most
profitable price that they can set (the
monopoly price) is where the optimum output level (where
marginal costIn economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Mathematically, the marginal cost function is expressed as the first derivative of the total cost function with...
(
MC) equals
marginal revenueIn microeconomics, Marginal Revenue is the extra revenue that an additional unit of product will bring. It is the additional income from selling one more unit of a good; sometimes equal to price...
(
MR) as seen on the diagram below) meets the demand curve. Under normal market conditions for a monopolist, this price will be higher than the equilibrium price (which is the price at which marginal cost for the producer equals marginal benefit for the consumer). In the chart below the shaded area represents the profits of the monopolist. The lower half represents the normal profits that would go to a competitive firm (ignoring output losses). The upper half represent the additional economic profit going to the monopolist.