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Chapter 3. Monopoly and Market Power
3.1 Market Power Introduction
This chapter will explore firms that have market power, or the ability to set a price for
their good.
Market Power = Ability of a firm to set a price for a good.
A monopoly is defined as a single firm in an industry with no close substitutes.
Monopoly = A single firm in an industry with no close substitutes.
The phrase, “no close substitutes” is important, since there are many firms that are the
sole producer of a good. Consider McDonalds Big Mac hamburgers. McDonalds is the
only provider of Big Macs, yet it is not a monopoly because there are many close
substitutes available: Burger King Whoppers, for example.
Market power is also called monopoly power. A competitive firm is a “price taker,” so
has no ability to change the price of a good. Each competitive firm is small relative to
the market, so has no influence on price. Firms with market power are also called “price
makers.”
Price Taker = A competitive firm with no ability to set the price of a good.
Price Maker = A noncompetitive firm with the ability to set the price of a good.
A monopolist is considered to be a price maker, and can set the price of the product that
it sells. However, the monopolist is constrained by consumer willingness and ability to
purchase the good, also called demand. For example, suppose that an agricultural
chemical firm has a patent for an agricultural chemical used to kill weeds, a herbicide.
The patent is a legal restriction that permits the patent holder to be the only seller of the
herbicide, as it was invented by the company through their research program. In Figure
3.1, an agricultural chemical firm faces an inverse demand curve equal to: P = 100 – Qd,
