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A monopolist faces the entire market demand curve and chooses output where MR = MC, then sets price on the demand curve above this quantity. The monopolist prices above marginal cost (P > MC), earning a markup that covers fixed costs and generates economic profit. This pricing power creates deadweight loss by restricting output below the socially efficient level where P = MC. The extent of markup depends on demand elasticity: more elastic demand limits pricing power.
Compare monopoly and competition outcomes graphically and numerically, calculating price, output, profit, and deadweight loss in each case. Use the Lerner Index (L = (P - MC) / P) to measure markup and relate it to elasticity.
A competitive firm takes price as given and produces where P = MC — it can't charge more because rivals offer the same good at lower prices. A monopolist faces no such discipline. It is the only seller, so the demand curve it faces is the entire market demand curve. But this doesn't mean the monopolist can charge any price it wants — it must choose a point on the demand curve. Higher prices mean fewer units sold, so there is a genuine trade-off.
The profit-maximizing decision follows directly from the logic you learned in general output choice: produce where marginal revenue equals marginal cost (MR = MC). The critical difference from competition is that the monopolist's marginal revenue is less than price. When you sell one more unit, you earn the price for that unit — but you've had to lower the price on all previous units (since the demand curve slopes down). This loss on infra-marginal units reduces MR below P for any downward-sloping demand. For a linear demand curve, MR has the same intercept but twice the slope — MR falls twice as fast as price as output rises.
To find the monopoly outcome: locate Q* where MR = MC, then go up to the demand curve to find the monopoly price P*. This price exceeds MC — the monopolist charges a markup. The Lerner Index quantifies this: L = (P − MC)/P = −1/ε, where ε is the price elasticity of demand. An elasticity of −2 gives L = 0.5, meaning price is 100% above marginal cost; an elasticity of −5 gives L = 0.2. More elastic demand disciplines the monopolist — consumers are price-sensitive and a large markup loses too many sales. Less elastic demand grants more pricing power. This is why pharmaceutical firms with patented drugs (inelastic demand — there are no substitutes) can charge enormous markups while commodity producers facing elastic demand cannot.
The social cost of monopoly is deadweight loss: the value of transactions that would have occurred under competition but don't occur under monopoly because output is restricted. Units between Q* and the competitive quantity Q_c have demand exceeding MC — buyers value them more than they cost to produce — yet they go unproduced. This lost value belongs to neither the monopolist nor consumers; it's destroyed. The monopolist's profit represents a transfer from consumers to the firm (consumer surplus captured as producer surplus), but the deadweight loss is a pure social loss. This is the fundamental economic rationale for antitrust law and regulation of monopoly pricing: the private optimum is socially inefficient.