Transcript Lec 21

Monopoly
Monopoly
• Market with a single supplier of a good or service
-- Examples
a. Local telephone
b. Utilities
c. DeBeers (South African Firm) controls 80% of
the production of diamonds
-- No close substitutes
-- Natural or legal barriers to entry prevent competition
No Close Substitutes
• Partial Substitutes – Bottled water may substitute for part
of a city’s water supply; however, for laundry, showers
and other purposes, there is no competitive substitute
• New products can weaken a monopoly – Pakistan Post
Office vs TCS, Email, Fax
• New products can create a monopoly – IBM PC opened
the door for microsoft’s DOS
Barriers to Entry
• Natural Barriers to Entry
-- Technology enable one firm to meet entire demand at a lower
price than two or more firms could
-- Economies of Scale – one firm cheaper than others
-- Acquisition of Competitors
-- Utilities are an example (Power Plants)
• Legal Barriers to Entry
-- Ownership of a natural resource
-- Patents
-- Public Franchise
-- Exclusive licenses
Barriers to Entry
• Control over an essential resource
• Economies of scale
• Legal barriers
• Required scale for innovation
• Economies of being established
Monopoly – Pricing/Production Constraints
• Since a monopoly is the only supplier in town, what
prevents it from charging and producing whatever it
wants?
• Answer – The monopoly still faces a downward sloping
demand curve for what it produces.
• A monopolist faces a tradeoff between price and the
quantity sold.
-- To sell a larger volume, the monopolist must
accept a lower price
Monopoly – A downward Sloping
Demand Curve
• Marginal Revenue (the change in total revenue divided
by the change in quantity sold) is always less than price.
• The Marginal Revenue Curve always lies below the
Demand Curve.
The Graph of the
Monopolist
• The imperfect competitor has to
lower price to sell more
P1
P2
D
Q1
Q2
Hypothetical Demand & Cost
Schedule for a Monopoly
Output
Price
TR
MR
1
$16
$16
$16
2
15
30
14
3
14
42
12
4
13
52
10
5
12
60
8
6
11
66
6
7
10
70
4
TC
ATC
MC
The Monopolist Making a Profit
(Calculating the Monopolist’s Profit)
20
18
MC
16
14
Price
ATC
ATC
12
10
D
8
6
4
MR
2
0
0
1
2
3
4
Output
The ATC at five units of output is about $9.90
5
6
7
The Monopolist Making a Profit
(Calculating the Monopolist’s Profit)
20
18
MC
16
14
Price
ATC
ATC
12
10
D
8
6
4
MR
2
0
0
1
2
3
4
Output
5
6
Total Profit = (Price – ATC) X Output
= ($12 - $9.90) X 5 ($2.10 X 5)
= $10.50
7
Monopoly – Output/Price Decision
• Even the monopoly wants to maximize its profits
• Demand constraints, however, limit the ability of the
monopoly to charge high prices and produce high
volumes
• Especially, the price elasticity of demand proves a limit
to the monopoly’s market power
• So, the monopoly still maximizes profit where MR=MC,
and
• Normally, the monopoly is able to earn economic profit
and do so indefinitely
Monopoly – Fairness/Efficiency
• Monopolies are inefficient because
1. Price exceeds equilibrium demand/supply level
2. Output (Production) is less than equilibrium
demand/supply level
 Monopolies may or may not be fair
1. Fair results – who is richer – the monopolist or the
consumer – both have market power
2. Fair rules – Protected position not available to
others? Can anyone acquire the monopoly?
The Monopolist in the Short Run and
the Long Run
• There is no distinction between the short run
and the long run for the monopolists
– If there is a demand for their product or service
they make a profit (economic profits)
– If there is not enough demand for their product for
them to make a profit they go out of business
Demand and Supply under Monopoly
24
The monopolist’s supply curve is her
MC curve. Her supply curve begins
at the break-even point (that is, the
minimum point of the ATC)
MC
22
20
18
D
16
14
ATC
12
MR
Break even point
10
8
0
1
2
3
4
5
6
Output
Because the monopolist is the ONLY seller in the industry, her
individual demand curve is also the Market Demand curve.
Likewise her supply curve is the Market Supply curve.
Limits to Monopoly Power
• The ultimate limit to monopoly power
may come from the government or from
the market itself
– If a firm gets too big or too bad, or both,
the government may decide to step in
using antitrust laws
– The market limits monopoly power
basically through the development of
substitutes
Economies of Scale and Natural
Monopoly
• There are only two justifications for
monopoly
– Economies of Scale justify bigness
because sometime only a firm with the
capability of a very large output can
produce anywhere close to the
minimum point of its ATC
– Natural Monopoly is a situation where
one firm is able to provide a service at a
lower cost than could several
competing firms
When Is Bigness Bad?
• Monopolies tend to be inefficient because
they do not produce at the minimum point
on their ATC
– This prevents resources from being allocated
in the most efficient manner
• Big business always has great political
power
– Economic power is easily converted into
political power
• The monopolist may engage in price
discrimination
Gains from Monopoly
• When there are potential advantages over a competitive
alternative
-- Economies of Scale – e.g. Public Utilities
-- Incentives to Innovate – Larger firms can spend more
money on R&D
The concept of “Critical Mass” – Until a firm
reaches a certain size, it cannot perform the R&D
functions required to maintain viability and
innovation – e.g. the pharmaceutical industry
When Is Bigness Good?
• Natural monopolies can take advantage of
economies of scale and deliver services
much more cheaply than a multitude of
competing firms
• It is probably all right if a firm is big
because it is very good
• If a firm is big because it is bad is another
story
Regulating a Monopoly
• A matter of controlling or regulating pricing
• The monopoly should be able to price in order to cover
its costs and make a “reasonable” profit
1. Marginal cost pricing – A pricing rule that sets
MC=Price – firm may incur an economic loss
2. Average cost pricing – A pricing rule that sets
P=ATC and enables firm to make a “normal”
profit
Two Policy Alternatives
• Two ways to prevent public
utilities from charging
outrageous prices
–government regulation
–government ownership
Conclusion
• Natural Monopolies are probably all
right, but only if they do not abuse their
power
• Monopolies based on other factors
must be looked on with suspicion
– They may be up to no good
– They may even be illegal
• Any monopoly must pass the test of
whether or not there are close
substitutes
Reference: Introduction to Economics
by
Lieberman & Hall
Chapter seven: Perfect Competition
Slides by John F. Hall