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Monopoly Outline •Pure monopoly •Barriers to entry •Monopoly compared to competition •Natural monopoly •The regulatory dilemma •Monopolistic competition Pure monopoly A “pure” monopoly is a market structure in which a single seller accounts for 100 percent of market sales. Pure monopolies are hard to find in the real world. Economists and judges as a rule believe a 90 percent market share is sufficient to constitute an “effective” monopoly. Figure 9.1 Cost and Revenue per Unit AC Industry demand Pm AC MR Qm MC AC Notice the monopolist earns an economic profit equal to the shaded are. Question is: Should this situation not be ripe for entry of new firms? Not if there are factors which impede entry of new firms. Barriers to entry: 2 definitions 1. “[A]nything which creates a disadvantage for potential entrants vis à vis established firms. The height of the barriers is measured by the extent to which, in the long run, established firms can elevate their selling prices above minimal average cost . . . without inducing potential entrants to enter” [Joe Bain, Industrial Organization, 2nd ed., p. 252]. 2. Barriers to entry into a market . . . can be defined to be socially undesirable limitations to entry of resources which are due to protection of resource owners already in the market” [Christian von Weizsäcker, Barriers to Entry, p. 13]. Examples of barriers to entry Absolute cost advantages Examples: Alcoa had access to low cost hydroelectric power in Pacific NW; Weyerhauser procured extraction rights to tracts of Douglas fir in 1901; International petroleum majors (Texaco, SOCAL, BP, et al) formed a pipeline consortium in California. Economies of scale: Dominant firm may enjoy cost advantages due to realization of scale economies in production, distribution, capital raising, or sales promotion. Barriers due to control of wholesale, retail distribution systems Examples: Control of wholesale diamond distribution by DeBeers; Control of advantageous retail shelf space by Proctor and Gamble, Kellogs. Barriers due to patents, copyrights, trademarks, and other legal barriers Examples: Xerox’s patent on xerography; Polaroid’s patent on instamatic photography Barriers due to product differentiation/brand power Examples: Cigarettes, pain relievers, designer jeans, athletic wear, batteries, soft drinks Strategic Barriers Alcoa’s restrictive covenants with hydroelectric suppliers. Standard Oil’s “secret rebate” policy with the railroad companies. “Lease-only” policy of IBM, United Shoe Machinery, International Salt IBM’s continual design modification was designed to forestall entry of firms such as Calcomp that marketed plugcompatible peripherals—e.g.,tapes and line printers. Microsoft charges PC makers a royalty for every computer shipped—regardless of whether the machine has a Windows operating system installed. Microsoft requires that Explorer icon appear on desktop in initial boot up sequence. Price, Cost Monopoly compared to Competition A Market Demand PM B H PC Notice that for each additional unit produced between QM and QC, Demand (marginal benefit) is higher than marginal cost. E MC = AC MR 0 QM QC Output Results summarized Price Quantity Econ Consumer Dead Surplus Weight Competition PC QC zero PCAE zero Monopoly PM QM PCPMBH PMAB BHE Dead weight is a measure of loss due to resource misallocation—it is equal to the surplus lost to consumers which is not captured by the producer. *Price that yields a normal profit to the competitive firm exceed MC by vertica distance AB LMC LAC q is the hypothetical output of a single sellers in a competitive market (100 sellers). A PC PM B D = AR MR 0 q = 1/100Qc QM Quantity Professor, What do you mean by the term “regulatory dilemma” I refer to the dilemma confronting regulators (e.g., public service commissioners) as they go about the task of subjecting firms covered by their legislative mandate to rate-ofreturn regulation. We will use some simple graphs to illustrate that marginal cost pricing will, in the case of sustainable natural monopoly, saddle the regulated firm with losses. The Courts have ruled that the regulated firm must receive a return on shareholder equity that is “fair.” $ Case 1: Unregulated Monopoly PM CM D = AR LMC MR 0 QM LAC QC MWHs $ Case 2: Marginal Cost Pricing D = AR C1 PC LMC MR 0 LAC QC MWHs Hence: •Option 2 is optimal on social efficiency criteria. Recall the necessary condition for socially efficient resource allocation: P = MC •Why not select option 2 and subsidize the regulated firm by amount C1PC? Subsidies give rise to problems of distributional equity. For example, suppose that gas companies were subsidies from general tax revenues—does this not amount to an income transfer $ Option 3: Average Cost Pricing PA LMC MR 0 LAC QA MWHs Comparing the results Option Dead Weight Loss Price Quantity given by area Econ Profit given by area 1 PM QM PMCM 2 PC QC 0 (C1PC) 3 PA QA 0 Monopolistic Competition A market structure featuring a relatively large number of sellers and a differentiated product/service Examples: Women’s shoes, snack foods, furniture, carpet, bathroom fixtures, men’s suits, cold cuts. The monopolistic competitor faces a downward sloping, but very elastic, demand curve. Short run equilibrium in monopolistic competition Dollars per Unit of Output MC AC P AC MRF Q DF Output (a) The Firm Earns Excess Profit Long Run Equilibrium in Monopolistic Competition Dollars per Unit of Output MC AC PE MRF QE DF Output (b) Long-Run Equilibrium: the Firm Earns Zero Economic Profit