Monopoly

Monopoly Structure

The essence of market power is the ability to alter the price of a product.

A monopoly firm is one that produces the entire market supply of a particular good or service.

Monopoly = Industry

Because a monopoly industry consists of only one firm, the firm is the industry.

The firm’s demand curve is identical to the market demand curve for the product.

Market demand is the total quantities of a good or service people are willing and able to buy at alternative prices in a given time period.

Price vs. Marginal Revenue

Marginal revenue (MR) is the change in total revenue that results from a one-unit increase in quantity sold.

Price equals marginal revenue only for perfectly competitive firms.

A monopolist can sell additional output only if it reduces prices.

Marginal revenue is always less than price for a monopolist.

The MR curve lies below the demand (price) curve at every point but the first.

Marginal revenue is always less than price for a monopolist.

The MR curve lies below the demand (price) curve at every point but the first

Total revenue before price reduction

= 1 ton X $6,000/ton = $6,000

Total revenue after price reduction

= 2 tons X $5,000/ton = $10,000

Marginal revenue

= $10,000 – $6,000 = $4,000

Price and Marginal Revenue

Monopoly Behavior

A monopolist must make a pricing decision that perfectly competitive firms never make.

Profit Maximization

The monopolist uses the profit-maximization rule to determine its rate of output.

According to the rule, a monopolists will produce at rate of output where marginal revenue equals marginal cost. (MR = MC)

The profit maximization rule applies to all firms.

Perfectly competitive firms produce the quantity where
MC = MR (= p).

The monopolist produces the quantity where
MC = MR (<P).

The Production Decision

Choosing a rate of output is a firm’s production decision.

It is the selection of the short-term rate of output with existing plant and equipment.

A monopolist finds the quantity where marginal revenue and marginal cost curves intersect.

Profit Maximization

The Monopoly Price

The intersection of the marginal revenue and marginal cost curves establishes the profit-maximizing rate of output.

The demand curve tells us the highest price consumers are willing to pay for that specific quantity of output.

Only one price is compatible with profit-maximization rate of output.

Monopoly Profits

Total profit equals profit per unit times the number of units produced.

Profit per unit = price minus average total cost

Profit per unit = p – ATC

Total profits = profit per unit times quantity

Total profits = (p – ATC) X q

Monopoly vs. Competitive Outcomes

A monopolist produces less and charges a higher price than a competitive industry.

Barriers to Entry

A monopoly attains higher prices and profits by restricting output.

The threat of entry does not affect monopolist due to high barriers to entry.

Barriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a particular market.

Patent protection

Legal harassment

Exclusive licensing

Bundled products

Government franchises

Patent Protection

A patent is a government grant of exclusive ownership of an innovation.

A patent is a source of monopoly power.

Polaroid’s patents forced Kodak out of the instant-photography business.

Legal Harassment

Suing potential new entrants can deter entry into an industry.

Lengthy legal battles are so expensive that the threat of legal action may deter entry into a monopolized market.

Exclusive Licensing

Lack of a license makes it difficult for potential competitors to acquire the factors of production they need.

Bundled Products

Forcing consumers to purchase complementary products thwarts competition.

Bundling products makes it difficult for competitors to sell their products profitably.

For example, Microsoft bundles software applications with its Windows operating systems.

Government Franchises

A monopoly granted by a government license.

Examples include local power, telephone and cable TV companies.

Comparative Outcome

A monopoly’s market power allows it to change the way its market respond to consumer demands.

Competition vs. Monopoly

In competition, high prices and profits signal consumers’ demand for more output.

In monopoly, the same.

In competition, the high profits attract new suppliers.

In monopoly, barriers to entry are erected to exclude potential competition.

In competition, production and supplies expand.

In monopoly, production and supplies are constrained.

In competition, prices slide down the market demand curve.

In monopoly, production and supplies are constrained.

In competition, a new equilibrium is established.

In monopoly, no new equilibrium is established.

In competition, average costs of production approach their minimum.

In monopoly, average costs are not necessarily at or near a minimum.

In competition, economic profits approach zero.

In monopoly, economic profits are at a maximum.

In competition, price equals marginal cost throughout the process.

In monopoly, price exceeds marginal cost at all times

In competition, the profit squeeze pressures firms to reduce cost or improve product quality.

In monopoly, there is no profit squeeze to pressure the firm to reduce costs.

Near Monopolies

Two or more firms may rig the market to replicate monopoly outcomes and profits.

In duopoly two firms together produce the industry output.

In oligopoly several firms dominate the market.

In monopolistic competition many firms each have monopolies on their own brand name but must compete against other brand names.

WHAT Gets Produced

There is a basic tendency for monopolies to inhibit economic growth.

There is no pressure to produce at minimum average cost.

WHAT Gets Produced

Monopolies do not engage in marginal cost pricing.

Marginal cost pricing means firms offer (supply) goods at prices equal to their marginal cost.

Monopolies do not deliver the most utility with available resources.

FOR WHOM

Higher prices charged by monopolists favor purchases by higher-income consumers.

Monopolists get fat profits and thus access to more goods and services.

HOW

Monopolists have less of an incentive to innovate.

They can continue to make profits with existing equipment

There is a tendency to inhibit technological improvement by keeping out competition.

Any Redeeming Qualities?

Despite the strong and general case to be made against monopoly, monopolies could also benefit society.

Research and Development

In principle, monopolies have a greater ability to pursue research and development.

They have the resources available to invest in expensive R&D functions.

Monopolies have no clear incentive for invention and innovation.

They can continue to make profits by maintaining market power.

Entrepreneurial Incentives

Promise of even greater profits is a strong incentive for monopolies to innovate.

Innovators in perfect competition also have the ability to earn large profits.

Economies of Scale

Economies of scale are present if average costs fall as the size (scale) of plant and equipment increases.

A large firm can produce goods at a lower unit cost than a small firm because of economies of scale.

Natural Monopoly

A natural monopoly is an industry in which one firm can achieve economies of scale over the entire range of market supply.

Examples include telephone, cable, and other utility services.

Economies of scale are a natural barrier to entry.

There exists a potential for abuse in natural monopoly.

Government regulation may be necessary to ensure that benefits of increased efficiency are shared with consumers.

Contestable Markets

Potential competition is a threat even to monopolies.

May cause them to behave more competitively.

How contestable a market is depends not on structure but on entry barriers.

Structure vs. Behavior

If potential rivals force a monopolist to behave like a competitive firm, then monopoly imposes no cost on consumers or on society at large.

The experience with the Model T suggest that potential competition can force a monopoly to change its ways.

Critics argue that even if markets are contestable, there will always exist a gap between a monopoly and a competitive outcome

Flying Monopoly Air

Market structure explains why it is cheap to fly to one place and expensive to fly somewhere else of equal distance.

Industry Structure

From a national perspective, the airline industry looks pretty competitive.

However, all of these companies do not fly to the same place.

In many markets, there is only one or two air carriers, thus, the firms in this market act like duopolies or monopolies.

The number of airlines serving a particular route is a far better measure of market power than the number of airlines flying anywhere.

Air fares from airports dominated by one or two carriers are 45-85 percent higher than at more competitive airports

Entry Effects

Another way to assess the impact of market structure on prices is to observe how airline fares change when airlines enter or exit a specific market.

Predatory Pricing

Temporary price reductions designed to drive out competition.

The Justice Department says American Airlines cut its fares when low-cost carriers arrived – then raised them when they left.

A monopoly carrier may use a sharp but temporary cut in fares to drive a new entrant out of the market

Barriers to Entry

One of the most formidable entry barriers to the airline industry is the ownership of landing rights and gates.

At Washington, D.C.’s National Airport, the six largest carriers owned 97percent of available takeoff/landing slots in 2000

To offer service from that airport, a new entrant would have to buy or lease a slot from one of these firms.

If existing firms are unwilling to sell or lease their slots, then competition is thwarted.