Monopoly

1. Monopoly CHAPTER 9 © 2003 South-Western/Thomson Learning

2. Barriers to Entry • A monopoly is the sole supplier of a product with no close substitutes • The most important characteristic of a monopolized market is barriers to entry new firms cannot profitably enter the market • Barriers to entry are restrictions on the entry of new firms into an industry • Legal restrictions • Economies of scale • Control of an essential resource

3. Legal Restrictions • One way to prevent new firms from entering a market is to make entry illegal • Patents, licenses, and other legal restrictions imposed by the government provide some producers with legal protection against competition

4. Patent and Invention Incentives • A patent awards an inventor the exclusive right to produce a good or service for 20 years • Patent laws • Encourage inventors to invest the time and money required to discover and develop new products and processes • Also provide the stimulus to turn an invention into a marketable product, a process called innovation

5. Licenses and other Entry Restrictions • Governments often confer monopoly status by awarding a single firm the exclusive right to supply a particular good or service • Broadcast TV and radio rights • State licensing of hospitals • Cable TV and electricity on local level

6. Economies of Scale • A monopoly sometimes emerges naturally when a firm experiences economies of scale as reflected by the downward-sloping, long-run average cost curve • In these situations, a single firm can sometimes supply market demand at a lower average cost per unit than could two or more firms at smaller rates of output

7. Natural Monopoly • Because such a monopoly emerges from the nature of costs, it is called a natural monopoly • A new entrant cannot sell enough output to experience the economies of scale enjoyed by an established natural monopolist  entry into the market is naturally blocked

8. Control of Essential Resources • Another source of monopoly power is a firm’s control over some nonreproducible resource critical to production • Professional sports teams try to block the formation of competing leagues by signing the best athletes to long-term contracts • Alcoa was the sole U.S. maker of aluminum for a long period of time because it controlled the supply of bauxite • China is the monopoly supplier of pandas • DeBeers controls the world’s diamond trade

9. Local Monopolies • Local monopolies are more common that national or international monopolies • Numerous natural monopolies for products sold in local markets • However, as a rule long-lasting monopolies are rare because, as we will see, a profitable monopoly attracts competitors

10. Revenue for the Monopolist • Because a monopoly, by definition, supplies the entire market, the demand for goods or services produced by a monopolist is also the market demand • The demand curve for the monopolist’s output therefore slopes downward, reflecting the law of demand • As seen in the following discussion this has important implications for revenues

11. Demand, Average and Marginal Revenue • Suppose De Beers controls the entire diamond market and suppose they can sell three diamonds a day at $7,000 each  total revenue of $21,000 • Total revenue divided by quantity is the average revenue per diamond which is also $7,000 • Thus, the monopolist’s price equals the average revenue per diamond

12. Demand, Average and Marginal Revenue • To sell a fourth diamond, De Beers must lower the price to $6,750  total revenue for 4 diamonds is $27,000 and average revenue is again $6,750 • The marginal revenue from selling the fourth diamond is $6,000  marginal revenue is less than the price or average revenue • Recall that these were equal for the perfectly competitive firm

13. Firm’s Costs and Profit Maximization • The monopolist can choose either the price or the quantity, but choosing one determines the other • Because the monopolist can select the price that maximizes profit, we say the monopolist is a price maker • More generally, any firm that has some control over what price to charge is a price maker

14. Profit Maximization • Exhibits 5 and 6 repeat the revenue data from the previous exhibits and also include short-run cost data • The cost data are similar to those already introduced in the preceding chapters • The key issue is which price-quantity combination should De Beers select to maximize profits

15. Short-Run Losses and the Shutdown Decision • A monopolist is not assured of profit • The demand for the monopolists good or service may not be great enough to generate economic profit in either the short run or the long run • In the short run, the loss-minimizing monopolist must decide whether to produce or to shut down • If the price covers average variable cost, the firm will produce • If not, the firm will shut down, at least in the short run

16. Monopolist’s Supply Curve • The intersection of a monopolist’s marginal revenue and marginal cost curve identifies the profit maximizing quantity, but the price is found on the demand curve • Thus, there is no curve that shows both price and quantity supplied  there is no monopolist supply curve

17. Long-Run Profit Maximization • For a monopoly, the distinction between the long and short run is not as important • If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run • However, short-run profit is no guarantee of long-run profit

18. Long-Run Profit Maximization • A monopolist that earns economic profit in the short-run may find that profit can be increased in the long run by adjusting the scale of the firm • Conversely, a monopoly that suffers a loss in the short run may be able to eliminate that loss in the long run by adjusting to a more efficient size

19. Price and Output Comparison • Purpose here is to compare monopoly using the benchmark established in our discussion of perfect competition • When there is only one firm in the industry, the industry demand curve becomes the monopolist’s demand curve  the price the monopolist charges determines how much gets sold

20. Why the Welfare Loss Might Be Lower • If economies of scale are extensive enough, a monopolist may be able to produce output at a lower cost per unit than could competitive firms • If this is true, the price or at least the cost of production could be lower under monopoly than under competition

21. Why the Welfare Loss Might Be Lower • The welfare loss shown in Exhibit 8 may also overstate the true cost of monopoly because monopolists may, in response to public scrutiny and political pressure, keep prices below what the market could bear • Finally, a monopolist may keep the price below the profit maximizing level to avoid attracting new competitors

22. Why the Welfare Loss Might Be Higher • Another line of thought suggests that the welfare loss of monopoly may, in fact, be greater than shown in our example • If resources must be devoted to securing and maintaining a monopoly position, monopolies may involve more of a welfare loss that simple models suggest

23. Why the Welfare Loss Might Be Higher • Consider, for example, radio and TV broadcasting rights confer on the recipient the exclusive right to use a particular band of the scarce broadcast spectrum • In the past, these rights have been given away by government agencies to the applicants deemed most deserving

24. Why the Welfare Loss Might Be Higher • Because these rights are so valuable, numerous applicants spend millions on lawyers’ fees, lobbying expenses, and other costs associated with making themselves appear the most deserving • The efforts devoted to securing and maintaining a monopoly position are largely a social waste because they use up scarce resources but add not unit to output

25. Why the Welfare Loss Might Be Higher • Activities undertaken by individuals or firms to influence public policy in a way that will directly or indirectly redistribute income to them are referred to as rent seeking • Second, monopolists insulated from the rigors of competition in the marketplace, may also become efficient

26. Why the Welfare Loss Might Be Higher • Finally, monopolists have also been criticized for being slow to adopt the latest production techniques, to develop new products, and generally lacking innovativeness

27. Price Discrimination • A monopolist can sometimes increase economic profit by charging higher prices to customers who value the product more • The practice of charging difference prices to different customers when the price differences are not justified by differences in cost is called price discrimination

28. Conditions for Price Discrimination • Conditions • The demand curve for the firm’s product must slope downward  the firm has some market power and control over price • There are at least two groups of consumers for the product, each with a different price elasticity of demand • The producer must be able, at little cost, to charge each group a different price for essentially the same product • The producer must be able to prevent those who pay the lower price from reselling the product to those who pay the higher price

29. Model of Price Discrimination • Consumers are divided into two groups with different demands

30. Examples of Price Discrimination • Because businesspeople face unpredictable yet urgent demands for travel and communication, and because employers pay such expenses, businesspeople are less sensitive to price than householders • Telephone companies are able to sort out their customers by charging different rates based on the time of day

31. Perfect Price Discrimination • If a monopolist could charge a different price for each unit sold, the firm’s marginal revenue curve from selling one more unit would equal the price of that unit  the demand curve would become the marginal revenue curve • A perfectly discriminating monopolist charges a different price for each unit of the good

32. Perfect Price Discrimination • Perfect price discrimination gets high marks based on allocative efficiency • Because such a monopolist does not have to lower price to all customers when output expands, there is no reason to restrict output • In fact, because this is a constant-cost industry, Q is the same quantity produced in perfect competition

33. Perfect Price Discrimination • As in perfect competition, the marginal benefit of the final unit of output produced just equals its marginal cost • And although perfect price discrimination yields no consumer surplus, the total benefits consumers derive just equal the total amount they pay for the good • Since the monopolist does not restrict output, there is no deadweight loss