Monopoly

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

Monopoly Structure 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.

Monopoly = 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 vs. Marginal Revenue Price equal marginal revenue only for perfectly competitive firms. A monopolist can sell additional output only if it reduces prices.

Price vs. Marginal Revenue 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.

Price vs. Marginal Revenue 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

Price and Marginal Revenue $14 A 13 B 12 C 11 b D 10 E 9 c F 8 PRICE (per basket) G 7 Demand (= price) d 6 5 e 4 3 f Marginal revenue 2 1 g 1 2 3 4 5 6 7 8 9 10 QUANTITY (baskets per hour)

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.

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

Profit Maximization 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.

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

Profit Maximization 1 2 3 4 5 6 7 8 9 10 11 12 13 $14 PRICE OR COST (per basket) QUANTITY (baskets per hour) Average total cost D Total Profit d Demand Marginal cost Marginal revenue

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

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

The Monopoly Price 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.

Total profits = (p – ATC) X q Monopoly Profits 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.

Monopoly vs. Competitive Outcomes $14 Marginal cost Average total cost 13 Demand Marginal revenue 12 11 D 10 E 9 8 PRICE OR COST (per basket) 7 d 6 5 4 3 2 1 1 2 3 4 5 6 7 8 9 QUANTITY (baskets per hour)

Barriers to Entry A monopoly attains higher prices and profits by restricting output.

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

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

Barriers to Entry Patent protection Legal harassment Exclusive licensing Bundled products Government franchises

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

Patent Protection 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.

Bundled Products 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.

Competition vs. Monopoly In competition, the high profits attract new suppliers. In monopoly, barriers to entry are erected to exclude potential competition.

Competition vs. Monopoly In competition, production and supplies expand. In monopoly, production and supplies are constrained.

Competition vs. Monopoly In competition, prices slide down the market demand curve. In monopoly, prices do not move down the market demand curve.

Competition vs. Monopoly In competition, a new equilibrium is established. In monopoly, no new equilibrium is established.

Competition vs. Monopoly In competition, average costs of production approach their minimum. In monopoly, average costs are not necessarily at or near a minimum.

Competition vs. Monopoly In competition, economic profits approach zero. In monopoly, economic profits are at a maximum.

Competition vs. Monopoly In competition, price equals marginal cost throughout the process. In monopoly, price exceeds marginal cost at all times.

Competition vs. Monopoly 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.

Near Monopolies In duopoly two firms together produce the industry output. In oligopoly several firms dominate the market.

Near Monopolies 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.

WHAT Gets Produced 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.

Research and Development 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.

Economies of Scale 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.

Natural Monopoly Economies of scale are a natural barrier to entry.

Natural Monopoly 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.

Contestable Markets 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.

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

Structure vs. Behavior Critics argue that even if markets are contestable, there will always exist a gap between a monopoly and a competitive outcome. This gap can be very costly to consumers.

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.

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

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

Industry Behavior 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.

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

Predatory Pricing 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.

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

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

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

Monopoly End of Chapter 7